The Delaware Supreme Court's two recent decisions in Dell and DFC strongly endorsed the application of market efficiency principles in appraisal actions, and gave virtually controlling weight to the deal price as the “best evidence” of a company's fair value where a robust sales process was conducted against the backdrop of a well-functioning market for the target's stock.  In the wake of those two decisions, the Court of Chancery has issued a series of opinions considering whether deal synergies or the unaffected market price should be used to adjust the deal price downward to determine the going concern fair value. Chancellor Andre G. Bouchard in In re Appraisal of Solera Holdings Consolidation, C.A. No. 12080-CB (Del. Ch. July 30, 2018), provided further guidance about how to measure and deduct the value of the buyer's synergies to arrive at the company's fair value.

Background

Solera Holdings Inc. was founded in 2005 and became a global leader in data and software for automotive, home ownership and digital identity management. Its stock was publicly traded on the New York Stock Exchange from 2007 until March 2016 when it was acquired by Vista Equity Partners in a merger transaction for $55.85 per share, approximately $3.85 billion in total equity value. In the appraisal action that followed, the petitioners relying solely on a DCF value model contended the fair value of their shares was $84.95 per share. Respondent argued initially that the best evidence of the fair value of the Solera shares was the deal price less estimated synergies expected by the buyer, a value of $53.95 per share. Subsequently, after trial and following the Court of Chancery's decision in the Aruba appraisal case adopting the unaffected market price of the company's stock as fair value, the respondent changed course and argued for use of the same approach by the Solera court. This equated to $36.39 per share, approximately 35 percent below the deal price.

The court found after trial that the merger was the product of an open process that bore the objective reliability emphasized by the Supreme Court in Dell and DFC. Specifically, the chancellor found that there was an opportunity for potential buyers to bid, the special committee effectively negotiated an arm's length transaction, and the market for Solera stock was efficient and well-functioning. As a result the court found that the merger price less synergies presented the best evidence of the fair value of the petitioners' shares.

Discussion

Delaware's appraisal statute, 8 Del. C. Section 262, has long-provided that the court “determine fair value exclusive of any element of value arising from the accomplishment or expectation of the merger.” Measurement of buyer synergies arising from the merger is not an issue when the court employs the oft-used DCF methodology to determine the value of the target firm as a stand-alone entity. But when the merger price becomes the best evidence of fair value, valuation experts generally regard the merger premium paid is attributable to synergies the buyer expects to realize from the merger transaction. In Solera, Bouchard initially addressed the argument that Vista as a financial buyer could not realize synergies, that only a strategic acquirer can realize synergies from operations. The court rejected that contention and found that financial buyers also could benefit from portfolio company synergies, private company cost savings and tax benefits from incremental leverage.

To measure the amount of the synergies, the court relied on expert evidence valuing the financial synergies at $6.12 per share. Rather than deduct the full synergy value from the deal price, however, the court relied on empirical studies demonstrating that the buyer includes a portion of its expected synergy gains in the premium it must pay to prevail and obtain control. The court accepted the expert's use of a 31 percent figure ($1.90 per share), the lowest percentage from the three empirical studies, to represent the amount of synergies included in the deal price paid the seller. It therefore deducted this amount ($1.90) from the merger price ($55.85) to arrive at the appraisal fair value ($53.95).

Finally, the court rejected the respondent's belated post-trial Aruba argument advocating use of the unaffected market price, rather than the deal price, as the best evidence of fair value. The court expressed doubt that the control premium paid in a merger was exclusively a synergy belonging to the buyer rather than an element of value that an appraisal petitioner could share. But much of the court's rationale for rejecting the Aruba approach relied on procedural grounds. It leaves for another day, and ultimately guidance from the Supreme Court, to resolve whether and how much of the deal premium needs to be deducted from the merger price to determine appraisal fair value.

Lessons Learned

The law concerning the measurement of synergies continues to develop. Precedents conflict over whether the value of control is part of the going concern value, recoverable by the appraisal claimant, or a synergy created by the buyer that must be excised from the fair value award under Section 262.

Proof of the value of synergies remains difficult as does measurement of the amount of synergistic value the buyer was willing to include in the deal price. Solera's approval of empirical industry studies to establish the percentage of synergies paid to the target will facilitate proof of this element by respondents. Until the Supreme Court provides much needed clarification for measuring the synergy adjustment to the deal price, uncertainty will prevail.  But where the merger price was once thought to serve as a floor in an appraisal contest, it is now clear that it serves as a ceiling when the Dell market and process conditions have been established.

P. Clarkson Collins Jr. ([email protected]) is a corporate governance and fiduciary litigation partner at Morris James in Wilmington.