United States: Delaware Court Of Chancery Determines Fair Value In Petsmart And SWS Group Appraisal Cases

In recent years, the Delaware Court of Chancery has issued a number of high-profile opinions in appraisal litigations, many of which addressed the central question of whether and to what extent the underlying transaction price is the best proxy for "fair value" in an appraisal proceeding. In the recent Dell and DFC decisions, the Court of Chancery declined to adopt the transaction price as the best measure of fair value, creating concern that appraisal petitioners would be able to regularly obtain awards at a premium to the deal price, even where the underlying transaction was the product of a sales process that otherwise satisfied the board's obligations under Delaware law.

However, the Court of Chancery recently issued two opinions in appraisal actions that may provide some comfort to potential public company sellers, buyers and M&A practitioners. The first, Vice Chancellor Slights's opinion in the PetSmart appraisal litigation, concluded that the $83 per share transaction price was the best measure of fair value, which was $4.5 billion less than what the appraisal petitioners claimed was the fair value of PetSmart. In the second opinion, in which bank holding company SWS Group was bought by Hilltop Holdings, Vice Chancellor Glasscock concluded that the fair value of SWS was actually 8% lower than the final transaction price, which he found reflected value derived from the acquirer's expected transaction synergies. Further clarity is expected when the Delaware Supreme Court issues its decisions in Dell and DFC, both of which are on appeal (DFC was argued on June 7, 2017).

PetSmart

The PetSmart appraisal litigation is one of the largest appraisal actions in recent memory. The appraisal petitioners held over 10.7 million shares worth almost $900 million at the deal price. The PetSmart petitioners positioned their case aggressively, arguing that the company's fair value exceeded the $83 per share deal price by over $45 per share.1

In an appraisal proceeding, the trial judge's role is to independently determine fair value after taking into account all relevant factors. Following a four-day trial, Vice Chancellor Slights found that the deal price was the best measure of the fair value of PetSmart's shares. The deal price resulted from a competitive bidding process in which 27 potential bidders were contacted, including three potential strategic buyers. BC Partners' successful offer of $83 per share reflected a 39% premium over PetSmart's unaffected stock price. No other bidder for PetSmart emerged in the several months between the announcement of the deal and the stockholder vote.

The petitioners, who had acquired a substantial majority of their 10.7 million shares after the transaction was announced, argued that the deal price was unreliable for a variety of reasons. However, Vice Chancellor Slights found that the credible evidence did not support the petitioners' argument, and determined that the deal price was the result of a fair sales process "comprised of a robust pre-signing auction in which adequately informed bidders were given every incentive to make their best offer in the midst of a 'well-functioning market.'" Indeed, the court noted that the PetSmart sales process "came close enough to perfection," and refused to second-guess the board's good-faith strategic decisions, including deciding to exclude Petco, PetSmart's principal competitor, from the sales process. The court also praised the board for accepting BC Partners' offer only after engaging in an analysis of all strategic options, including continuing as a standalone company, and for being ready to defend the company in a proxy contest against activist investors, if necessary.

The court also rejected the petitioners' argument that the sales process could not have produced a "fair value" price because it was largely populated by private equity bidders (even though strategic bidders were invited), holding that "while it is true that private equity firms construct their bids with desired returns in mind, it does not follow that a private equity firm's final offer at the end of a robust and competitive auction cannot ultimately be the best indicator of fair value for the company." Fundamentally, the court's conclusion regarding financial bidders appears to depart from certain recent appraisal cases, including the decision by Vice Chancellor Laster in Dell, that discounted the value of bids from private equity buyers because their investments are typically premised on desired returns and therefore their bids may not reflect a target company's "economic fair value."

The court also found that there was "no basis" to accept the contention that PetSmart's financial advisor labored under disabling conflicts, noting that the advisor's previous work with Petco had been disclosed to the PetSmart board and, if anything, was "deemed as a benefit not a conflict." The court further noted that the advisor's prior relationships with potential private equity buyers, including some that actively participated in the sale process, was "correctly deemed by the Board to be a 'fact of business life.'"

After determining that the deal price was a reliable indicator of fair value, the court reviewed the DCF analyses prepared by the parties' valuation experts. The court was skeptical of both parties' DCF analyses, noting that the "vast delta between the valuations generated by the parties' proffered methodologies raises red flags." In rejecting the parties' DCF analyses as the best measure of fair value, Vice Chancellor Slights concluded that they were unreliable because the created-for-auction management projections upon which those analyses were based could not "support a meaningful DCF analysis."

SWS

Several days after the PetSmart decision, Vice Chancellor Glasscock decided the SWS Group appraisal action.2 In contrast to PetSmart, Vice Chancellor Glasscock concluded that the deal price was unreliable as evidence of fair value and instead relied on a DCF analysis to find that the fair value of SWS at the time of the merger was $6.38 per share, approximately 8% below the merger price of $6.92 per share.

This appraisal proceeding arose from the January 2015 merger between SWS Group, a small bank holding company, and a wholly-owned subsidiary of Hilltop Holdings, itself a major creditor of SWS. A group of investment funds, holding an aggregate of 7.4 million shares of SWS common stock, sought appraisal. The petitioners' valuation expert placed 80% weight on a DCF analysis and 20% on a comparable companies analysis, arriving at a fair value of $9.61 per share, or 39% above the deal price. The respondents' valuation expert used a DCF analysis exclusively to reach a $5.17 per share valuation, or 25% below the deal price.

Vice Chancellor Glasscock found that "certain structural limitations unique to SWS," such as its relatively small size ($198 million market capitalization) and lack of scale, made the "application of the merger price not the most reliable indicia of fair value." The court also noted that the sales process was "problematic." In rejecting the use of a comparable companies analysis, Vice Chancellor Glasscock found that the companies selected by the petitioners' valuation expert "diverge[d] in significant ways from SWS in terms of size, business lines, and performance." The court then reviewed the DCF analyses and adopted the use of management projections in this case because SWS's management "routinely prepared three-year projections." Vice Chancellor Glasscock also observed that the fact that his DCF analysis, which was based on management projections but employed several different inputs and assumptions than those used by the parties' valuation experts, resulted in a value below the deal price was "not surprising" because this was a "synergies-driven transaction whereby the acquirer shared value arising from the merger with SWS."

* * *

The deference that the Court of Chancery will or should give to the merger price is closely watched by deal professionals. In Lender Processing Services,3 Vice Chancellor Laster observed that, since the Delaware Supreme Court's 2010 Golden Telecom opinion, the Court of Chancery has "regularly considered the deal price as a relevant factor when determining fair value, but it has not deferred automatically or presumptively to the deal price." In CKx,4 the court relied exclusively on the deal price because the other valuation methods were unreliable, where the court found that the company lacked sufficiently comparable peers and management projections could not be relied upon. In Ancestry.com, the court again relied exclusively on the deal price because the court concluded that the strength of the sale process was "unlikely to have left significant stockholder value unaccounted for," and the court's own DCF analysis was confirmatory of the deal price. The court has also given exclusive weight to the deal price in the AutoInfo, Ramtron, BMC and Lender Processing appraisal actions, all of which involved a robust sales process and where the court found the other evidence of fair value to be unreliable or weak.

In contrast, the Court of Chancery has also issued decisions where it has not given exclusive weight to the deal price. In Dell, the court gave limited weight to the deal price because the respondent failed to establish that the outcome of the sale process offered the most reliable evidence of the company's value as a going concern. In DFC, the court gave equal weight to the deal price, the court's DCF valuation, and one of the valuation expert's comparable companies analysis as a result of the fact that the negotiated price was derived "during a period of significant company turmoil and regulatory uncertainty." In Dunmire, the court again declined to rely on the deal price where, among other things, the merger was not a product of an auction, no third parties had been solicited, and a controlling stockholder stood on both sides of the deal.

The PetSmart and SWS decisions do not depart significantly from the Delaware courts' appraisal jurisprudence and demonstrate that a well-run sales process will be an important element in determining whether a court will rely upon transaction price as the best measure of fair value. In PetSmart, the court held that the arm's-length auction process produced reliable evidence of the company's fair value, while the SWS opinion describes a flawed transaction process that did not provide reliable evidence of fair value. The adequacy of the sales process was particularly important in PetSmart, given the petitioners' claim that the fair value of PetSmart actually exceeded the deal price by $4.5 billion – essentially asking the court to conclude that the market and process drastically undervalued PetSmart. In addition, the SWS opinion highlights the potential risk to appraisal arbitrageurs that fair value determinations pursuant to appraisal proceedings may be below the deal price. Both opinions also reflect judicial skepticism of the now standard appraisal litigation practice of retaining paid expert witnesses to conduct valuation analyses, with Vice Chancellor Slights observing that such paid experts have "very different incentives" than the buyer and seller in an arm's-length, competitive sales process that takes place within a fully functioning market and that Delaware courts "must remain mindful" that the DCF method is subject to manipulation and guesswork, which can produce "volatile" valuation results in a litigation setting. These opinions provide useful data points for understanding Delaware's approach to the appraisal process. The pending appeals in the Dell and DFC actions are likely to provide additional guidance regarding the degree to which, in various circumstances, Delaware courts will be influenced by transaction price in the determination of fair value in appraisal proceedings. Indeed, the June 7, 2017 oral argument on the DFC appeal highlighted the fundamental tension between the broad language of the Delaware appraisal statute, as underscored by the Delaware Supreme Court's 2010 Golden Telecom opinion, and attempts by appraisal defendants to argue that the Court of Chancery must defer to the deal price where the transaction results from a robust, arm's-length process and the relevant management projections are not a reliable basis for a valuation analysis.

Footnotes

1. In re Appraisal of PetSmart, Inc., C.A. No. 10782-VCS (Del. Ch. May 26, 2017).

2. In re Appraisal of SWS Group, Inc., C.A. No. 10554-VCG (Del. Ch. May 30, 2017).

3. Merion Capital L.P. v. Lender Processing Services, Inc., C.A. No. 9320-VCL (Del. Ch. Dec. 16, 2016).

4. Huff Fund Inv. P'ship v. CKx, Inc., C.A. No. 6844-VCG (Del. Ch. Nov. 1, 2013).

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.