I've been thinking so moe about the May 31 Delaware Chancery decision in the Dell appraisal proceeding. As Paul Weiss summarizes the case:
Vice Chancellor Laster of the Delaware Court of Chancery held that, for purposes of Delaware’s appraisal statute, the fair value of the common stock of Dell Inc. at the time of its sale to a group including the Company’s founder Michael Dell was $17.62 per share, almost a third higher than the $13.75 deal price. The decision has received a good deal of attention from the press and commentators, largely because the Court rejected the use of the transaction price as compelling evidence of fair value, despite several recent Delaware appraisal decisions that have relied heavily or exclusively on the transaction price.
VC Laster cited a number of factors in support of his decision, but, as Paul Weiss observes, one of the major take home lessons seems to be that "target boards may wish to make a record of their focus on the company’s intrinsic value, as opposed to the premium to market represented by the transaction price."
The focus on intrinsic value, of course, is a longstanding principle of Delaware law as the VC pointed out:
“The concept of fair value under Delaware law is not equivalent to the economic concept of fair market value. Rather, the concept of fair value for purposes of Delaware's appraisal statute is a largely judge-made creation, freighted with policy considerations.” Finkelstein v. Liberty Digital, Inc., 2005 WL 1074364, at *12 (Del. Ch. Apr. 25, 2005) (Strine, V.C.). In Tri–Continental Corp. v. Battye, 74 A.2d 71 (Del.1950), the Delaware Supreme Court explained in detail the concept of value that the appraisal statute employs:The basic concept of value under the appraisal statute is that the stockholder is entitled to be paid for that which has been taken from him, viz., his proportionate interest in a going concern. By value of the stockholder's proportionate interest in the corporate enterprise is meant the true or intrinsic value of his stock which has been taken by the merger. In determining what figure represents the true or intrinsic value, ... the courts must take into consideration all factors and elements which reasonably might enter into the fixing of value. Thus, market value, asset value, dividends, earning prospects, the nature of the enterprise and any other facts which were known or which could be ascertained as of the date of the merger and which throw any light on future prospects of the merged corporation are not only pertinent to an inquiry as to the value of the dissenting stockholder's interest, but must be considered....Subsequent Delaware Supreme Court decisions have adhered consistently to this definition of value.
The difficulty, of course, is that there is no such thing as "intrinsic value." As with any other asset, a company is worth only what somebody is willing to pay for it.
Given that the meaning of "fair value" is a product of common law adjudication rather than statutory interpretation, Delaware courts can and should rethink their approach. Instead of focusing on the purported intrinsic value, the court should focus on the fact that while the company's only value is its market value, an asset can have different values in different markets. (Otherwise, arbitrage would never be profitable.) Two distinct markets are implicated in this setting. On the one hand, there is the ordinary stock market in which the company's shares trade. On the other, however, there is the market for corporate control. Prices in the latter market typically exceed those in the former. Hence, we speak of a "control premium" that is paid when someone buys all of the shares of a company's stock.
The relevant inquiry thus is not what is the company's "intrinsic value" but did the board of directors do an adequate job of figuring out the reservation price of the highest realistically credible bidder. In cases where the board's motives are unquestioned, courts should defer to the board's decision in that regard.
In cases like Dell, however, there are good reasons to question the board's motives. As Paul Weiss explained, VC Laster correctly pointed to such factors as:
The transaction was a management buyout. “Because of management’s additional and conflicting role as buyer, MBOs present different concerns than true arms’ length transactions.”
There was limited pre-signing competition for the Company, and the effectiveness of the post-signing go-shop period was limited by the size and complexity of the Company.
Those are far more relevant inquiries than "intrinsic value." As a White & Case briefing remarked:
Limited pre-signing competition can be an impediment to achieving fair value even if a robust post-signing market check is undertaken during a "go-shop" period given numerous disincentives facing would-be topping go-shop bidders, according to the Court. In particular, the ability for the incumbent buyer to make at least one matching bid in the event of a superior proposal from a third party – a common feature of a go-shop – may have a chilling effect on go-shop bids, especially when the target company is large and complex and therefore requires significant and costly due diligence by the go-shop bidder. The chilling effect may be accentuated in the context of a management-led buyout, in which the incumbent buyer presumably has the best knowledge about the company's prospects and therefore presumably has priced the company properly; moreover, a go-shop bidder in this context must overcome the lack of support from management, which support may be an asset impacting valuation in and of itself. Indeed, in the Dell case, evidence showed that only three financial sponsors and no strategic bidders were involved in the pre-signing sale process, and even though 60 potential buyers were contacted during the go-shop phase, the Court still found that the lack of pre-signing competition rendered the merger consideration unreliable.