The Delaware Court of Chancery recently issued a decision in the matter of Manichaean Capital, LLC et. al. (the “petitioners”) v. SourceHOV Holdings, Inc. (“SourceHOV” or the “respondent”). The petitioners had submitted their shares to the court for appraisal pursuant to 8 Del. C. § 262 in connection with a merger (the “merger”) of three businesses in July 2017 – SourceHOV, Novitex Holding, Inc. (“Novitex”), and Quinpario Acquisition Corp. (“Quinpario”). SourceHOV and Novitex were both privately held prior to the merger, while Quinpario was a NASDAQ-listed, special purpose acquisition company formed to find an opportunity like the merger. Following the merger, the combined businesses traded on the NASDAQ as Exela Technologies, Inc. The market value of the consideration received by the ex-SourceHOV shareholders in the merger implied an aggregate equity value for SourceHOV at the time of the transaction of $694 million, or approximately $4,177 per share.
Based on feedback from the parties (who were all in agreement on this point), the court determined that market evidence was not useful in this instance for several reasons. One, SourceHOV was privately held, and, two, its managers had made no real effort to run a broad-based process to sell the business prior to the merger. Instead, the court turned to the traditional valuation methodologies presented by the petitioner’s expert and the respondent’s expert. Because both experts agreed that a discounted cash flow (DCF) analysis was the most appropriate method to value SourceHOV, the court focused its review on the DCF analyses submitted by each expert.
The DCF analysis prepared by the petitioner’s expert valued SourceHOV at $5,079 per share at the time of the merger, while the respondent’s expert valued the business at $2,817 per share. Ultimately, with one minor exception, the court adopted the DCF analysis prepared by the petitioner’s expert in totality in its decision. In rejecting the DCF analysis prepared by the respondent’s expert, the court focused its criticisms on the methodology used by the expert in selecting the equity beta applied in the build-up to the discount rate used in its analysis. The court found the respondent’s expert’s approach to calculating the equity beta to be “methodologically novel” and “untethered to accepted methods.” As a result, the court questioned the credibility of the expert’s entire valuation analysis.
In determining the petitioner expert’s valuation analysis to be more credible, the court also addressed five areas in which the respondent claimed the petitioner expert’s DCF was flawed: 1) the debt-load projections used in the analysis; 2) the depreciation and amortization projections; 3) the appropriate set of financial projections to use in the analysis; 4) the number of shares of SourceHOV stock outstanding; and 5) the size premium used by the petitioner’s expert in the build-up to the equity cost of capital used in its DCF analysis. The court ruled in favor of the petitioner’s expert on three of these five factors (the debt-load projections, depreciation and amortization projections, and financial projections). In its decision to side with the petitioner’s expert, the court cited the fact that the expert used the same assumptions and inputs that SourceHOV management was using in its financial models at the time of the merger. This ruling reinforces past Delaware Chancery Court precedence that gave significant deference to the information that management was presenting to various constituencies at the time of the transaction in question, as long as management is being consistent in its presentation.
The court also sided with the petitioner’s expert in connection with the expert’s treatment of certain restricted stock units, and their inclusion (or exclusion) in the calculation of the total number of shares of SourceHOV stock outstanding. The only area in which the court differed from the petitioner’s expert’s DCF analysis and applied its own assumption was in the selection of the size premium used in the analysis. Ultimately, the court determined the fair value of SourceHOV at the time of the merger to be $4,591 per share, or approximately 10% above the implied market value of SourceHOV in the merger.