The Delaware Supreme Court last week reversed the Delaware Chancery Court’s 2018 ruling in Verition Partners Master Fund Ltd. and Verition Multi-strategy Fund Ltd. v. Aruba Networks, Inc. (“Aruba”). This recent decision highlights the importance of performing convincing synergies analysis when valuing share prices for strategic acquisitions.
On February 15, 2018, Vice Chancellor J. Travis Laster decided that the petitioners (the Verition funds) in Aruba should receive $17.13 per share, which was based on the respondent’s (Aruba) 30-day average unaffected market price. The Chancery Court attempted to rely on a deal-price-less-synergies value in reaching its decision, recognizing that “the transaction in this case generated substantial synergies.” However, Laster noted that neither of the parties’ experts presented any explicit analysis of synergy value during the trial. (Ironically, as discussed below, the Supreme Court based its decision on a deal-price-less-synergies value.) The Chancery Court was left to determine its own deal-price-less-synergies value in the transaction, which it estimated to be $18.20 per share.
When deciding between the 30-day average unaffected market price of $17.13 per share and deal-price-less-synergies value of $18.20 per share, Laster ultimately determined that “for Aruba, using its unaffected market price provides the more straightforward and reliable method for estimating the value of the entity as a going concern.” Laster further stated that the deal-price-less-synergies value “could have errors at multiple levels” and otherwise still incorporate “an element of value resulting from the merger.”
On appeal, the Supreme Court reversed the decision and found that the Verition funds should receive $19.10 per share, which was based on Aruba’s post-trial estimate of the deal-price-less-synergies value. In both the Supreme Court’s and Chancery Court’s decisions, the appraised values were well below the deal consideration of $24.67 per share negotiated in Hewlett-Packard's acquisition of Aruba.
The Supreme Court made three key findings in its reversal of Laster’s decision.
First, the target’s unaffected share price may be informative of fair value, but it is not an indisputable measure of fair value. Well-informed and financially motivated bidders conducting due diligence involving confidential, nonpublic information may reach a different determination of the fair value of the target. Moreover, ample evidence suggests that financial buyers with no means of generating operational synergies from the transaction commonly pay prices in excess of the target’s unaffected share price. In other words, even financial buyers commonly pay an “acquisition premium” in a buyout transaction.
Second, the Supreme Court is skeptical of any deduction for “agency costs” in deriving the fair value of dissenters’ shares. Laster described agency costs as being the “flipside of the benefits of control, which includes the ability to make changes in corporate management, strategy, and policy.” He cited prior cases where the “premium that an acquirer is willing to pay for the entire firm anticipates incremental value both from synergies and from the reduced agency costs that result from unitary (or controlling) ownership.” In the case of Aruba, the Supreme Court stated that “the Court of Chancery’s view that some measure of agency costs had to be accounted for [and deducted from the merger price] finds no basis in the record,” “nor does [the Supreme Court] find any basis in the corporate finance literature ...” The economic benefits to the buyer from removing agency costs, if any, “were likely to be fully accounted for by its expected synergies.”
Third, the Supreme Court reinforced the high degree of importance Delaware judges generally place on a deal-price-less-synergies value when the transaction involves a strategic buyer operating in a “robust” sales process. The price resulting from a competitive auction (real or perceived) where the bidders have unencumbered access to accurate and complete information is presumed to generate a reliable indicator of the target’s value. However, if the winning bidder is a strategic buyer, then the court will seek to quantify and remove any synergy value in deriving the price to be paid to the dissenters
To elaborate on the importance of this third point, Stout reviewed 23 Delaware Chancery Court cases involving acquisitions of U.S.-listed companies decided since 2010. We found five cases that involved a strategic buyer operating in a robust transaction process, including the Hewlett-Packard/Aruba transaction. In short, the Chancery Court attempted to rely on a deal-price-less-synergies value in all of those cases but was unsuccessful in three for reasons unique to each decision. Aruba was the only case in the entire sample where the Chancery Court determined the unaffected market price to be the fair value of the target.
The treatment of synergy value in a Delaware appraisal case can be complex, but that does not excuse those involved in the case from addressing the matter, including the judge. As the Supreme Court noted in the Aruba case, “estimating synergies and allocating a reasonable portion to the seller certainly involves imprecision, but no more than other valuation methods …”
The parties, attorneys, experts, and other participants in a Section 262 appraisal proceeding would be well-served to perform a comprehensive and convincing synergies analysis in deriving their fair value conclusions. Although Aruba did not present any such analysis to the Chancery Court, it did so in the post-trial briefing and convinced the Supreme Court to enter judgment on that basis.