United States: Merger Price And Process Win The Day Yet Again In Delaware Appraisal Action

On June 30, 2015, the Delaware Court of Chancery issued a post-trial opinion in which it yet again rejected a dissenting shareholder's attempt to extract consideration for its shares above the merger price through appraisal rights.  SeeLongPath Capital, LLC v. Ramtron Int'l Corp., Slip. Op. June 30, 2015, C.A. No. 8094-VCP (Del. Ch. June 30, 2015).  LongPath is just the latest decision in which the Chancery Court has upheld merger price as the most reliable indicator of fair value where it was the result of a fair and adequate process.  Vice Chancellor Parsons' opinion reaffirms the importance of merger price and process in Delaware appraisal actions, and offers helpful guidance to companies, directors and their counsel in defending against claims that the company was sold at too low a price.


Ramtron International Corporation was a semiconductor company that produced F-RAM, a faster and more efficient version of random access memory, or RAM, most commonly known for its use in computers.  On March 8, 2011, Cypress made an offer to purchase Ramtron for $3.01 per share, a 37% premium over Ramtron's stock price that day.  After Ramtron rejected that offer, Cypress came back to the table in June 2012, expressing an interest in acquiring Ramtron at $2.48 per share.  Ramtron management rejected that offer too, whereupon Cypress commenced a hostile tender offer at $2.68 per share.  The parties ultimately agreed to merge in November 2012, with Cypress paying $3.10 per share.  LongPath Capital, LLC, which had begun acquiring Ramtron shares in October 2012 after the merger agreement was signed, commenced an appraisal proceeding in December 2012.

As is typical in appraisal proceedings, the parties presented competing expert opinions regarding the fair value of Ramtron's shares.  LongPath's expert opined that Ramtron's fair value as of the date of the merger was $4.96 per share, and based his opinion on a combination of a DCF analysis predicated on management-prepared financial projections and two purportedly comparable transactions.  Ramtron's expert opined that Ramtron's fair value was $2.76 per share.  In arriving at his conclusion, Ramtron's expert assumed that the merger price was the result of a fair and competitive process and that the management-prepared projections were overly optimistic, but he nonetheless relied on those projections in performing his own DCF analysis

After a three-day trial, Vice Chancellor Parsons concluded that the management-prepared projections suffered from numerous defects, rendering them unreliable, and that the best evidence of Ramtron's fair value was the merger price of $3.10 per share less $0.03 in negative synergies that Cypress expected from the merger.

Takeaways and Analysis

1.  The Court afforded no weight to the experts' DCF analyses because they relied on management-prepared projections, which the Court found unreliable.

a.  The projections were not created in the ordinary course of business, but rather were created in anticipation of a hostile bid and for purposes of marketing the company for sale immediately after Cypress made its first offer of $2.48 per share. In fact, Ramtron's CEO's contemporaneous email to the team preparing the projections stated that the assumptions needed "to hold water in the event of a subsequent dispute." In addition, Ramtron's CEO testified that he used other sets of projections that were prepared in the ordinary course of business to provide estimated revenue and cash flow to the company's lenders.

As the Court observed, "[m]uch has been said of litigation-driven valuations, none of it favorable." Where management prepares financial projections in response to a hostile bid or other potential transaction or in advance of litigation, courts are likely to give those projections little to no weight in their determination of fair value. While Delaware courts generally favor a DCF model in an appraisal proceeding, that is not the case where the "data inputs used in the model are not reliable."

b.  The long term, multi-year projections were created by a new management team that had been with Ramtron for less than a year and had never prepared any analyses other than short term projections covering a maximum of five quarters. In Merlin Partners LP v. AutoInfo, Inc., C.A. No. 8509-VCN, 2015 WL 2069417 (Del. Ch. Apr. 30, 2015), which the authors have previously discussed here, the Court likewise afforded no weight to multi-year projections when management had never prepared such projections before.

Courts are likely to view projections prepared by new management teams with more skepticism than those prepared by teams that have been with the company for a significant period of time. A fundamental reason why courts prefer contemporaneously-prepared management projections is that management "ordinarily has the best first-hand knowledge of the company's operations." A new management team may have less insight into the company's operations than a seasoned team. In addition, it is imperative that those creating the projections have experience preparing the type of analyses at issue. Courts will not look favorably upon projections prepared by management that was just "winging it."

c.  The projections were unrealistic and did not accord with the reality of the F-RAM business. First, at the time of the merger, Ramtron was transitioning to a new producer for its F-RAM, ROHM Co. Ltd. based in Japan. Management's projections assumed that Ramtron would be able to transition to ROHM within 60 days and begin achieving cost savings within six months when, in the past, it had taken Ramtron seven years to transition to new producers. Second, evidence demonstrated that transitioning to a new producer required a significant cash investment, and Ramtron was cash-strapped during the relevant time period. Third, the projections defied historical trends and painted an unrealistic picture of a dramatic uptick in the company's revenue and gross margins over four years, which would have been an unprecedented growth rate for the company.

Courts do not conduct fair value determinations in a vacuum. Rather, they will test experts' valuations by reference to "reality checks." A valuation which fails to account for (or assumes away) the realities of the company's current business environment and historical results is unlikely to be accorded much, if any weight.

d.  The projections relied on 2011 and 2012 revenue figures that were distorted as a result of Ramtron's use of "point of purchase" accounting and well-documented channel stuffing. By using point of purchase accounting, Ramtron recognized revenue when it sold F-RAM products to wholesale distributors, as opposed to recognizing revenue when their products were actually sold to end-user customers. The Court found that Ramtron manipulated its revenue numbers by stuffing inventory into the channel in order to recognize the attendant revenue sooner, notwithstanding that there was no actual increase in demand from customers. This channel stuffing resulted in recognizing excess revenue of $6.6 million over three years, which the Court found significant given Ramtron only once generated more than $70 million in revenue in a single year.

Obviously, manipulation of revenue or other financial metrics renders projections based on such manipulated figures inherently unreliable. Channel stuffing and other forms of manipulation, of course, may also expose directors and officers to liability under the federal securities or other laws.

2.  The Court also concluded that the two "comparable transactions" selected by LongPath's expert were, in fact, not comparable at all. The Court criticized the lack of data points available from only two transactions, and noted that multiples calculated based on equity value/last twelve months revenue ranged from $2.74 to $6.13, a range of $3.39 that exceeded the merger price itself. Moreover, these multiples implied that Ramtron's fair value ranged from somewhere between 88% and 198% of the $3.10 merger price, which the Court viewed as not credible.

A comparable transactions analysis, like a comparable companies analysis, is unlikely to be afforded any weight where the transactions at issue involve different types of companies or "vastly different multiples," or do not pass a court's reality check.

3.  The Court concluded that the merger price provided the best evidence of Ramtron's fair value. The Court observed that Ramtron repeatedly rejected Cypress's overtures and actively solicited other potential buyers. Those prospective buyers were given the management-prepared projections, but none of them bid. In the end, the merger was the result of a three months' long process during which Ramtron sought to sell itself to anyone but Cypress, no other buyers came to the table, and, as a result of Ramtron's hard bargaining, Cypress repeatedly raised its price until settling on $3.10, which was a 25% premium over Cypress's initial offer. According to Vice Chancellor Parsons, "[t]his lengthy, publicized process was thorough and gives me confidence that, if Ramtron could have commanded a higher value, it would have."

Merger price can be the most reliable evidence of fair value. Courts have given merger price 100% weight in the fair value analysis where it was the result of a fair and adequate process. As Vice Chancellor Jacobs once stated, "[t]he fact that a transaction price was forged in the crucible of objective market reality (as distinguished from the unavoidably subjective thought process of a valuation expert) is viewed as strong evidence that the price is fair." Van de Walle v. Unimation, Inc., Civ. A. No. 7046, 1991 WL 29303, at *17 (Del. Ch. Mar. 7, 1991). A multi-bidder auction, however, is not a "prerequisite to finding that the merger price is a reliable indicator of value." Where the price is the result of an arm's length process, particularly one in which a premium has been extracted by the seller, courts are likely to find that market forces have generated the most reliable indicator of the selling company's fair value. 

4.  In concluding, the Court also rejected certain "reality checks" offered by LongPath as evidence that the merger price was an unreliable indicator of value. The Court did not accord any weight to Ramtron's CEO's statement that, when Cypress made its initial overture, he believed Ramtron would be worth $6-8 per share "several years out," because this was mere speculation as to fair price in the future, not evidence of Ramtron's value at the time of the merger. The Court also accorded no weight to a financial analyst's $4 trading target for Ramtron in January 2012 because, five months later, that analyst had pulled its target price and admitted it could not model Ramtron accurately. Finally, the Court expressed concern over ROHM's consideration of a minority stake in Ramtron at $3.00 per share, but discounted its significance because ROHM ultimately chose not to invest in Ramtron, just like all potential buyers other than Cypress.

A merger price resulting from a "proper transactional process" can be a reliable indicator of fair value because it is grounded in objective market realities.  Here, Ramtron's outside financial advisor actively sought competing bids and the company entered into non-disclosure agreements with six potential bidders.  No company made a bid other than Cypress.  As Vice Chancellor Parsons explained, "[t]he usefulness of a transaction price . . . is that 'buyers with a profit motive [are] able to assess [company-specific] factors for themselves and to use those assessments to make bids with actual money behind them.'"  Indeed, to accept LongPath's expert's conclusion, the Court would have to find that "the market left an amount on the table exceeding Ramtron's unaffected market capitalization.  This would be a significant market failure, especially in the context of a well-publicized hostile bid and a target actively seeking a white knight."  Thus, speculation on what the company would have been worth, or hypothetical scenarios of what a company might have paid, are unlikely to be accorded weight in an appraisal proceeding where the merger price results from a fair process.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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