AuthorMiller, Robert T.


This Essay considers two methods of valuing public companies in the context of appraisal proceedings under section 262 of the Delaware General Corporation Law (DGCL). The first method relies on the efficient capital markets hypothesis (ECMH) and values the company based on the market price of its shares before any public disclosure of the possibility of a transaction (the unaffected market price). The second relies on the price that an unrelated party agrees to pay to acquire the company in a transaction negotiated at arm's length after a robust sales process by the selling board (the deal price). Both the unaffected market price and the deal price are determined by market forces, albeit in different markets: with the unaffected market price, the relevant market is the stock market generally, while with the deal price, the relevant market is the market for corporate control. The deal price is almost always much higher than the unaffected market price, commonly thirty to fifty percent higher. (1) Each valuation method raises technical legal issues under the statutory language of section 262, and although such issues are often important in appraisal proceedings, I shall largely set them aside. My purpose is to explore why two different market prices diverge so significantly and systematically and to determine what in general this implies for the use of the two prices in Delaware appraisal proceedings.


    Section 262 of the DGCL provides that, in certain cases, a stockholder of a corporation merging with another corporation may refuse to accept the merger consideration and instead seek appraisal of his shares in the Court of Chancery. (2) In such cases, the court is required to determine the "fair value" of the stockholder's shares on the date of the merger, (3) taking into account "all relevant factors." (4) Under Weinberger v. UOP, Inc., the court may consider "proof of value by any techniques or methods which are generally considered acceptable in the financial community and otherwise admissible in court," (5) but the statutory mandate to consider all relevant factors entails that there may be no presumption in favor of any particular method of valuing the shares. (6) Furthermore, the court is to value the company as a going concern on a standalone basis (7) and then award the shareholder his proportionate share of that value. Statutory fair value excludes "any element of value arising from the accomplishment or expectation of the merger," (8) and so the value of synergies created by the transaction may not be included in the fair value of the shares, even if the deal price includes value from such synergies. Historically, the Court of Chancery has relied on many different valuation methods, including the unaffected market price of the company's shares, the deal price, discounted cashflow analyses, comparable company analyses, and comparable transaction analyses.

    For many decades, appraisal actions involving public companies were rare except in related-party transactions. This began to change in the early 2000s with the emergence of appraisal arbitrageurs, i.e., hedge funds, often founded by plaintiffs' lawyers, whose investment strategy was to acquire shares in companies that had announced mergers precisely in order to seek appraisal for such shares. (9) For several years, the appraisal arbitrageurs enjoyed spectacular returns, (10) mostly by convincing the Court of Chancery to find, on the basis of discounted cash flow analyses, that the fair value of the company's shares exceeded the deal price. Such cases produced strong negative reactions from the business community, the corporate bar, and many academics, and in response the Delaware General Assembly enacted certain minor changes to the appraisal statute. These changes had little effect, (11) however, and appraisal arbitrage reached its apogee in 2016 in In re Appraisal of Dell, Inc. (12) In that case, the court gave no weight to the deal price, even though it resulted from a months-long, highly publicized sales process conducted, as the court itself concluded, in a way that easily comported with all applicable fiduciary standards. (13) Instead, the court valued the company using its own discounted cashflow analysis and concluded that, under the intense glare of the investment community, the directors of one of the largest companies in the world, assisted by world-class financial advisors, backed up by the recommendations of the leading proxy-advisory firms, (14) and with the approval of a majority of the unaffiliated shares voting on the merger, (15) had sold the company for more than $6 billion less than its fair value. (16) Apparently, that was too much for the Delaware Supreme Court. In a pair of opinions, one reversing the Court of Chancery in Dell (17) and the other reversing it in a similar but less dramatic case, DFC, (18) the Delaware Supreme Court came down strongly in favor of relying on market prices in appraisal cases. In both decisions, the court remanded to the Court of Chancery, indicating that it expected that court to enter an award at the deal price.


    But the situation was not quite so simple. In both cases, the Delaware Supreme Court emphasized that, from an economic point of view, a fair price is one that a willing seller would accept from a willing buyer, a point that is equally valid with respect to the unaffected market price and the deal price. Furthermore, in both cases, although the Delaware Supreme Court clearly expected the Court of Chancery to enter an award at the deal price, it first emphasized that the company's shares traded in an efficient market and stated that the unaffected market price was evidence of their fair value. (19) Although certainly aware that deal prices are generally much higher than unaffected market prices, the court never mentioned this fact, a fact that has been the subject of academic debate for decades (20) and that is of obvious importance in appraisal cases.

    This omission naturally engendered some confusion. What should the Court of Chancery do when the company's shares trade in an efficient market, which suggests that the fair value is the unaffected market price, and the sales process is robust, which suggests that the fair value is the deal price? A case involving this question quickly arose. In Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., the Court of Chancery had to appraise the shares of Aruba Networks after its acquisition by Hewlett-Packard. (21) The shares of the company had traded in an efficient market prior to the transaction, and Aruba's sales process, while imperfect, was fairly robust. Following DFC and Dell, the Court of Chancery found that the company's unaffected market price was evidence of its fair value. Also following DFC and Dell, the court found that the deal price was also evidence of fair value, at least once it was corrected to exclude elements of value arising from the merger. Such elements certainly include synergies, and the merger undoubtedly involved significant synergies, some of which Aruba likely captured in the deal price. Accordingly, relying on synergy estimates prepared by the acquirer and its consultants, as well as an academic study of the fraction of synergies captured by targets, the court computed a deal-price-minus-synergies value for the company. (22) The court also thought that elements of value arising from the merger included reductions in agency costs arising when a public company, with its diffuse shareholder base, is acquired and its ownership becomes concentrated in a controlling shareholder, who will better monitor management. But noting that its computation of the synergies impounded in the deal price was highly uncertain and not even attempting to compute a reduction in agency costs impounded in that price, the court held that the unaffected market price, which did not involve such uncertainties, was more reliable evidence of the fair value of the company, (23) and it entered an award accordingly.

    On appeal, the Delaware Supreme Court reversed and remanded with directions to enter an award at the deal price less synergies. (24) Part of its reasoning was perfectly clear. It stated that reductions in agency costs may occur when a public company's diffuse ownership becomes concentrated in a controlling shareholder such as a private equity fund, but not when, as with Hewlett-Packard's acquisition of Aruba, one public company without a controlling shareholder acquires another; in such transactions, one set of diffuse owners replaces another. (25) In any case, any gains from reductions in agency costs at the target are merely a kind of synergy, and if any existed in this transaction, they were included in the acquirer's estimation of synergies. (26) This reasoning is very convincing, but it supports nothing more than eliminating from consideration the Court of Chancery's concern about agency costs. Indeed, it leaves that court's concern about the uncertainty of estimating synergies quite untouched. To the extent that the Delaware Supreme Court responded at all to this point, it argued that, on the facts of the particular case, there was reason to believe that the target and acquirer had material nonpublic information ("MNPI") about the target's business that justified a deal price higher than the unaffected market price. (27) Indeed, the court was able to point to very specific MNPI--an earnings report that would beat market expectations. (28) For this reason, the Supreme Court regarded the deal price less synergies as a better indication of fair value than the unaffected market price.

    Given the holdings of DFC, Dell, and Aruba, and given too that in negotiated transactions targets virtually always share nonpublic information with acquirers, it may have seemed after Aruba that the deal...

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