DGCL § 262(h) provides that shareholders who succeed in an appraisal proceeding are entitled to the "fair value" of their shares "exclusive of any element of value arising from the accomplishment or expectation of the merger." Query whether that language makes control premia irrelevant? In Armstrong v. Marathon Oil, , 513 N.E.2d 776 (Ohio 1987), Marathon merged with U.S. Steel on March 11, 1982. U.S. Steel previously had acquired a majority of Marathon's stock in a cash tender offer at $125 per share. In the merger, U.S. Steel paid $100 per share in the form of newly issued U.S. Steel bonds. In a subsequent appraisal proceeding, the Ohio Supreme Court held that the $125 paid in the cash tender offer was irrelevant to determining the fair value of the shares subject to the appraisal proceeding. Applying the Ohio appraisal statute, which was substantially similar to that of Delaware, the court deemed control premia to be irrelevant to the value of shares by a stockholder who already had control of the company. Instead, the value of plaintiffs' shares was to be determined by their market value on March 10, 1982, which was about $75, adjusted downward to the extent that the market price anticipated the pending merger.
In Weinberger v. UOP, Inc., 457 A.2d 701, 713 (Del.1983), by way of contrast, the Delaware Supreme Court held that only "speculative elements of value that may arise from the 'accomplishment or expectation' of the merger are excluded" from the determination of fair value under DGCL § 262(h). The word speculative nowhere appears in the statutory text, of course. The court nevertheless went on to describe the disallowance of "speculative elements of value" as "a very narrow exception to the appraisal process, designed to eliminate use of pro forma data and projections of a speculative variety relating to the completion of a merger." The chancery court thus may consider "elements of future value, including the nature of the enterprise, which are known or susceptible of proof as of the date of the merger and not the product of speculation...." I have always assumed that Weinberger thus allowed the chancery court to consider evidence of, among other things, control premia paid in comparable acquisitions.
Despite the Delaware Supreme Court's departure from the plain language of the statutory text, the court's approach makes substantial policy sense. The real issue, after all, ought to be whether the dissenting shareholders received a fair premium over market. In order to answer that question, one must start with the price paid in the merger and, if appropriate, work up from there.
Yet, there is that stubborn statutory language requiring exclusion “of any element of value arising from the accomplishment or expectation of the merger.” Also, one must take into account the historical purpose of the appraisal statute, which was to dissenting shareholders the same value they would have received had the business remained in existence as a going concern without the merger taking place.
Suppose plaintiff sought to admit evidence relating to synergistic effects the merger would have, making the combined entity more valuable than the separate companies, such as might be the case if the merger created a vertically integrated company that achieves great economies of scale. What relevance would such information have to valuation in an appraisal proceeding?
The Delaware Supreme Court addressed that issue in one of its many Technicolor decisions, holding that in a two step acquisition value added by the acquiring corporation subsequent to its initial purchase of a controlling block of shares was properly to be considered part of going concern value that dissenting shareholders who sought appraisal were entitled to share. The Chancery Court had refused to consider such elements of value on grounds that doing so "would be tantamount to awarding [the dissenting shareholder] a proportionate share of a control premium, which the Court of Chancery deemed to be both economically undesirable and contrary" to precedent. The Supreme Court disagreed, opining that "[t]he underlying assumption in an appraisal valuation is that the dissenting shareholders would [have been] willing to maintain their investment position had the merger not occurred." Cede & Co. v. Technicolor, Inc., 684 A.2d 289, 298 (Del.1996).
But Technicolor was a case in which there had been a significant lapse of time between the acquirer’s initial purchase of a controlling block of stock and the subsequent freeze out merger, during which the acquirer had made changes in the corporation's business plans that added new value. What about a case in which the acquirer effects a merger before making planned changes to the business? Should the appraisal valuation take into account the potential synergies to be gained? What about any pre-offer market appreciation anticipating such synergies?
The plain language of the statute would seem to preclude including such “elements of value” in the appraisal price. On the other hand, assuming evidence of such valuations is not speculative, Weinberger would seem to require taking them into account. Likewise, the policy of giving dissenting shareholders a fair price for their shares calls for taking synergistic elements into account, while the policy of giving the shareholders the fair value of their stock in the company as a going concern calls for exclusing such elements.
It is a puzzle.
My attention was drawn once again to this issue by Francis Pileggi’s detailed post exploring the recent Chancery Court decision in Gearreald v. Just Care, Inc., C.A. No. 5233-VCP (Del. Ch. April 30, 2012):
In this appraisal proceeding pursuant to 8 Del. C. § 262, the post-trial issue addressed by the Court was whether the “fair value” of the company was worth more than the $40 million acquisition price.
In an unusual twist, the Court found that the “fair value” of the company for appraisal purposes was only $34 million – - $6 million less than the cash acquisition price.
A stunning Marathon Oil like outcome!
VC Parsons held that:
The Court … must determine the fair value of “the company to the stockholder as a going concern.” Determining the value of a “going concern” requires the Court to exclude any synergistic value, that is, “the amount of any value that the selling company’s shareholders would receive because a buyer intends to operate the subject company, not as a stand-alone going concern, but as a part of a larger enterprise, from which synergistic gains can be extracted.” (8-9)
Parsons cited Union Illinois 1995 Inv. Ltd. Partnership v. Union Financial, 847 A.2d 340 (Del.Ch. 2004), in which then-VC (now-C) Leo Strine opined that:
By its plain terms, § 262 only excludes from the amount awardable to the petitioners “value arising from the accomplishment or expectation of the merger” that gave rise to the petitioners' right to appraisal. The literal terms of § 262 do not preclude a court from considering, in using a comparable-companies analysis for example, that acquirers typically share a portion of synergies with sellers in sales transactions and that that portion is value that would be left wholly in the hands of the selling company's stockholders, as a price that the buyer was willing to pay to capture the selling company and the rest of the synergies. For that matter, the literal terms of § 262 do not preclude a court from using a comparable-transactions analysis that considers the price at which the subject company would likely sell in an auction. Again, such an approach would not award the petitioners value from the particular merger giving rise to the appraisal; it would simply give weight to the actual price at which the subject company could have been sold, including therein the portion of synergies that a synergistic buyer would leave with the subject company shareholders as a price for winning the deal.
The exclusion of synergy value, rather, derives from the mandate that the subject company in an appraisal be valued as a going concern. Logically, if this mandate is to be faithfully followed, this court must endeavor to exclude from any appraisal award the amount of any value that the selling company's shareholders would receive because a buyer intends to operate the subject company, not as a stand-alone going concern, but as a part of a larger enterprise, from which synergistic gains can be extracted.
The parties in this case accept, as do I, that this mandate binds me and that my attempt to value UFG must center on determining its value as a going concern. That requires me to exclude from any valuation analysis a consideration of even the portion of synergies that might be expected to be left with the UFG stockholders in a sale of the entity as a whole.
This understanding is an important one in this case. Because the definition of fair value used in a § 262 proceeding is not based on fair market value and involves policy considerations, such as the need to exclude synergies in order to value the entity as a going concern, the petitioners in an appraisal proceeding can be awarded a sum that deviates—upward or downward—from what an economist or investment banker or Warren Buffett would believe was the market value of the petitioners' shares.
This passage raises several interesting and difficult questions. First, and perhaps foremost, given that appraisal is now a crap shoot in which one can end up with less than the price offered in the merger, why would any sane investor invoke appraisal rights?
Second, if one must exclude synergies, why would the target ever have a higher value as a going concern post-merger than pre-merger? Put another way, can the Chancery Court consider such elements of value as (1) eliminating quasi-rents by vertically integrating the target and buyer, (2) increasing the combined entity’s market share, (3) intra-firm diversification, (4) terminating and replacing inefficient incumbent target managers? Don’t all of these elements of value also arise from “the accomplishment or expectation of the merger”? But if you also exclude them, what’s left?
Third, if most strategic takeover deals are at least partly motivated by desired synergies (which I suspect is true), doesn’t excluding those synergies put the appraisal statute in direct conflict with modern economic realities? Put another way, don’t we want target management to bargain for a price that extracts a share of anticipated synergies for the benefit of target shareholders? (I set aside the issue of whether a diversified shareholder would care about allocation of the gains.) If the appraisal proceeding backs those elements of value out of the fair value, however, what incentive does the bidder have to acede to those demands? This would seem a particularly pertiennt concern in freezeout mergers involving a controlling shareholder, where we would want to incentivize both bidder and the target’s representatives to strike a price reflecting those synergies despite the latter’s conflict of interest.
Fourth, and following directly from the preceding, what useful purpose does the appraisal remedy now serve?
Fifth, can you really square use of a comparable transaction-based valuation method with the need to exclude elements of synergistic values? If those comparable transactions were motivated even in part by expected synergies, would not the comparable transaction method inevitably reflect some element of value driven by synergies?
Sixth, if elements of value arising out of synergistic values are non-speculative, how do you square excluding them with Weinberger?
Seventh, how do you measure the appropriate amount of synergistic value to be backed out of the calculation? In Just Care, VC Parsons went through a lengthy and laborious examination of the target’s post-acquisition business deals to determine which of them likely could have been undertaken by the company as a going concern. It is an exercise that strikes the reader as one of speculative reasoning of the sort Weinberger would seem to implicitly condemn.
In sum, this issue presents yet another area in which the law governing appraisal rights appears to be broken. Once again, the student comes away from the cases with the unavoidable impression that the Delaware courts are just sort of making this stuff up as they go along. Accordingly, one again comes to the conclusion that the best thing to do would be to toss out current law in its entirety and start over with a blank sheet of paper.
For a valiant effort to grapple with these issues, see Hamermesh, Lawrence A. and Wachter, Michael L., The Fair Value of Cornfields in Delaware Appraisal Law. Delaware Journal of Corporate Law (DJCL), Vol. 31, Pg. 119, 2005; U of Penn, Inst for Law & Econ Research Paper No. 05-24. Available at SSRN: http://ssrn.com/abstract=810908 or http://dx.doi.org/10.2139/ssrn.810908