Securities Regulation Daily Court of Chancery’s stock valuation method was an abuse of discretion
Wednesday, April 17, 2019

Court of Chancery’s stock valuation method was an abuse of discretion

By David Yucht, J.D.

The Court of Chancery abused its discretion by conducting a stock valuation by using a 30-day average market price as the fair value of shares, without taking any other factors into account.

The Delaware Supreme Court found that the Court of Chancery’s decision to use Aruba Network Inc.’s stock price instead of the deal price minus synergies was rooted in an erroneous factual finding that lacked record support. Consequently, the supreme court concluded that the lower court abused its discretion in arriving at Aruba’s 30-day average unaffected market price as the fair value of shares belonging to Verition Partners Master Fund Ltd. The supreme court reversed the lower court’s judgment and remanded the matter for the Court of Chancery to enter a final judgment for Verition awarding $19.10 per share, which reflected the deal price minus the portion of synergies left with the seller as estimated by Aruba (Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., April 16, 2019, per curiam).

Hewlett-Packard Company, a publicly traded corporation, approached Aruba, another publicly traded company, about a potential combination. Aruba hired professionals and, in addition to negotiating with HP, began to shop the deal. Other logical bidders were approached, but none of them showed interest. The Aruba board eventually decided to accept HP’s offer of $24.67 per share. News of the deal leaked causing Aruba’s stock price to rise. The next day, after the market closed, Aruba released its quarterly results, which beat analyst expectations. Aruba’s stock price rose by 9.7 percent the following day to close at $24.81 per share, just above the deal price. The deal closed on May 18, 2015.

Lawsuit. Verition filed an appraisal proceeding in the state Court of Chancery, asking the court to appraise the "fair value" of their shares based on a Delaware statute. Aruba, now controlled by HP, responded. Verition maintained that Aruba’s fair value was $32.57 per share, whereas Aruba contended that it was between $19 to $20 per share. The Court of Chancery found that the fair value was $17.13 per share. The lower court judge relied exclusively on the stock price because he thought he needed to estimate and back out theoretical "reduced agency costs" from the deal price to arrive at a figure that reflected Aruba’s value as a going concern. According to the lower court, using the "unaffected market price" of Aruba’s publicly traded shares "provide[d] a direct estimate" of that endpoint, which led the judge to find the sole indicator of fair value to be that "unaffected market price" of $17.13 per share. The "unaffected market price" was determined by averaging the trading price of Aruba’s stock during the thirty days before news of the merger leaked, which was a few months prior to closing. Verition appealed.

Valuations. The state supreme court concluded that the lower court abused its discretion in arriving at Aruba’s 30-day average unaffected market price as the fair value of the Verition’s shares. In a valuation case, a court must value a company "as an operating entity . . . but without regard to post-merger events." In cases where a court has used the price at which a company is sold in a third-party transaction, it has excised a reasonable estimate of whatever share of synergy or other value the buyer expects from changes it plans to make to the company’s "going concern" business plan that has been included in the purchase price as an inducement to the sale. Here, the Court of Chancery abused its discretion in using Aruba’s "unaffected market price" because it did so on the incorrect theory that it needed to make an additional deduction from the deal price for unspecified "reduced agency costs." The lower court believed that replacing a dispersed group of owners with a concentrated group of owners would add value because the new owners were more capable overseeing management, and that added value must be excluded under statute as "arising from the…expectation of the merger." However, in this case the merger did not replace Aruba’s public stockholders with a concentrated group of owners. According to the supreme court, the price that HP paid was a better assessment of Aruba’s going-concern value for reasons consistent with corporate finance theory. The supreme court opined that lower court injected due process and fairness problems into the proceedings. The lower court’s desire not to award deal price minus synergies could be seen—in light of the overall tone of his opinion —as a results-oriented move to generate an odd result compelled by his personal frustration at being reversed in a recent unrelated matter. The supreme court applied Aruba’s $19.10 deal price minus synergies value which in its opinion was corroborated by abundant evidence.

The case is No. 368, 2018.

Attorneys: Michael J. Barry (Grant & Eisenhofer P.A.) for Verition Partners Master Fund Ltd. and Verition Multi Strategy Master Fund Ltd. Michael P. Kelly (McCarter & English, LLP) for Aruba Networks, Inc.

Companies: Verition Partners Master Fund Ltd.; Verition Multi Strategy Master Fund Ltd.; Aruba Networks, Inc.

MainStory: TopStory MergersAcquisitions DelawareNews

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