In Verition Partners Master Fund Ltd. v. Aruba Networks, Inc.,¹ the Delaware Supreme Court clarified the proper determination of the fair value of an acquired company in a statutory appraisal action. Reversing the Delaware Court of Chancery’s application of the “unaffected market price” standard for fair value, the Delaware Supreme Court held that, where a publicly traded company is acquired by another publicly traded company following a sale process in which interested buyers were given a fair opportunity to bid, the best indicator of fair value under Delaware law is the deal price minus synergies.² While the market price of an acquired company prior to the announcement of a transaction (“unaffected market price”) remains one important indicator of fair value, when an acquirer has learned additional, nonpublic information about the acquired company through due diligence, the deal price is “more likely to be indicative of . . . fundamental value” than the market price for the acquired company’s stock.³ The Delaware Supreme Court observed that “a buyer in possession of material nonpublic information about the seller is in a strong position (and is uniquely incentivized) to properly value the seller when agreeing to buy the company at a particular deal price, and that view of value should be given considerable weight by the Court of Chancery absent deficiencies in the deal process.”⁴

Overview of Delaware Appraisal Law

Under Delaware’s appraisal statute, stockholders who perfect their appraisal rights are “entitled to an appraisal . . . of the fair value of the stockholder’s shares” as of the merger date.⁵ This generally requires a fact-sensitive analysis because in determining fair value, the Court of Chancery is required to “take into account all relevant factors.”⁶ The Delaware Supreme Court has emphasized that the purpose of appraisal is to make sure that dissenting stockholders get “fair value” or compensation “based on what would fairly be given to them in an arm’s-length transaction.”⁷ Importantly, appraisal is not intended to provide dissenters with the “highest conceivable value” for their shares.⁸ Moreover, when determining fair value, Delaware courts are required to exclude “any synergies or other value expected from the merger giving rise to the appraisal proceeding itself.”⁹

Notable recent decisions preceding the Delaware Supreme Court’s Aruba Networks decision include DFC Global Corp. v. Muirfield Value Partners, L.P., which held that the Chancery Court should ordinarily give deal price significant weight as one of the “relevant factors” of fair value absent flaws in the deal process,¹⁰ and Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd., which held that in arriving at fair value, the Chancery Court should consider deal price and stock market price of the target in addition to other relevant factors and explain its relative weighting of those factors “based on reasoning that is consistent with the record and with relevant, accepted financial principles.”¹¹

Background of Aruba Networks

In August 2014, Aruba Networks, Inc. (“Aruba”) was approached by Hewlett-Packard Company (“HP”) regarding a potential acquisition by HP.¹² While engaging HP in negotiations for a potential acquisition, Aruba explored potential transactions with five other strategic bidders.¹³ These efforts were ultimately unsuccessful, and Aruba and HP eventually agreed to the terms of a potential acquisition of Aruba by HP at a price of $24.67 per share.¹⁴ Before the news of the acquisition leaked, the 30-day average of Aruba’s common stock price was $17.13 per share. After the market learned about the merger agreement, Aruba’s share price jumped to $22.24.¹⁵ The transaction was consummated in May 2015.¹⁶

Rather than accepting the offered deal price, petitioners Verition Partners Master Fund Ltd. and Verition Multi-Strategy Master Fund commenced an appraisal proceeding in the Delaware Court of Chancery in August 2015.¹⁷ Petitioners claimed that they were entitled to $32.57 per share—a 32% premium on the deal price.¹⁸ Following a trial before Vice Chancellor Laster, Aruba took the position that the proper appraisal value was $19.10 per share—a 22.6% discount on the deal price.¹⁹ Aruba’s position was based on the negotiated deal price, minus its estimate of the synergies from the transaction.

Following the Delaware Supreme Court’s decisions in DFC and Dell, the Chancery Court requested supplemental briefing on the impact of those decisions.²⁰ Thereafter, for the first time, Aruba took the position that “fair value” should be calculated based solely on the pre-announcement stock price of $17.13 per share.²¹

When the Chancery Court issued its post-trial opinion, it first determined that petitioners had failed to show any deficiency in the deal process. Specifically, the Chancery Court noted that the transaction was “a third-party, arm’s-length merger,” and did not involve a “controller . . . squeezing out the minority” or “management buyout where insiders’ informational advantages might have raised concerns.”²² In short, the Chancery Court found that “[n]othing about the deal structure could be considered exploitative.”²³

With respect to the specific question of fair value, the Chancery Court agreed with Aruba’s proposed $17.13 per share calculation and held that the market price of Aruba’s common stock was superior to the “deal price minus synergies” standard because, as conceded by Aruba’s expert, synergies were difficult to determine with precision.²⁴ Moreover, the Chancery Court found that the “deal price minus synergies” standard was flawed because it would “incorporate an element of value derived from the merger itself: the value that the acquirer creates by reducing agency costs.”²⁵ Because the “thirty-day average unaffected market price” was the “best evidence of Aruba’s fair value as a going concern, exclusive of any value derived from the merger,” the Chancery Court awarded plaintiffs $17.13 per share.²⁶ This reflected a steeper discount (30.7%) than that originally sought by Aruba.

The Delaware Supreme Court Application of the “Deal Price Less Synergies” Standard

On appeal, the Delaware Supreme Court reversed the Chancery Court’s determination of fair value with reference to the unaffected market price of Aruba’s common stock and held that the Chancery Court should have applied the “deal price minus synergies” standard instead.

The Delaware Supreme Court held that DFC and Dell did not compel the Chancery Court to calculate fair value based solely on Aruba’s unaffected market price. While agreeing that the unaffected market price of a stock traded in an efficient market “is an important indicator” of a target’s economic value “that should be given weight,” the Delaware Supreme Court observed that under the semi-strong theory of market efficiency, the market price can be “further informed by the efforts of arm’s length buyers of the entire company to learn more through due diligence, involving confidential nonpublic information, and with the keener incentives of someone considering taking the non-diversifiable risk of buying the entire entity.”²⁷ Thus, “the unaffected market price and that price as adjusted upward by a competitive bidding process leading to a sale of the entire company” was superior to an approach that only considered the common stock price.²⁸ In the particular circumstances of the case, “HP had more incentive to study Aruba closely than ordinary traders in small blocks of Aruba shares, and also had material, nonpublic information that . . . could not have been baked into the public trading price.”²⁹ Accordingly, the Delaware Supreme Court determined that the Chancery Court should have calculated fair value based on the “deal price minus synergies” standard.³⁰

With respect to the Chancery Court’s holding that the “deal price minus synergies” standard failed to account for certain agency costs arising from the transaction, the Delaware Supreme Court agreed with the petitioners’ argument that this holding was “not grounded in the record.”³¹ The financial literature on which the Chancery Court had based its agency-cost holding referred primarily to transactions, such as private equity transactions, in which a dispersed group of owners was replaced with a concentrated group of owners who would likely be “more capable of making sure management isn’t shirking or diverting the company’s profits.”³² By contrast, the transaction at issue in Aruba Networks would only “swap out one set of public stockholders for another:  HP’s.”³³ As such, the Chancery Court erred to the extent it determined that the proper calculation of fair value required accounting for such agency costs.

In applying the deal price less synergies standard, the Delaware Supreme Court noted that the Chancery Court had concluded that “because the HP-Aruba transaction involved enormous synergies, ‘the deal price . . . operates as a ceiling for fair value.’”³⁴ Agreeing that this conclusion was “abundantly supported by the record,” the Delaware Supreme Court ordered that a final judgment be entered for the petitioners in the amount of $19.10 per share, the amount that Aruba itself had estimated based on the deal price less synergies method.³⁵ This amount was a 22.6% discount to the deal price.

Conclusion

Aruba Networks reflects an important extension of the Delaware Supreme Court’s trend of recognizing market-driven indications of value as the most important drivers of “fair value” in statutory appraisal proceedings. Though the decision does not mandate a “deal price minus synergies” standard in all statutory appraisal proceedings, absent a showing of deficiencies in the process that led to the deal price or other unusual circumstances, merger consideration less synergies will be viewed as strong—and likely conclusive—evidence of fair value. Accordingly, Aruba Networks will likely further limit appraisal arbitrage activity by investors who purchase shares of a target after a transaction is announced and then commence an appraisal proceeding seeking to recover a premium above the deal price. Because fair value must exclude deal synergies, which can be substantial, Aruba Networks shows that stockholders exercising appraisal rights face a substantial risk of receiving less than the deal price.