On December 14, 2017, the Delaware Supreme Court issued its much-anticipated opinion in the Dell appraisal case, Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd.,1 affirming in part, and reversing in part, the Delaware Court of Chancery's finding that the fair value of Dell exceeded the merger price. The Supreme Court's comprehensive opinion is notable because it rejected the Court of Chancery's decision to give no weight to market-based measures of fair value—namely, Dell's stock price and the merger price—and rely instead on its own discounted cash flow (DCF) analysis. Although the Supreme Court emphasized that there were many factors indicating that the merger price was the best evidence of the fair value of Dell, and remarked that the Court of Chancery could choose to enter judgment at the deal price with no further proceedings, it declined to mandate that result.
In a May 31, 2016, post-trial opinion,2 Vice Chancellor Laster held that the fair value of Dell was $17.62 per share—30 percent higher than the $13.75 price paid in the $25 billion merger where the founder, CEO, and 16 percent stockholder of Dell (Mr. Michael Dell) and private equity firm Silver Lake Partners took Dell private. The Court of Chancery acknowledged prior case law in which the deal price was found to be the best indicator of fair value and found that Dell's sales process was thorough and would not support a breach of fiduciary duty claim. However, the Court of Chancery found that the deal price was not a reliable indicator of the fair value of Dell for several reasons, including that the transaction was a management buyout (MBO), the price reflected the constraints of an "leveraged buyout (LBO) pricing model" because the only active bidders were financial sponsors, and there was a perceived "valuation gap" between the market's perception of Dell and the company's "operative reality" in light of its large recent investments. Accordingly, the Court of Chancery relied on its own DCF analysis and assigned no weight to the deal price in reaching a valuation of $17.62. Following the Court of Chancery's decision, there was a sense that Delaware courts might be skeptical of the merger price as an indicator of fair value in an MBO, creating greater appraisal risk in that type of transaction.
In its opinion reversing that decision, the Supreme Court began by noting that the Delaware appraisal statute, 8 Del. C. § 262, required the trial court to "take into account all relevant factors" in determining the fair value of shares as of the merger date. Pointing to its decisions in DFC Global Corporation v. Muirfield Value Partners, L.P.,3 which had been issued while the Dell case was on appeal, and a decision several years ago in Golden Telecom, Inc. v. Global GT LP,4 the Supreme Court noted that it had consistently declined to impose a presumption in favor of the deal price. The Supreme Court found that the trial court properly took "into account all relevant factors," but concluded that the decision to assign no weight to the deal price did not follow from the court's factual findings or accepted financial principles and should have been given "heavy, if not dispositive, weight."
The Supreme Court reached this conclusion for three reasons. First, the Court of Chancery's belief that a "valuation gap" existed between Dell's stock price and its intrinsic value ran contrary to the efficient market hypothesis and evidence that the market analysts had considered Dell's long-range outlook, including $14 billion in recent investments, when setting their price targets. Second, in keeping with the DFC Global opinion, the lack of strategic bidders, and financial sponsors' focus on obtaining a certain internal rate of return, was not a basis for disregarding the deal price, particularly because the pre-signing and post-signing go-shop processes presented "objective indicia of reliability" of the deal price. Third, the theoretical characteristics of MBO transactions—the structural barriers of a go-shop process, the "winner's curse" that prevents prospective buyers from outbidding management who presumptively would have paid more if the company was "worth it," and the impediment created by management's inherent value to the company—were not present in the Dell MBO. Rather, the Supreme Court found that the size and complexity of Dell did not create a structural barrier in the go-shop process, that all necessary information had been available to bidders through an extensive due diligence process, and that Mr. Dell would have participated with rival bidders.
The Supreme Court went on to explain that there is no requirement in Delaware law that a company must prove the sales process is the "most reliable" evidence of fair value in order for the deal price to be given weight. However, given the "compelling" evidence in this case of a strong sales process and market efficiency, the Supreme Court concluded that the trial court's "failure to give the resulting price heavy weight . . . abuses even the wide discretion afforded the Court of Chancery in these difficult cases." The Supreme Court emphasized that this was not a case where market forces were unreliable, such that a DCF analysis would provide a more accurate basis on which to assess the price. The court also critiqued the DCF analysis applied by the Court of Chancery because it resulted in a price at which there had been no willing buyers, suggesting that the court's valuation was flawed.
There are several important takeaways from this decision for practitioners and parties considering MBO or LBO transactions alike:
As it had done in the DFC Global decision, the Supreme Court recognized the "sound economic and policy reasons supporting the use of the deal price as the fair value." Despite the Supreme Court's refusal to prospectively limit the Court of Chancery's ability to create its own valuation analysis, it again sent a strong signal that the deal price should be given substantial weight where a thorough process is followed.
Also in keeping with DFC Global, this decision should further reduce concerns about private equity buyers' internal pricing models having a negative effect on the reliability of the deal price. The Supreme Court emphasized that both financial and strategic buyers have expected internal rates of return, such that the buyer's status as a financial sponsor is not necessarily meaningful to a fair value analysis.
Finally, the fact that a transaction is an MBO does not automatically undermine the reliability of the deal price, particularly where some of the more problematic features of an MBO—such as an imbalance in information—are not present.