Delaware Chancery Court Weighs in on Fair Value in Statutory Buyouts

The Delaware Chancery Court recently found that reliable market indicators provide the best evidence of a corporation’s fair value in statutory appraisal rights cases. Moreover, the court held that, in some situations, changes in value between the merger’s signing and closing dates may be considered when buying out shareholders who dissent to a merger.

Why the Market Knows Best

The court in In Re Appraisal of Regal Entertainment Group considered two market-based indicators — 1) the unaffected trading price of the corporation’s stock, and 2) the deal price minus premiums paid for synergies — to be more reliable than a discounted cash flow (DCF) methodology. Although the DCF method is widely accepted, market-based methods are generally preferred for deals involving public companies sold in an open market process.

Of the two market-based methods, the court decided that the deal price less synergies was the best measure of value in this case. Reliance on this measure was appropriate because there were several objective indicators that the sale process was sufficiently reliable, including:

• The acquiror was unaffiliated with and had no prior ownership of the company,
• Eight of the seller’s nine directors had no conflicts of interest,
• There was robust public information about the company’s value,
• The buyer conducted supplementary due diligence to uncover nonpublic information,
• The buyer and seller engaged in active negotiations over the price, and
• The parties entered into a merger agreement that permitted a post-signing market check that allowed other bidders to potentially emerge.

Regarding the unaffected trading price, certain factors rendered it less reliable. For example, a controlling shareholder had recently engaged in large block sales, and the corporation’s stock price had recently fallen.

How to Handle Post-Signing Increase in Value

In determining fair value, the court in Regal started with the deal price less synergies, then added an amount to reflect an increase in value between signing and closing. Why? After the deal was signed, but before it closed, Congress passed the Tax Cuts and Jobs Act of 2017 (TCJA). This law substantially reduced the corporate tax rate. So, the court increased fair value to reflect the company’s anticipated tax savings under the TCJA. This decision was based on somewhat unusual circumstances: the enactment of major tax legislation that substantially reduced the company’s tax burden.

However, in a more recent case — BCIM Strategic Value Master Fund LP v. HFF, Inc. — the Chancery Court expanded the availability of post-signing price adjustments to include situations in which value increases post-signing because of sustained outperformance. In this case, after the deal was signed but before closing, the company reported quarterly results that dramatically exceeded its internal projections and analyst expectations.

The court in BCIM found that the deal-price-less-synergies metric was the most reliable indicator of value. However, because fair value is measured at closing, the court held that an upward adjustment was appropriate to reflect the post-signing increase in value. The purchaser argued that short-term improvements didn’t indicate a long-term trend that would justify an adjustment to the deal price. But the court concluded, based largely on management testimony, that the company’s improved performance was “significant and durable.”

To determine the amount of the adjustment, the court couldn’t rely solely on the increase in the company’s stock price; some of the increase was likely in anticipation of the merger’s closing. To determine the portion of the increase attributable to improved performance, the court relied on an expert who conducted a regression analysis of price changes in previous instances in which the company had outperformed earnings guidance.

Why Valuation Expertise is Essential

As these two cases illustrate, value can fluctuate dramatically between the time a merger agreement is signed and the time it closes. A valuation expert can help you assess the impact of any fluctuations on the price of your deal.