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Highlights of 2019 Delaware Valuation Decisions

Authors:
  • Sutter Securities Financial Services, San Francisco

Abstract

This article discusses 2019 Delaware Supreme Court and Court of Chancery decisions regarding corporate valuations.
TIMELY NEWS, ANALYSIS, AND RESOURCES FOR DEFENSIBLE VALUATIONS
Vol. 25, No. 11, November 2019
BUSINESS VALUATION UPDATE
bvresources.com
Reprinted with permissions from Business Valuation Resources, LLC
By Gilbert E. Matthews, CFA,
Sutter Securities, Inc. (San Francisco, Calif., USA)
This year to date has been another active period
for valuation cases in the Delaware courts. The
Supreme Court reversed one 2018 Court of
Chancery decision and affirmed another, and
the Court of Chancery decided four valuation
cases; these decisions are discussed below. The
predominant theme is that, in arm’s-length trans-
actions, appraisal value continues to be based
primarily on the transaction price rather than on
discounted cash ow.
The exhibit on page 3 shows that, since 2006,
transaction price has been the dominant metric
in arm’s-length transactions, while most apprais-
als in related party transactions have been deter-
mined using DCF. Since 2013, only one appraisal
in an arm’s-length transaction (AOL Inc.1) was
based on the court’s DCF calculation; the others
that used DCF considered it only as conrmatory
of the valuation based on transaction price.
Aruba Networks
The most important 2019 decision was the
Supreme Court’s reversal of the lower court’s de-
cision in Aruba Networks. Vice Chancellor Travis
Laster had valued Aruba at “unaffected market
price”—the average price during the 30 days
prior to a news article that leaked the pending
1 In re Appraisal of AOL Inc., 2018 WL 1037450 (Del.
Ch. Feb. 23, 2018); modied, 2018 WL 3913775 (Del.
Ch. Aug. 15, 2018). In this case, the court concluded
that the seller’s commitment to a single buyer com-
promised the sale process, making the negotiated
transaction price unreliable as a measure of value.
transaction.2 He appraised the company at 69.4%
of the deal price.
Neither petitioners nor respondent had dis-
cussed unaffected market price at trial. After
the Supreme Court issued its opinion revers-
ing Laster’s decision in Dell,3 Laster requested
“supplemental brieng on ‘the market attributes
of Aruba’s stock’ in part because he ‘learned how
many errors [he] made in the Dell matter.’ ” 4 The
respondent then argued for unaffected market
price in its subsequent post-trial brief. Laster’s
decision ruled that “Aruba’s unaffected market
price provides the best evidence of its going
concern value.”
5
The vice chancellor had noted that:
Aruba management knew internally that
Aruba was having an excellent quarter and
would beat its guidance. But … [it] time[d]
the announcement of the merger to coin-
cide with the announcement of Aruba’s Feb-
ruary 2015 earnings.6
2 Verition Partners Master Fund Ltd. v. Aruba Networks,
Inc., 2018 Del. Ch. LEXIS 52 (Del. Ch. Feb. 15, 2018)
(Aruba I”); rev’d, 210 A.3d 128 (Del. 2019) (Aruba II”).
The author discussed Aruba I in Business Valuation
Update, October 2018.
3 In re Appraisal of Dell Inc., 2016 Del. Ch. LEXIS 81
(May 31, 2016); rev’d, Dell Inc. v. Magnetar Global
Event Driven Master Fund Ltd, 2017 Del. LEXIS 518
(Del. Dec. 14, 2017).
4 Aruba II at 131, quoting the court’s letter to the
parties.
5 Aruba I at *4.
6 Aruba I at *63.
Highlights of 2019 Delaware Valuation Decisions
2 Business Valuation Update November 2019 Business Valuation Resources
HIGHLIGHTS OF 2019 DELAWARE VALUATION DECISIONS
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R. JAMES ALERDING, CPA/ABV, ASA
ALERDING CONSULTING LLC
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LEWIS & CLARK LAW SCHOOL
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Nonetheless, he concluded:
[T]he record does not provide a persuasive
reason to question the reliability of Aruba’s
trading price based on the decision by
Aruba management to bundle together two
pieces of information.7
The Supreme Court disagreed, concluding that
the not-yet-disclosed information had affected
the public market:
HP [the buyer] … had material, nonpublic in-
formation that, by denition, could not have
been baked into the public trading price…. In
particular, HP had better insight into Aruba’s
future prospects than the market because it
was aware that Aruba expected its quarterly
results to exceed analysts’ expectations.8
The Supreme Court criticized the Court of Chan-
cery’s decision that the unaffected market price
was fair value:
The lack of a developed record on whether
the stock price was an adequate proxy for
fair value buttresses our holding that the
Court of Chancery abused its discretion by
awarding the thirty-day average unaffected
market price of $17.13 per share.9
Because of requirements for SEC review and a
shareholder vote, an acquisition of public com-
panies necessarily cannot close until well after
the announcement of a transaction. The Supreme
Court pointed out that the Delaware appraisal
statute requires that the company be valued at
the closing date:
Although §262 requires the Court of Chan-
cery to assess Aruba’s fair value as of “the
effective date of the merger,” the Court of
Chancery arrived at the unaffected market
7 Aruba I at *66..
8 Aruba II at 139.
9 Aruba II at 140.
bvresources.com November 2019 Business Valuation Update 3
HIGHLIGHTS OF 2019 DELAWARE VALUATION DECISIONS
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price by averaging the trading price of
Aruba’s stock during the thirty days before
news of the merger leaked, which was three
to four months prior to closing.10
The Supreme Court directed a nal judgment
that petitioners be awarded $19.10 per share,
which was Aruba’s estimate of the deal price
($24.67) minus synergies. It agreed with the lower
court’s conclusion that the transaction price in-
cluded substantial synergies.11 The Supreme
Court noted that the $19.10 valuation, which was
77.4% of the deal price and 11.5% above the un-
affected market price, “was corroborated by …
Aruba’s [expert’s] DCF, comparable companies,
and comparable transactions analyses.”12
PLX Technology
In this duciary duty case, a hedge fund’s repre-
sentative who was a director of the publicly traded
10 Aruba II at 132.
11 Laster concluded that the transaction prices minus
synergies was $18.20 per share. [Aruba I at *45.]
12 Aruba II at 142.
company, among other things, had conversations
with the buyer and its investment banker that
were not disclosed to other board members. The
Court of Chancery agreed with plaintiffs that the
hedge fund had aided and abetted breaches of
the board’s duties to shareholders. However, Vice
Chancellor Laster rejected the plaintiffs’ claim that
the $6.50 deal price was unfair. He concluded that
plaintiffs “were unable to prove that the breaches
resulted in damages.”13
Laster determined that the projections the plain-
tiffs’ expert used in his DCF calculations were
awed in three respects:
1. The projections included “a new line of busi-
ness involving a new set of customers with a
new set of requirements” and “evidence at
trial did not give [the Court] sufcient con-
dence to base a damages award on this
element of the projections”14;
13 In re PLX Technology Inc. S’holders Litig., 2018 WL
5018353 (Del. Ch. Oct. 16, 2018) at *56; aff’d, 211
A.3d 137 (2019).
14 Ibid. at *52.
Valuation Methods Used in Delaware Appraisal Decisions
Number of
Valuations
DCF or
Similar
Comparable
Companies
Comparable
Transactions Asset Value Transaction
Price
Unaffected
Mkt. Price
Arm’s-Length Transactions
1998-2005 2 2 0 0 0 1 0
2006-2013 4 3 1 0 0 2 0
2014-2019 14 6 2 1 0 12 1
Total 20 11 3 1 0 15 1
Related Party Transactions
1998-2005 14 8 7 4 0 0 0
2006-2013 7 7 1 1 1 0 0
2014-2019 9 9 0 0 0 0 0
Total 30 24 8 5 1 0 0
Note: Some decisions used more than one method.
4 Business Valuation Update November 2019 Business Valuation Resources
HIGHLIGHTS OF 2019 DELAWARE VALUATION DECISIONS
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2. “PLX management had a track record of
missing its projections”15; and
3. “[B]idders do not appear … to have be-
lieved that [the projection] supported
valuations in the range that [plaintiffs’
expert] posited…. If the projections were
sufficiently reliable to support a cred-
ible valuation of $9.82 per share, then it
seems likely that another buyer would have
competed.16
Also, Laster concluded that plaintiffs’ expert’s
discount rate was too low. He faulted expert’s
beta because it was based on daily returns rather
than weekly or monthly returns:
[W]hen the return interval is shortened, the
following occurs: Securities with a smaller
market value than the average of all securi-
ties outstanding (the market) will generally
have a decreasing beta, whereas securities
with a larger market value than the average
of all securities outstanding will generally
have an increasing beta.17
Defendants’ expert did not fully credit the projec-
tions for the new line of business, and his DCF
calculation valued PLX at less than the transac-
tion price.18 The court ruled:
Although flawed from a fiduciary stand-
point, the details of the sale process that
the Board conducted and the nature of the
synergistic deal with Avago that it gener-
ated means that the plaintiffs received con-
sideration that exceeded the value of the
Company on a stand-alone basis.19
15 Ibid.
16 Ibid. at *53.
17 Ibid. at *54, quoting Gabriel Hawawini, “Why Beta
Shifts as the Return Interval Changes, Fin. Analysts J.,
May-June 1983 at 73.
18 Ibid. at *52.
19 Ibid. at *56.
The Supreme Court afrmed the trial court’s de-
cision that plaintiffs failed to prove that they suf-
fered damages.
Trussway
In February 2019, a shareholder who was
squeezed out of Trussway Holdings Inc., a
private company, was awarded an amount 5%
higher than the merger value. Vice Chancellor
Sam Glasscock III determined fair value solely
on DCF, rejecting petitioner’s expert’s compa-
rable company analysis because the “supposed
‘comparable companies’ are too divergent from
[Trussway], in terms of size, public status, and
products, to form meaningful analogs for valua-
tion purposes.”20
The court averaged DCF calculations based
on two periods: a nine-year management pro-
jection and the rst ve years of that projec-
tion. It described the ve-year period as “more
standard.”21 (However, the reason it is “more
standard” does not stem from valuation theory
but simply reects the fact that few companies
make projections beyond ve years.) The valu-
ation based on the ve-year period was 15%
lower than the valuation based on the nine-year
period.
The management projections included “stra-
tegic initiatives” that included, among other
things, selling new products to be added to the
company’s product line and gaining additional
market share through sales to market segments
in which the company did not yet participate.22
Both experts adjusted their valuations to reect
their concerns that the longer-term projections
were optimistic. Petitioner’s expert increased
his discount rate by 1% after the rst ve years,
and respondent’s expert gave 25% weight to the
20 Hoyd v. Trussway Holdings LLC, 2019 WL 994048 (Del
Ch. Feb. 28, 2019) at *5.
21 Ibid. at *7.
22 Ibid. at *2.
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nine-year projection and 75% weight to the ve-
year period.23
In using the ve-year period, the court effectively
substituted the 2.3% perpetual growth rate (as to
which both experts agreed) for the higher growth
rate that management expected in the nal four
years. The court agreed with the experts’ view
that an adjustment should be made to a value
based on the nine-year projection, and it ex-
plained its decision to give partial weight to the
shorter period:
Of more concern to me is Trussway man-
agement’s ability (or that of any human
prognosticator) to accurately predict cor-
porate performance nine years out, particu-
larly concerning new facets of a business.
I am also aware that there is a degree of
huckster’s optimism in these predictions.24
Jarden
The Jarden decision in July 2019 determined the
appraisal price in a third-party transaction solely
on the unaffected market price, the closing price
immediately before The Wall St. Journal pub-
lished rumors of the transaction.25 Vice Chancel-
lor Joseph Slights III relied on “expert testimony
… including an event study that analyzed the
market’s response to earnings and other mate-
rial announcements.”26 He noted that: (i) Jarden
had no control shareholders; (ii) 94% of its shares
were in the public oat; (iii) the bid-ask spread
was only 0.02%; and (iv) approximately 20 ana-
lysts had published reports on Jarden in the year
prior to the merger.27 He also concluded that the
23 Ibid. at *6.
24 Ibid.
25 In re Appraisal of Jarden Corp., 2019 WL 3244085
(Del. Ch. July 19, 2019) at *28-*29; modied, 2019 WL
4452209 (Sept.16, 2019). The court dened unaf-
fected market price as a single price rather than an
average over a period of time. [Ibid. at *19-*20.]
26 Ibid. at *2.
27 Ibid. at *27.
unaffected market price was not “stale” on the
closing date.28
Petitioners’ expert posited that a “conglomerate
discount ”depressed the market price. The court
rejected this discount, noting that “it is not clear
that this notion is accepted within the academ[ic
community] or among valuation professionals”29
The court determined that the transaction price
was not an applicable valuation standard in this
matter, explaining:
I place less weight on this market-based
valuation approach in this case because
the sales process was not well-conceived
or well-executed and the expert analysis of
the transaction synergies raised more ques-
tions than it answered.30
Even though the court agreed with petitioners’
claim that the negotiating approach of Jarden’s
executive chairman “may well have set an arti-
cial ceiling on what Newell was willing to pay,”31
it nonetheless based its valuation on unaffected
market price.
The vice chancellor dismissed the petitioners’ val-
uation based on comparable companies, saying,
“After considering the evidence, I am satised
that Petitioners’ comparable companies analysis
is not credible because Jarden had no reliable
comparables.”32 Several appraisal decisions in
recent years have arrived at a similar conclusion.
Slights noted that his valuation was conrmed by
his DCF calculation and by “the most reasonable
estimate” of “the Merger price less synergies.”33
In his DCF calculation, he used the midpoint of
the experts’ ination and GDP growth estimates
28 Ibid. at *31.
29 Ibid.
30 Ibid. at *26.
31 Ibid. at *24.
32 Ibid. at *3.
33 Ibid. at *50.
6 Business Valuation Update November 2019 Business Valuation Resources
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as the perpetual growth rate,34 an approach the
Court of Chancery often uses.
Columbia Pipeline
An August 2019 decision by Vice Chancellor
Laster based appraisal value in a third-party
transaction solely on the deal price.35 Deal price
has become the predominant standard of value
in appraisals of companies acquired in arm’s-
length transactions.
The vice chancellor rejected petitioners’ claim
that the company’s value increased between
signing and closing.36 He also rejected the unaf-
fected market price as a measure of value in this
case37 and rejected its DCF analysis.
Petitioners’ DCF valuation was 24% over the deal
price and 57% over unaffected market. Laster
rejected their DCF analysis as contrary to con-
temporaneous market evidence:
[Expert]’s opinion that the value of Columbia
materially exceeded the deal price conicts
with the market behavior of other potential
strategic acquirers who had shown interest
in Columbia, and who did not step forward
to top TransCanada’s price.38
He also expressed concern about the terminal
value petitioners’ expert calculated:
[T]he terminal value represented 125% of
his valuation of Columbia…. This court has
questioned the utility of a DCF in a case
where the terminal value represented
97% of the result, nding that “[t]his back-
loading highlights the very real risks” pre-
sented by using that methodology and
34 Ibid. at *32.
35 In re Appraisal of Columbia Pipeline Group, Inc., 2019
WL 3778370 (Del. Ch. Aug. 12, 2019) at *43.
36 Ibid.
37 Ibid. at *49.
38 Ibid. at *50.
“undermin[ing] the reliability of applying
the DCF technique.”39
Laster observed, “The wide swings in output that
result from legitimate debate over reasonable
inputs undermine the reliability of [petitioner’s
expert]’s DCF model.”40
He did not reduce the price for synergies, noting
that the synergy adjustment proposed by re-
spondent was excessive:
[Respondent] did not meet its burden of
proof. [It] likely could have justied a smaller
synergy deduction, but it claimed a larger
and unpersuasive one. This decision there-
fore declines to make any downward adjust-
ment to the deal price.41
Stillwater Mining
A second August 2019 decision by Laster also
ruled that appraisal value in an arm’s-length
transaction was the deal price.42 He rejected
trading price, given the availability of “a market-
tested indicator like the deal price.”43 He also
rejected DCF in this case:
The legitimate debates over [contested]
inputs and the large swings in value they
create undercut the reliability of the DCF
model as a valuation indicator.44
Laster determined that the trading price was not
a measure of fair value because inadequate dis-
closure of Stillwater’s reserves impacted it. He
observed that SEC limitations on disclosure of
39 Ibid. at *51, quoting Union Ill. 1995 Investment LP v.
Union Finl. Group, Ltd., 847 A.2d 340, 361 (Del. Ch.
2003).
40 Ibid. at *52.
41 Ibid. at *45.
42 In re Appraisal of Stillwater Mining Co., 2019 WL
3943851 (Del. Ch. Aug. 21, 2019) at *50.
43 Ibid. at *59.
44 Ibid. at *61.
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reserves that did not rise to the “probable” level
affected the viability of trading price as a valua-
tion indicator:
[The SEC did] not permit a mining company
to disclose information about inferred re-
sources, which are mineral deposits where
the quantity, grade, and quality “can be es-
timated” based on “geological evidence,”
“limited sampling,” and “reasonably
assumed, but not veried, geological and
grade continuity.”45
Stillwater is the only U.S. source of “platinum
group metals,” palladium, platinum, and rhodium.
The vice chancellor observed, “Between signing
and closing, the prices of palladium and platinum
increased materially, with a direct effect on Still-
water’s value.”46 He did not adjust his appraisal
for this price movement because petitioners did
not argue for it or quantify its effect on value.
[W]hether to adjust the deal price for an in-
crease in value between signing and closing
presents numerous difcult questions. In
this case, the petitioners did not argue for
an adjustment to the deal price, and so
the parties did not have the opportunity
to address these interesting issues…. The
petitioners accordingly failed to prove that
the deal price should be adjusted upward
to reect a change in value between signing
and closing.47
Expert Witness Testimony
The Court of Chancery often rejects not only
expert testimony that is not persuasive, but also
testimony that is not supported in the valuation
45 Ibid. at *58, quoting the SEC’s Industry Guide
7 [17 C.F.R. 229.801(g)]. Industry Guide 7 was
rescinded on Oct. 31, 2018 [sec.gov/corpfin/
secg-modernization-property-disclosures-mining-
registrants].
46 Ibid. at *48.
47 Ibid. at *50
literature, e.g., the conglomerate discount reject-
ed in Jarden and the beta based on daily price
changes rejected in PLX Technology.
The court on several occasions has criticized
experts who overreach in their valuations. As
discussed above, it faulted the petitioners’ ex-
pert’s DCF analysis in Columbia Pipeline as con-
trary to market evidence. Also, the respondent’s
expert in Columbia Pipeline was deemed to have
been unpersuasive as to the amount of syner-
gies included in the transaction price; the court
commented that respondent “likely could have
justied a smaller synergy deduction.”
On the other hand, the absence of testimony on
relevant valuation issues can be harmful. Because
there was no testimony as to the impact of in-
creased palladium and platinum prices prior to
closing in Stillwater Mining, the court was unable
to quantify the impact of this change on the ap-
praised value.
In both Columbia Pipeline and Stillwater Mining,
Laster quoted a 2016 opinion:
An argument may carry the day in a par-
ticular case if counsel advance it skillfully
and present persuasive evidence to support
it. The same argument may not prevail in
another case if the proponents fail to gen-
erate a similarly persuasive level of proba-
tive evidence or if the opponents respond
effectively.48
He added in both decisions:
Likewise, the approach that an expert es-
pouses may have met “the approval of this
court on prior occasions,” but may be re-
jected in a later case if not presented per-
suasively or if “the relevant professional
community has mined additional data and
pondered the reliability of past practice
48 Merion Capital L.P. v. Lender Processing Services, L.P.,
2016 WL 7324170 (Del. Ch. Dec. 16, 2016) at *16.
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and come, by a healthy weight of reasoned
opinion, to believe that a different practice
should become the norm.”49
The valuation approaches that the Court of Chan-
cery will accept necessarily depend on the facts
of the specic case.
The appraisal exercise is, at bottom, a fact-
nding exercise, and our courts must ap-
preciate that, by functional imperative, the
evidence, including expert evidence, in one
appraisal case will be different from the
evidence presented in any other appraisal
case. Different evidence, of course, can lead
to different decision paths and different
outcomes.50
Conclusion
These recent cases demonstrate the importance
of high-quality expert testimony in valuation liti-
gation. Although each decision is fact-specic,
experts should be familiar with past practice in
the Court of Chancery and with the its interpre-
tation of fair value and operative reality. Experts
should be careful to utilize practices that are
supported in the academic and valuation com-
munities and should be aware of current devel-
opments in the profession. Columbia Pipelines
criticism of petitioners’ DCF calculation and of re-
spondent’s synergies claim are warnings against
overreaching, while the court’s inability in that
case to determine the market impact of higher
product prices shows how the absence of rel-
evant testimony can impact a decision.
In the past, event studies were often used in
other types of security cases but not in apprais-
als. The current focus on deal prices and his-
torical market prices in arm’s-length transactions
49 Columbia Pipeline at *16 and Stillwater Mining at
*20, quoting Global GT v. Golden Telecom, Inc., 993
A.2d 497, 517 (Del. Ch. 2010); aff’d, 11 A.3d 214 (Del.
2010).
50 Jarden at *1.
has necessitated testimony on event studies in
appraisal cases where the court relies on market
factors rather than corporate valuations.
In recent cases, many experts have not used
comparable companies and comparable
transactions. This may be a consequence of
the Court of Chancery’s frequent rejection of
these approaches. Nonetheless, these valu-
ation methods are widely used in the invest-
ment community. Comparable companies are
frequently used in research reports, and both
approaches are commonly included in invest-
ment bank presentations to corporate clients
and in fairness opinions. In investment bank
fairness opinions issued in connection with the
acquisitions of companies that were appraised
in Delaware since 2010, 97% used comparable
companies and 76% used comparable transac-
tions as a valuation method. Chancellor William
B. Chandler III wrote in 2011:
[I]t is preferable to take a more robust ap-
proach involving multiple techniques—such
as a DCF analysis, a comparable transac-
tions analysis (looking at precedent trans-
action comparables), and a comparable
companies analysis (looking at trading com-
parables/multiples)—to triangulate a value
range, as all three methodologies individu-
ally have their own limitations.”51
Comparable transactions can be useful in ap-
praisals when they can be adjusted for the
impact of synergies. Experts should continue
to use comparable companies when they deem
it appropriate and should explain to the court
the basis for their selection of the compara-
bles and why they are relevant to the subject
company.
Gilbert E. Matthews, CFA, is chairman emeritus
and a senior managing director of Sutter Securi-
ties, Inc. (San Francisco). He has more than 50
51 Muoio & Co. v. Hallmark Entm’t Invs. Co., 2011 Del. Ch.
LEXIS 43 (Mar. 9, 2011) at *83-*84.
bvresources.com November 2019 Business Valuation Update 9
HIGHLIGHTS OF 2019 DELAWARE VALUATION DECISIONS
Reprinted with permissions from Business Valuation Resources, LLC
years of experience in investment banking and
has spoken and written extensively on fairness
opinions, corporate valuations, and litigation re-
lating to valuations.
Editor’s Note: Case digests and full opinions of
the cases that are the focus of this article are avail-
able at BVLaw at bvresources.com/products/
bvlaw.
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