Although expressly declining to create a presumption that the deal price of an arm’s-length merger equates to fair value, the Delaware Supreme Court reversed and remanded a chancery court’s appraisal decision with suggestions that the deal price may be the most reliable indicator given the facts. If anything, the deal-specific circumstances provided a stronger, not weaker, argument to give weight to the deal price and the record did not support chancery’s upward revision of the growth rate used in its discounted cash flow analysis (DFC Global Corporation v. Muirfield Value Partners, L.P., August 1, 2017, Strine, L.).
The chancery court appraised the value of DFC Global Corp. at $10.21 per share, or about 7.5 percent above the $9.50 deal price. DFC, a payday lender, struggled through regulatory changes and investigated selling itself to a financial sponsor. Lone Star Fund bought the company in June 2014 for $9.50 per share. In the appraisal proceeding, the Chancellor reasoned that the transaction "was negotiated and consummated during a period of significant company turmoil and regulatory uncertainty, calling into question the reliability of the transaction price as well as management’s financial projections." He instead gave equal weight to "three imperfect techniques": a discounted cash flow analysis, the company’s comparable company analysis, and the transaction price.
Appealing the ruling, DFC argued that the high court should establish a presumption that in certain cases involving arm’s-length mergers, the price of the transaction is the best estimate of fair value. The court would not go that far, since the statutory text gives the chancery court broad discretion to determine fair value by examining "all relevant factors." Furthermore, it would be difficult to craft the precise conditions that would invoke such a presumption, and the chancery court has a proven record of exercising its discretion to give the deal price predominant or exclusive weight when it determines that is the best indicator of fair value on the facts. On these facts, however, the Supreme Court was swayed by two case-specific arguments for reversing the appraisal decision.
Regulatory developments did not undermine merger price. First, the court of chancery gave only one-third weight to the deal price despite having found that the transaction resulted from a two-year, robust market search; that the company was purchased in an arm’s-length sale; and that there was no hint of self-interest. Under these conditions, the Supreme Court wrote, "economic principles suggest that the best evidence of fair value was the deal price." Nevertheless, the chancery court cited regulatory developments and the fact that the prevailing buyer was a financial buyer as undermining the utility of the deal price as an indicator of fair value. Its findings on these points were not rationally supported by the record.
The record showed that DFC’s stock price often moved over the years and that these movements were affected by the potential of tighter regulation. The chancery court did not cite any basis to conclude that market players focused on the company’s value would not have factored in the potential for regulatory action. Many parties had an interest in examining the regulatory risk, including not just stockholders but also potential buyers and debtholders. Their collective judgment was more likely to be accurate than "any individual’s guess."
The supreme court also said that it did not understand the logic of chancery’s finding that the buyer focused on achieving a certain internal rate of return and on reaching a deal within its financing constraints, rather than on the company’s fair value. This "private equity carve out," as the high court put it, does not have a basis in the record or in economic literature. Both strategic and financial buyers should have a targeted rate of return that justifies buying the business; it does not follow that the price it is willing to pay is not a meaningful indicator of fair value. Here the financial buyer was subjected to a competitive bidding process, the company was unsuccessful in its attempts to refinance its public debt, and the company had its existing debt placed on negative credit watch within one week of the merger announcement.
Discounted cash flow analysis. DFC also identified unsupported assumptions in chancery’s discounted cash flow analysis. In a reargument motion below, DFC pointed out that the court’s model included working capital figures that differed from those the court had expressly adopted. The court corrected the clerical error; if it had stopped there, the discounted cash flow model would have yielded a fair value below the deal price. But at the appraisal petitioners’ prompting, the court increased its perpetuity growth rate from 3.1 percent to 4.0 percent, resulting in a fair value akin to its original estimate.
There was no adequate basis in the record to support this change in growth rate. The company had already experienced rapid growth coinciding with growth in the payday lending industry as a whole—which, in turn, was a driver of the regulatory reforms threatening DFC. Management’s projections were optimistic and the company fell short of meeting its projections even after revising them downward during the sales process.
Instructions on remand. The supreme court reversed and remanded with instructions to reassess the weight the court chooses to afford factors relevant to fair value. If the court chooses to use a weighting of different valuation methodologies, it must explain its weighting in a manner supported by the record. The high court also suggested that the Chancellor "may conclude that his findings regarding the competitive process leading to the transaction, when considered in light of other relevant factors, … suggest that the deal price was the most reliable indication of fair value."
The case is No. 518, 2016.
Attorneys: Raymond J. DiCamillo (Richards, Layton & Finger, P.A.) for DFC Global Corp. Stuart M. Grant (Grant & Eisenhofer P.A.) for Muirfield Value Partners, L.P., Oasis Investments II Master Fund Ltd. and Candlewood Special Situations Master Fund, Ltd.
Companies: DFC Global Corp.; Muirfield Value Partners, L.P.; Oasis Investments II Master Fund Ltd.; Candlewood Special Situations Master Fund, Ltd.
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