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Valuation Decisions by the Delaware Supreme Court, 2017-2019

Authors:
  • Sutter Securities Financial Services, San Francisco

Abstract

This article discusses Delaware Supreme Court decisions in 2017-19 regarding corporate valuations, primarily in appraisal cases.
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FVLE Issue 83 February/March 2020 Page 18
Continued on next page
In the past three years, the
Delaware Supreme Court has
affirmed four valuation decisions
and reversed three. It affirmed the
Court of Chancery’s decisions in
the valuations of ISN Software,
SWS Group, Clearwire, and PLX
Technology, and it issued impor-
tant detailed decisions reversing
appraisals in Dell, DFC Global, and
Aruba Networks.
Vice Chancellor Sam Glass-
cock III appraised ISN Software, a
private company, using DCF only,
even though all three experts used
comparable companies. The
Supreme Court affirmed the deci-
sion, which valued ISN’s shares at
a 158 percent premium over the
transaction price.1
The Supreme Court affirmed
Vice Chancellor Glasscock’s
appraisal of SWS Group, a broker-
dealer at 92% of the deal price. He
based his valuation solely on dis-
counted cash flow (DCF). He
rejected the petitioners’ claim that
that a broker-dealer’s excess regu-
latory capital was a non-operating
asset that was additive to value,
stating, “Petitioners seem to con-
flate distributable cash or assets
with a balance sheet increase in
regulatory capital as the result of
the conversion of debt to equity.”2
He ruled that the exercise of war-
rants after the merger agreement
but before closing was not contin-
gent on the merger and thus “the
exercise was part of the Company's
operative reality as of the merger
date.”3
ACP Master v. Sprint (Clearwire)
Clearwire, a telecom company,
owned a large block of 2.5 GHz
spectrum. Clearwire’s unaffected
market price was about $1.30.
Sprint owned 51 percent of Clear-
wire but did not have voting con-
trol. When news of the potential
acquisition of Sprint by Softbank
deal leaked, Clearwire shares rose
to $2.22.
In connection with Softbank’s
proposed acquisition of 70 percent
of Sprint, Softbank wanted Sprint
to have control of Clearwire. Sprint
bought out a 5 percent holder at
$2.97 to obtain 50.4 percent of the
vote, and Clearwire’s Special Com-
mittee then approved a merger with
Sprint at $2.97. After minority
shareholder opposition, Sprint
raised its bid to $3.40. DISH made
a hostile tender offer at $4.40, and
Sprint topped at $5.00.
Dissenting shareholders of
Clearwire objected to the $5.00
transaction price and sought
appraisal. Their expert valued
Clearwire at $16.08. Vice Chancel-
lor Travis Laster relied on respon-
dent’s expert’s DCF analysis (which
included the value of a non-operat-
ing asset, Clearwire's unused spec-
trum4) and awarded the dissenters
$2.13 per share5—43 percent of the
transaction price. No previous
Delaware appraisal had awarded
dissenters less than 80 percent of
transaction price. Laster conclud-
ed:
There is also no evidence that
anyone at Sprint or Softbank
believed that Clearwire was
worth $5.00 per share.
Rather, they agreed to pay
that price because of the mas-
sive synergies from the trans-
action and the threat that
DISH posed as a hostile
minority investor.6[Emphasis
added.]
He observed, “The deal price also
provided an exaggerated picture of
Clearwire's value,” noting that
“Sprint estimated that the merger
yielded synergies ranging from
$1.5 to $2 billion, or $1.95 to 2.60
per share.”7
Laster relied on Clearwire
management’s projections and
rejected projections made by
Sprint:
Sprint management created
the Full Build Projections to
convince Softbank to increase
the merger consideration by
showing what Sprint's busi-
ness would look like if the
merger failed and Sprint nev-
ertheless decided – contrary
to the evidence – to use Clear-
wire's spectrum as Sprint
would have if the merger had
closed. Sprint and Softbank
would not have done that.
The Full Build Projections did
not reflect Clearwire's opera-
tive reality on the date of the
merger.8
The Supreme Court affirmed
Laster’s opinion.
Valuation Decisions by the Delaware
Supreme Court, 2017 – 2019
expert
TIP
DCF valuations involve many
inputs, and even slight differences
in these inputs can produce large
valuation gaps.
GILBERT E. MATTHEWS, CFA
Sutter Securities Incorporated
San Francisco, CA
gil@suttersf.com
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PLX Technology
Vice Chancellor Laster agreed with
plaintiffs in a fiduciary duty case
that a hedge fund investor had
aided and abetted breaches of the
board’s duties to shareholders.
The hedge fund’s representative on
the PLX board of directors failed to
inform other board members that
he had discussions with the buyer
and its investment banker. Howev-
er, although plaintiffs were suc-
cessful in their breach of fiduciary
duty claim, the Court rejected
plaintiffs’ argument that the $6.30
per share transaction price was
unfair. Thus, it ruled that plaintiffs
“were unable to prove that the
breaches resulted in damages.”9
The trial court stated that it
did not have confidence in manage-
ment projections that included “a
new line of business involving a
new set of customers with a new
set of requirements” and noted that
the company had a history of not
achieving its projections.10 Laster
observed, “If the projections were
sufficiently reliable to support a
credible valuation of $9.82 per
share, then it seems likely that
another buyer would have compet-
ed.”11
Laster rejected plaintiffs’
expert’s beta because it was based
on daily returns, rather than week-
ly or monthly returns, explaining:
[W]hen the return interval is
shortened, the following
occurs: Securities with a
smaller market value than the
average of all securities out-
standing (the market) will
generally have a decreasing
beta, whereas securities with
a larger market value than the
average of all securities out-
standing will generally have
an increasing beta.12
The Supreme Court affirmed
Laster’s conclusion that the plain-
tiffs failed to prove that they suf-
fered damages.
FVLE Issue 83 February/March 2020 Page 19
DFC Global
Chancellor Andre Bouchard valued
DCF Global at $10.30 per share,
giving equal weight to each of the
deal price ($9.50), comparable
companies ($8.07), and DCF
($13.07, raised to $13.33 after
reargument). He gave only one-
third weight to the deal price
because the purchaser was a
financial buyer that was focusing
on achieving a certain IRR. After
reargument, he made an adjust-
ment to working capital that
reduced his valuation and then
changed the perpetual growth rate
used in his DCF calculation from
3.1 percent to 4.0 percent.13
The Supreme Court accepted
the comparable company analysis
but reversed the decision on sever-
al points:
1. It rejected the concept that an
LBO buyer’s winning bid in a
contested deal was negatively
impacted by its target IRR.
2. It rejected the higher growth
rate used in the revised opinion.
3. It rejected the trial court’s
weighting of the three valuation
methods it used.
The Supreme Court endorsed
the lower court’s application of the
comparable company method that
had been used by both experts,
commenting that “this was a rare
instance where both experts agreed
on the comparable companies the
Court of Chancery used and so did
several market analysts and others
following the company.”14
It faulted the Chancellor’s
upward adjustment to the growth
rate:
[T]he Court of Chancery then
substantially increased its
perpetuity growth rate from
3.1% to 4.0%, which resulted
in the Court of Chancery
reaching a fair value akin to
its original estimate of the
company's value. But, no ade-
quate basis in the record sup-
ports this major change in
growth rate.15
It pointed out the impact of that
error on the lower court’s valua-
tion, saying:
With that [growth rate] error
corrected, and addressing
certain foreign exchange
adjustments, the Court of
Chancery's discounted cash
flow model would yield $7.70
per share [rather than
$13.33].16
The Supreme Court instruct-
ed the lower court that if it elects to
weight different valuation methods,
it must explain its weighting:
[T]he Court of Chancery must
exercise its considerable dis-
cretion while also explaining,
with reference to the econom-
ic facts before it and corporate
finance principles, why it is
according a certain weight to
a certain indicator of value...
In this case, the decision to
give one-third weight to each
metric was unexplained and
in tension with the Court of
Chancery's own findings
about the robustness of the
market check.17
Dell
Vice Chancellor Laster valued Dell
at 27 percent above the deal price,
solely using DCF.18 He enunciated
several reasons why he gave no
weight to the deal price:
1. Deal prices in management buy-
out (MBO) transactions are
unreliable as measures of fair
value.19
2. The price that leveraged buyout
(LBO) sponsors would pay is
limited by the need to achieve
IRRs of 20 percent or more, and
by limits on financial leverage.20
3. The market for Dell’s shares was
inefficient, and a valuation gap
existed between market percep-
tion and Dell's operative reality,
driven by analysts’ focus on
short-term results.21
4. The shopping process was inad-
equate.22
Continued on next page
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5. Financial sponsors are con-
cerned about a “winner's
curse.”23
The Supreme Court disagreed
with each of the trial court’s rea-
sons for rejecting the deal price:
1. The transaction was not a man-
agement buy-out:
[T]his was not a buyout led
by a
controlling stockholder.
Michael
Dell only had
approximately 15% of the
equity.24
[A]ny outside bidder who
persuaded stockholders
that its bid was better
would have access to Mr.
Dell’s votes.25
[T]here is no evidence that
management was critical
here given both Black-
stone’s and Icahn’s doubts
about Mr. Dell’s leadership
and [their] apparent willing-
ness to pursue transactions
without his continued
involvement.26
2. As discussed in DCF Global,
LBO sponsors’ IRR require-
ments did not justify rejecting
their bids as a measure of fair
value:
The trial court’s complete
discounting of the deal
price due to financial spon-
sors' focus on obtaining a
desirable IRR and not “fair
value” was also error.27
[T]o the extent that the
Court of Chancery chose to
disregard Dell's deal price
based on the presence of
only private equity bidders,
its reasoning is not ground-
ed in accepted financial
principles, and this assess-
ment weighs in favor of
finding an overall abuse of
discretion.28
FVLE Issue 83 February/March 2020 Page 20
3. The market for Dell’s shares was
efficient and there was no “valu-
ation gap”:
The trial court believed that
short-sighted analysts and
traders impounded an
inadequate and lowball
assessment of all publicly
available information into
Dell's stock price, diminish-
ing its worth as a valuation
tool. But the record shows
just the opposite: analysts
scrutinized Dell’s long-
range outlook when evalu-
ating the Company and set-
ting price targets.29
4. The shopping process was satis-
factory:
The Committee, composed
of independent, experi-
enced directors and armed
with the power to say “no,”
persuaded Silver Lake to
raise its bid six times. Noth-
ing in the record suggests
that increased competition
would have produced a bet-
ter result.
[The lower court’s] assess-
ment that more bidders . . .
should have been involved
assumes there was some
party interested in proceed-
ing. Nothing in the record
indicates that was the case.
Fair value entails at mini-
mum a price some buyer is
willing to pay not a price
at which no class of buyers
in the market would pay.31
[Emphasis added.]
5. The Special Committee ad-
dressed the information asym-
metry problem and the “win-
ner’s curse” risk as best it
could:
[T]he likelihood of a win-
ner's curse can be mitigat-
ed through a due diligence
process where buyers have
access to all necessary
information. And, here, Dell
allowed Blackstone [during
the go-shop period] to
undertake “extensive due
diligence,” diminishing the
“information asymmetry”
that might otherwise facili-
tate a “winner’s curse.”32
The Supreme Court rejected the
lower court’s DCF valuation. It
commented:
[W]here a robust sale process
... occurred, the Court of
Chancery 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 based on widely diver-
gent partisan expert testimo-
ny.33
DCF valuations involve many
inputs—all subject to dis-
agreement by well-compen-
sated and highly credentialed
experts—and even slight dif-
ferences in these inputs can
produce large valuation
gaps.34
The Supreme Court concluded that
transaction price should be the
dominant factor in determining
Dell’s fair value. It ruled, “Overall,
the weight of evidence shows that
Dell's deal price has heavy, if not
overriding, probative value.”35
Aruba Networks
Although neither side had
addressed unaffected market price
at trial, Vice Chancellor Laster val-
ued Aruba at “unaffected market
price,” which he defined as the
average price during the 30 days
prior to a news article that dis-
cussed the pending transaction.36
The Court’s appraised value was
69.4 percent of the $24.67 deal
price.
Subsequent to the Aruba
trial, the Supreme Court issued its
opinion reversing Laster’s decision
in Dell. Laster then requested
Continued on next page
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FVLE Issue 83 February/March 2020 Page 21
“supplemental briefing on ‘the mar-
ket attributes of Aruba’s stock’ in
part because he ‘learned how many
errors [he] made in the Dell mat-
ter.’”37 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.”38
The decision 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 coincide with the
announcement of Aruba’s
February 2015 earnings.39
Although the market had no infor-
mation as to the unexpectedly good
quarter prior to the merger
announcement, the trial court con-
cluded:
[T]he record does not provide
a persuasive reason to ques-
tion the reliability of Aruba's
trading price based on the
decision by Aruba manage-
ment to bundle together two
pieces of information.40
The Supreme Court reversed
the Court of Chancery’s decision.
It disagreed with the lower court’s
conclusion as to the reliability of
the trading price, observing:
[The buyer] had material, non-
public information that, by
definition, could not have been
baked into the public trading
price ... In particular, HP [the
buyer] 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.41
[Emphasis
added.]
The Supreme Court pointed
out that the Delaware appraisal
statute requires that the company
be valued at “the effective date of
the merger,” and that the unaffect-
ed market price was “three to four
months prior to closing.”42 It firm-
ly rejected the use of unaffected
market price to value Aruba:
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 aver-
age unaffected market price of
$17.13 per share.43 [Emphasis
added.]
The Supreme Court awarded peti-
tioners $19.10 per share, which
was Aruba’s estimate of the deal
price ($24.67) minus synergies. It
agreed with the lower court’s con-
clusion that the transaction price
included substantial synergies.44
It noted that “Aruba’s estimate of
$19.10 ... was corroborated by ...
Aruba’s [expert’s] DCF, comparable
companies, and comparable trans-
actions analyses.”45
CONCLUSION
The Supreme Court, under now-
retired Chief Justice Leo Strine,
Jr., actively reviewed valuation
cases and did not hesitate in
reversing decisions that it deemed
incorrect. With valuation stan-
dards more clearly defined by these
recent decisions, it seems likely
that fewer major Supreme Court
valuation decisions will be forth-
coming in the near future.
8Id. at *87.
9In re PLX Technology Inc. S’holders Litig., 2018 WL
5018353 (Del. Ch. Oct. 16, 2018) at *56; aff’d, 211
A.3d 137 (2019).
10 Id. at *52.
11 Id. at *53.
12 Id. at *54, quoting Gabriel Hawawini, “Why Beta Shifts
as the Return Interval Changes,” Financial Analysts
Journal, May-June 1983, p. 73.
13 In re Appraisal of DFC Global Corp., 2016 Del. Ch.
LEXIS 103 (Del. Ch. July 8, 2016); modified, C.A. No.
10107-CB [unpublished] (Del. Ch. Sept. 14, 2016);
rev’d, DFC Global Corp. v. Muirfield Value Partners,
L.P., 172 A.3d 346 (Del. 2017). The case settled short-
ly after the Supreme Court’s decision; terms were not
announced.
14 DFC Global Corp. v. Muirfield Value Partners at 351.
15 Id. at 350.
16 Id. at 361.
17 Id. at 388.
18 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., 177 A.3d 1 (Del. 2017).
19 Appraisal of Dell at *87-*88.
20 Id. at *90-*97.
21 Id. at *101-*115.
22 Id. at *115-*125.
23 Id. at *139-*142.
24 Dell v. Magnetar at 30.
25 Id. at 11.
26 Id. at 32.
27 Id. at 27. The Supreme Court decision in DFC Global
was issued subsequent to the Court of Chancery deci-
sion in Dell.
28 Id. at 31.
29 Id. at 24.
30 Id. at 28.
31 Id. at 29.
32 Id. at 32.
33 Id. at 35.
34 Id. at 38.
35 Id. at 30.
36 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).
37 Aruba II at 131, quoting the Court’s letter to the par-
ties.
38 Aruba I at *4.
39 Id. at *63
40 Id. at *66.
41 Aruba II at 139.
42 Id. at 132.
43 Id. at 140. Subsequently, Laster appraised two com-
panies acquired in arm’s-length transactions at the
deal price. [In re Appraisal of Columbia Pipeline
Group, Inc., 2019 WL 3778370 (Del. Ch. Aug. 12,
2019) and In re Appraisal of Stillwater Mining Co.,
2019 WL 3943851 (Del. Ch. Aug. 21, 2019)].
44 Laster concluded that the transaction prices minus
synergies was $18.20 per share. [Aruba I at *45.]
45 Aruba II at 142.
1In re ISN Software Corp. Appraisal Litig., 2016 Del.
Ch. LEXIS 125 (Del. Ch. Aug. 11, 2016); aff'd, ISN
Software Corp. v. Ad–Venture Capital Partners, L.P.,
173 A.3d 1047 (Del. 2017).
2In Re Appraisal of SWS Group, Inc., 2017 Del. Ch.
LEXIS 90 (Del. Ch. May 30, 2017) at *41; aff’d, 2018
Del. LEXIS 77 (Feb 23, 2018).
3Id. at *38.
4Id. at *93.
5Id. at *97.
6ACP Master, Ltd. v. Sprint Corp., 2017 Del. Ch. LEXIS
125 (Del. Ch. July 21, 2017) at *75, aff'd, 184 A.3d
1291 (Del. 2018).
7Id. at *79.
ResearchGate has not been able to resolve any citations for this publication.
Why Beta Shifts as the Return Interval Changes
  • Id
Id. at *54, quoting Gabriel Hawawini, "Why Beta Shifts as the Return Interval Changes," Financial Analysts Journal, May-June 1983, p. 73.
Muirfield Value Partners at 351
  • Corp Dfc Global
DFC Global Corp. v. Muirfield Value Partners at 351.
); rev'd, Dell Inc. v. Magnetar Global Event Driven Master Fund Ltd
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., 177 A.3d 1 (Del. 2017).
at 27. The Supreme Court decision in DFC Global was issued subsequent to the Court of Chancery decision in Dell
  • Id
Id. at 27. The Supreme Court decision in DFC Global was issued subsequent to the Court of Chancery decision in Dell.
Laster appraised two companies acquired in arm's-length transactions at the deal price. [In re Appraisal of Columbia Pipeline Group
  • Id
Id. at 140. Subsequently, Laster appraised two companies acquired in arm's-length transactions at the deal price. [In re Appraisal of Columbia Pipeline Group, Inc., 2019 WL 3778370 (Del. Ch. Aug. 12, 2019) and In re Appraisal of Stillwater Mining Co., 2019 WL 3943851 (Del. Ch. Aug. 21, 2019)].
); aff'd, ISN Software Corp. v. Ad-Venture Capital Partners
In re ISN Software Corp. Appraisal Litig., 2016 Del. Ch. LEXIS 125 (Del. Ch. Aug. 11, 2016); aff'd, ISN Software Corp. v. Ad-Venture Capital Partners, L.P., 173 A.3d 1047 (Del. 2017).
  • Acp Master
  • V Ltd
  • Sprint Corp
ACP Master, Ltd. v. Sprint Corp., 2017 Del. Ch. LEXIS 125 (Del. Ch. July 21, 2017) at *75, aff'd, 184 A.3d 1291 (Del. 2018).