praise of merger appraisals
23 February 2017 By Reynolds Holding
Reynolds Holding is
a writer and editor at Columbia Law School. Formerly the legal
editor at Breakingviews, he has been a national editorial
producer for the Law & Justice Unit at ABC News, a senior writer
for Time magazine and the executive editor of Legal Affairs, the
first general-interest magazine about the law. He spent more
than a decade as an investigative reporter and columnist for The
San Francisco Chronicle, where he was named a Pulitzer Prize
finalist for explanatory writing. Before becoming a journalist,
he practiced corporate law at the New York firm of Debevoise &
Plimpton. He graduated from Harvard College and Duke University
School of Law.
shareholders deserve praise for their appraisals. Dissenters to payday
lender DFC Global’s $1.3 billion sale three years ago persuaded a
Delaware judge that they received about 8 percent less than fair value
for their stock. The company appealed, citing a judge’s computational
error as proof that courts shouldn’t second-guess deal prices. It’s
now up to the state’s Supreme Court to uphold a process that keeps
merging companies honest.
appraisal rights – a century-old fixture of Delaware law – allow
shareholders who didn’t vote for a cash merger to ask a judge for a
sweeter deal. Last July, Chancellor Andre Bouchard ruled that DFC
investors should have received $10.21 a share rather than the $9.50
that private equity firm Lone Star paid.
acknowledged that the arm’s-length sale to a third-party buyer after a
two-year process gave the merger price credibility. Even so, Lone
Star’s focus on its internal rate of return and its view that DFC was
on the verge of an upswing meant the amount was below fair value. The
judge calculated a new number by giving equal weight to the deal
price, the company’s discounted cash flow and the median value of
a mistake that inflated Bouchard’s cash-flow calculation. When the
judge redid the numbers, however, he also increased the company’s
assumed growth rate from 3.1 percent to 4 percent, leading to an even
higher fair value of $10.30 a share.
Understandably miffed, DFC appealed to the Delaware Supreme Court,
calling the case “the perfect illustration of the arbitrariness and
imprecision” involved in appraisal actions. The best fix, argued the
company, was to defer to the price “proven by a real-world,
arm’s-length, conflict-free transaction.”
It’s a fair
point. In fact, several recent cases – including one last year
involving title insurer Fidelity National Financial’s $2.9 billion
purchase of Lender Processing Services – ended with the merger price
prevailing. It’s not hard to imagine the Supreme Court adopting a
narrow rule requiring deference to that price in strictly arm’s-length
probably be a mistake, however. Appraisal was designed to protect
minority shareholders who prefer to keep their stock from being
unfairly exploited by a majority intent on cashing them out – sort of
like a right to eminent domain. It also gives bidders an incentive to
offer the best deal possible and minimize the number of dissenters.
more, even an arm’s-length transaction with no conflicts of interest
can undervalue a target. Common deal protections are one culprit.
No-shop provisions block sellers from seeking a higher price, and
matching rights that give buyers the option to meet or beat an offer
discourage other bidders. “Crown jewel” lockups, which hand over
valuable assets even if a transaction falls through, can be an
impediment that courts often discourage, though they have turned up in
deals like Intercontinental Exchange’s $8.2 billion acquisition of
NYSE Euronext. Breakup fees also can thwart better offers.
of corporate bidders, whose long-term focus may justify a premium
price, also may cause problems. Private-equity firms like Lone Star
need hefty rates of return over relatively few years and can borrow
only limited amounts, all factors that can depress a bid. The tortuous
process of taking computer company Dell private in 2013 met resistance
largely for those reasons. Delaware Vice Chancellor Travis Laster
noted how fairly the $25 billion transaction had been conducted before
awarding dissenting stockholders $17.62 a share last year instead of
the $13.75 that Michael Dell and Silver Lake Partners had paid.
shareholder approval doesn’t ensure top dollar. Institutional
investors may accept less if it produces a timely gain or offsets a
loss for quarterly reporting purposes. And fair value at signing may
be anything but if the company is worth substantially more at closing,
the date relevant to the appraisal calculation.
lawsuits are the bane of M&A, but appraisal actions offer little
reason to worry. They’re costly and carry the risk that shareholders
will end up with the merger price – or less. That’s why they generally
target only suspect deals.
subject to appraisal lawsuits are, for example, sold for substantially
lower premiums than other firms, researchers at Oregon State and San
Diego State universities found. Every 10 percentage-point reduction in
a deal premium increases the chances of an appraisal case by about
0.72 percent, according to a study from Columbia and Vanderbilt
universities. The lawsuits are also notably successful, with Delaware
judges awarding holdout investors between 8.5 percent and 149 percent
above the merger price in seven of the nine cases decided between 2010
and 2015, according to New York law firm Fried Frank.
can be imprecise and maybe even arbitrary, but on balance it’s a
useful check on unfair transactions. It ensures that America’s most
financially literate – though imperfect – court will review how
companies sell themselves, how their advisers behave and how their
boards reach decisions. That’s reason enough for the Delaware Supreme
Court to keep its judgment in favor of appraisals.
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