The petitioners in this matter – former stockholders of Dell, Inc. – exercised their appraisal rights instead of voting for a buyout led by the company’s founder and CEO, Michael Dell. The price in the buyout to which the petitioners objected was $13.75 a share, which the Delaware Court of Chancery (the “Chancery Court”) noted was “a 37% premium to the company’s 90-day-average unaffected stock price.”
At the lengthy appraisal trial, which featured 17 depositions and live testimony from seven fact witnesses and five expert witnesses, the petitioners argued that the fair value of Dell’s common stock was $28.61 per share – more than double the deal price per share. The petitioners’ expert relied upon the discounted cash flow (DCF) method to support its valuation. In contrast, Dell contended that the fair value of its common stock was only $12.68 per share based on its application of the DCF method, but that, in light of the uncertainties facing the PC industry, the fair value could be as high as the deal price per share of $13.75 (but not greater).
The Chancery Court acknowledged in its decision that the consideration of the deal terms between the actual buyer and seller is one form of market evidence to consider in appraisal proceedings. However, the Chancery Court opined that flaws in Dell’s sale process meant that the deal price of $13.75 per share was “not the best evidence” of the company’s fair value. The Chancery Court identified numerous problems with the pre-signing phase of the sale process and the post-signing go-shop process, which contributed to the deal price falling short of fair value.
Ultimately, the Chancery Court decided that “because it is impossible to quantify the exact degree of the sale process mispricing,” it was going to discount the final merger consideration of $13.75 entirely – giving it no weight when determining fair value. The Chancery Court also rejected Dell’s freely traded stock price as being relevant for a number of reasons, including the opinion that short-sighted analysts and traders did not give the company adequate credit for major investments the company had recently made that had not yet improved results. Thus, a “valuation gap” appeared between the real intrinsic value of the company and its stock price. The Chancery Court ultimately arrived at its fair value conclusion of $17.62 per share based on its own DCF analysis, which relied upon a mix of the DCF inputs proposed by the petitioners’ and the company’s experts as well as some of its own DCF adjustments.
The company appealed the decision, claiming that the Chancery Court erred by disregarding Section 262(h)’s requirement that it “take into account all relevant factors” in determining fair value. The petitioners filed a cross-appeal related primarily to the Chancery Court’s application of the DCF method.
The Supreme Court reversed and remanded the Chancery Court’s decision to give no weight to any market-based measure of fair value.
First, stating that the Chancery Court’s analysis ignored the efficient market hypothesis long endorsed by this court, the Supreme Court rejected the Chancery Court’s view that the Dell stock price was understated relative to the true intrinsic value of the company and, thus, was an anchor to deal pricing at the start of the deal process. The Supreme Court concluded that the record at trial showed that the market analysts covering Dell were not short-sighted, but rather “analysts scrutinized Dell’s long-range outlook when evaluating the company and setting price targets, and the market was capable of accounting for Dell’s recent mergers and acquisitions and their prospects in its valuation of the company.” Specifically, the Supreme Court noted ample evidence that the market for Dell stock was efficient. The record shows that Dell had a deep public float, was covered by over 30 equity analysts, boasted 145 market makers, was actively traded with over 5% of shares changing hands each week, and lacked a controlling stockholder.
Second, the Chancery Court suggested that the lack of strategic buyers in the sale process – and, accordingly, the involvement of only private equity bidders – also pushed the deal price below fair value. The Supreme Court rejected this argument as well, stating that if no strategic buyer is interested in buying a company, it does not suggest a higher value, but a lower one.
Third, the Chancery Court expressed various theories about management buyouts (MBOs) and why these transactions do not produce a reliable market indicator of value. The Supreme Court rejected these theories stating that the supposed prerequisite elements for problematic MBOs did not exist in the case at hand. For example, in this case rival bidders faced minimal structural barriers to a deal; extensive due diligence and cooperation from the company helped address any information asymmetries that might otherwise imply the possibility of a winner’s curse; and, assuming his value, Michael Dell would have participated with rival bidders.
As to the DCF method, the Supreme Court agreed with the Chancery Court that the petitioners’ valuation lacked credibility given that it implied that the MBO undervalued the company by $23 billion. However, the Supreme Court also criticized the Chancery Court’s decision to give no weight to Dell’s stock price or the deal price, but instead to a value Dell at nearly $7 billion in excess of the deal price, based on its own DCF analysis. The Supreme Court stated that the Chancery Court should be chary about imposing the hazards that always come when a law-trained judge is forced to make a point estimate of fair value using the DCF method. This is especially important for this case where the opposing experts’ indications of value diverged significantly, where there were 1,100 variable inputs in these competing DCFs, and where there is strong market-based pricing data available.
The Supreme Court opined: “Given that we have concluded that the trial court’s key reasons for disregarding the market data were erroneous, and given the obvious lack of credibility of the petitioners’ DCF model – as well as legitimate questions about the reliability of the projections upon which all of the various DCF analyses are based – these factors suggest strong reliance upon the deal price and far less weight, if any, on the DCF analyses.”
The Supreme Court ruled that “taken as a whole, the market-based indicators of value – both Dell’s stock price and deal price – have substantial probative value.” In fact, the Supreme Court noted that the transaction process exemplifies many of the qualities that Delaware courts have found in affording substantial, if not exclusive, weight to the deal price in a fair value analysis.
While the Supreme Court ruling should reinforce the importance of considering the deal price in answering the valuation question in appraisal cases, it does not establish a black-and-white new rule that the deal price should always be afforded significant weight. Quite the contrary, in fact, as the Supreme Court stated: “We are not saying that the market is always the best indicator of value, or that it should always be granted some weight. We only note that, when the evidence of market efficiency, fair play, low barriers to entry, outreach to all logical buyers, and the chance for any topping bidder to have the support of Mr. Dell’s own votes is so compelling, then failure to give the resulting price heavy weight because the trial judge believes there was mispricing missed by all the Dell stockholders, analysts, and potential buyers – abuses even the wide discretion afforded the Court of Chancery in these difficult cases.”