Daniel S. Atlas, Kaitlin E. Maloney and Jenness E. Parker of Skadden, Arps, Slate, Meagher & Flom.

Following the Delaware Supreme Court's appraisal decisions in Aruba, Dell and DFC, the Delaware Court of Chancery relied exclusively on market-based metrics to determine fair value in three recent appraisal decisions. In both In re Appraisal of Columbia Pipeline Group, Del. Ch. Aug. 12, 2019), and In re Appraisal of Stillwater Mining, (Del. Ch. Aug. 21, 2019), the court found that deal price was the most reliable indicator of fair value. In In re Appraisal of Jarden, (Del. Ch. July 19, 2019), the court relied on unaffected market price to determine fair value. Heeding the Delaware Supreme Court's caution against using the DCF methodology when market-based indicators are available, the court in each case declined to give weight to DCF valuations. An analysis of the facts and takeaways from these recent opinions follows.

'Columbia Pipeline Group'

In CPG, the court held that the deal price was the most reliable indicator of fair value because the deal process was characterized by the following objective indicia of reliability:

• The merger was an arm's-length transaction with a third party.
• CPG's board did not labor under any conflicts of interest.
• TransCanada conducted due diligence and received confidential insights about CPG's value.
• CPG contacted other potential buyers pre-signing, and those parties failed to pursue a merger when they had a free chance to do so.
• CPG negotiated with TransCanada and extracted multiple price increases; and
• No bidders emerged during the post-signing phase.

The court acknowledged several perceived "flaws" in the sales process, including: a one-on-one meeting not authorized by CPG's board between CPG's CEO and TransCanada's senior manager during which CPG's CEO assured TransCanada that it faced no competition, purported favoritism towards TransCanada over other bidders during the pre-signing process and CPG's breach of standstill agreements with potential buyers. However, the court ultimately held that petitioners failed to prove that these flaws actually caused CPG's board to leave a portion of CPG's fundamental value on the table. 

The court declined to excise any value for synergies from the deal price because although "TransCanada could have justified a smaller synergy deduction, it claimed a larger and unpersuasive one." The court also rejected the parties' DCF analyses because it had determined that a reliable market-based metric existed. As a result, the court did not need to consider the DCF analyses, which had many inputs that were subject to "legitimate debate, and the outcome of those debates generated large swings in the valuation output."

'Stillwater'

In Stillwater, the court again held that the deal price was the most reliable indicator of fair value because the deal process was characterized by the same objective indicia of reliability as in CPG: the merger was an arm's-length transaction with a third party; the Stillwater board did not labor under any conflicts of interest; Sibanye conducted due diligence and received confidential insights about Stillwater's value; Stillwater extracted multiple price increases from Sibanye; and no bidders emerged during the post-signing phase. The court explained that analyzing objective indicia of reliability was a holistic exercise, and that the Delaware Supreme Court has not established "minimum characteristics that a sale process must have before a trial court can give it weight."

As in CPG, the court acknowledged several perceived flaws in the sales process, including Stillwater president and CEO's "unsupervised activities" and change-of-control benefits, the company's "soft-sell" approach and the purportedly compressed pre-signing market check. Yet, the court held that although "the sale process was not perfect, and the petitioners highlighted its flaws, the facts of this case, when viewed as a whole, compare favorably or are on par with the facts in [enhanced scrutiny opinions] C&J Energy, PLX, DFC, Dell, and Aruba."

Regarding Stillwater's purportedly inadequate pre-signing market check, the court held that a sale process need not "involve some level of active outreach during the pre-signing phase" to be considered a reliable metric of fair value. The court explained that even "if Stillwater had pursued a single-bidder strategy" the deal price would have been afforded dispositive weight because "the merger agreement allowed for a passive post-signing market check in line with what decisions have held is sufficient to satisfy enhanced scrutiny."

Similar to CPG, the court declined to adjust for synergies because there was no evidence of quantifiable synergies. The court again rejected the parties' divergent DCF valuations because a reliable market-based metric was available and "legitimate debates over the [DCF] inputs and the large swings in value they create undercut the reliability of the DCF model as a valuation indicator."

'Jarden'

In Jarden, the court held that Jarden's unaffected market price of $48.31 per share (22% below deal price) was the best evidence of its fair value because Jarden's stock traded in a semi-strong efficient market. The court relied on the following factors in reaching that conclusion: trading on the New York Stock Exchange; daily and weekly trading volumes; high market capitalization; high public float; narrow bid-ask spread; Jarden's lack of controlling stockholder; and the high number of covering equity analysts (20). In particular, the court focused on the fact that Jarden's stock price traded below deal price pre-closing, which indicated that the market did not think Jarden was worth materially more than the deal price or that a topping bid was forthcoming.

The court did not afford deal price ($59.21 per share) any weight in determining fair value because of certain perceived flaws in the sales process, including the CEO (who was also the lead negotiator): exhibiting a "cut to the chase" negotiating mentality, setting "an artificial ceiling" on price negotiations without board authorization; (iii) providing counteroffers without board authorization; and recommending to the board a financial adviser without providing full disclosure of his prior relationship with the bank. The court found that these flaws, "coupled with the fact that there was no effort to test the merger price through any post-signing market check, raised legitimate questions regarding the usefulness of the merger price as an indicator of fair value." Moreover, although the court recognized that synergies were realized, the trial record "raised more questions than it answered" regarding both the amount of synergies and which company captured them in the merger.

Because of the parties' "fantastically divergent conclusions following their DCF analyses," ($48.01 vs. $70.36 per share), the court crafted an independent DCF analysis to reconcile the experts' input disagreements to corroborate the unaffected market price. Most importantly, the court sought to resolve the parties' dispute over the terminal investment rate, which accounted for 87% of the difference between the models. After adopting certain inputs from both experts, the court constructed a DCF model that valued Jarden at $48.13 per share. However, in further modifying its model to resolve for certain errors on a motion for reargument, the court noted:

"Ironically, in the opinion, I cautioned that our courts should not wade 'deep into the weeds of economics and corporate finance" without "the guidance of experts trained in these disciplines.' Yet that is precisely what I did. … The better approach, therefore, would have been to leave it at that rather than 'parse through the inputs and hazard semi-informed guesses about which expert's view was closer to the truth.'"

The court's final DCF model yielded a fair value for Jarden of $48.23 per share. Having found Jarden's unaffected market price was a reliable indicator of fair value, the court found comfort that its DCF valuation "corroborate[d] the most persuasive market evidence" ($0.08 delta).

Takeaways

• To determine reliance on the deal price for setting appraisal value, the Delaware Court of Chancery, in line with Aruba, Dell and DFC, will analyze whether the sale process bore objective indicia of fairness.

• The Delaware Supreme Court has not established any minimum requirements necessary to afford deal price strong, if not dispositive weight.

• Even if the sales process has flaws, petitioners will have difficulty rebutting the reliability of the deal price if they cannot show that a significant portion of the company's fundamental value was left on the table.

• The court in two recent opinions analyzed whether the deal process was reliable by considering whether the deal process would have passed muster under a traditional Revlon (enhanced scrutiny) analysis.

• The court may find that a post-signing market check confirms the reliability of the deal price where a merger agreement contains reasonable deal protections that would pass muster under enhanced scrutiny.

• The court may decline to deduct synergies from the deal price without sufficient and persuasive evidence.

• When reliable market-based metrics are available, the court will likely avoid reliance on DCF valuations.

Jenness E. Parker, counsel at Skadden, Arps, Slate, Meagher & Flom, focuses her practice on deal litigation and corporate governance litigation matters in Delaware and other state and federal courts around the country.

Kaitlin E. Maloney and Daniel S. Atlas are litigation associates with the firm.