What the Dell
Decision Teaches Us About Valuation
The ruling involving Michael Dell’s management buyout highlights why
two reputable share-valuation experts could differ by 126%.
Mark L. Zyla
July 18, 2016 | CFO.com | US
The May 31 Delaware Court of Chancery decision
In Re: Appraisal
of Dell, Inc. highlights many of the valuation issues
faced not only by the Chancery Court in post-merger disputes, but by
many courts in all types of disputes over valuation.
In the Dell matter, the Chancery Court held that the fair value of
Dell, Inc. was $17.62 per share in a going-private transaction in
September 2013. This opinion of value by the Court was about 30% more
than the transaction price of $13.78 per share. At first glance, the
Court’s opinion of value was surprising, since it is greater than a
transaction price derived through a year-long process involving
competing arm’s-length proposals.
The story essentially begins In 2012, when Michael Dell approached
Dell’s board about taking the company private through a management
buyout (MBO), to be sponsored by one or more private equity firms.
Before the eventual transaction, a special committee of Dell’s board
retained two investment advisers and a consulting firm to assist in
“shopping” the company during a 45-day “go-shop” period as part of the
board’s due diligence.
of the investment advisers contacted about 60 potential acquirers,
which resulted in at least two credible offers to acquire the company.
In September 2013 the shareholders approved a deal from one of the
financial sponsors rather than one of the two bids obtained during the
“go shop” period.
As part of the transaction, Dell obtained two fairness opinions which
concluded that the transaction was fair “from a financial point of
view.” But certain groups of shareholders dissented from the
transaction and asserted their appraisal rights, believing the
transaction price to be too low.
During the trial, both parties presented valuation experts, each one
of which providing an opinion of the fair value of a share of common
equity of Dell as of the transaction date. The petitioner’s expert in
the case concluded that the fair value of Dell was $28.61 per share,
while the respondent’s valuation expert concluded $12.68 per share.
The court noted that “two highly distinguished scholars of valuation
science, applying similar valuation principles, thus generated
opinions that differed by 126%, or approximately $28 billion. This is
a recurring problem.” The Court eventually concluded the fair value of
Dell was $17.62 per share.
The Dell decision highlights why two reputable experts may differ
about an opinion of value. First, experts must deal with how value is
defined by the courts. In the Chancery Courts of Delaware, fair value
is defined as: “the fair value of the shares exclusive of any element
of value arising from the accomplishment or expectation of the merger
or consolidation, together with interest, if any, to be paid upon the
amount determined to be the fair value. In determining such fair
value, the Court shall take into account all relevant factors.”
Fair value is the value to existing shareholders just prior to the
corporate action (in the case of Dell, the management buy-out) and
should not include any value enhancement from the transaction itself.
The definition of value in a particular matter often leads the
valuation expert to use certain specific assumptions and methodologies
in performing the valuation. Two common valuation techniques often
used to measure the fair value of an operating entity like Dell are
the use of multiples of similar publicly traded companies (“the
guideline public company method”) and a
flow method (DCF).
In a large going-private transaction like the Dell buyout, the share
price of similar publicly traded companies may be affected by a
competitor’s proposed MBO. As a result, the guideline public company
method may include benefits from the proposed transaction which are
contrary to the definition of fair value. As such, the DCF often
becomes the primary valuation method, but supported by multiples of
similar, guideline companies. In Dell, however, the court relied
solely upon the DCF method.
The DCF has three basic components: the explicit forecast period of
cash flows, cash flow after the forecast period, and the discount rate
reflecting the risk of receiving the cash flows. The starting point of
the discounted cash flow is typically forecasts prepared by management
reflecting their expectation of the future. Courts tend to prefer
prospective financial information (PFI) prepared at the same time in
the ordinary course of business so that any potential biases in the
assumptions are likely mitigated.
Next, the value contributed by cash flows after the first forecast
period are often limited by using an assumption to reflect the overall
growth in the economy in estimating these longer term returns.
The third component of the DCF is the selection of a discount rate to
discount the cash flows to the present to reflect the relative risk of
not achieving the forecasts. Academics continue to debate the
assumptions which underlie the cost of capital. The cost of capital is
typically used as a proxy for the discount rate in a DCF. The
assumptions used by valuation specialists in the DCF can cause a wide
variation in conclusions.
In the Dell case, the valuation experts assumed different weightings
of debt and equity in estimating the appropriate capital structure of
the company. Both experts also made different assumptions in the
required return on equity, which were incorporated into their
respective discount rate. The court, however, ignored certain
assumptions used by both experts and computed its own discount rate.
In contemplating the MBO, Dell’s board retained an outside consulting
firm to assist in preparing detailed forecasts of expected cash flows
of the company. At the trial, both experts used the forecasts as a
basis for their DCF. But the respondent’s expert adjusted the
forecasts for the declines in market conditions from the time the
forecasts were prepared in January 2013 to the transaction date, as
well as a “transition period” to normal operations and stock-based
While courts traditionally prefer forecasts prepared at the same time,
the court in the Appraisal of Dell concluded that the
respondent’s expert’s adjustments to two specific sets of projections
were reliable, although one was more conservative and the other more
optimistic. In reaching its opinion of the share’s value, the court
made adjustments to the experts’ discount rates and their assumptions
regarding excess working capital and taxes. But the court used the
respondent’s expert’s two adjusted forecasts. The Court gave equal
weight to conclusions under both forecasts after other adjustments in
its opinion that the fair value was $17.62 per share.
What can we learn about valuation from this opinion?
First, each situation is based on facts and circumstances. In Dell,
the per share price of a publicly traded share of a company’s stock
was determined not to be its fair value. Secondly, despite the company
being presented to a host of potential acquirers, the eventual
transaction price was determined to be not at fair value.
But fair value may be based on contemporaneously prepared forecasts if
they’re deemed reliable. Finally, guideline companies and comparable
transactions may also indicate fair value but also require detailed
analysis to determine their reliability.
Mark L. Zyla is Managing Director of Acuitas, an Atlanta-based
valuation and litigation consultancy firm. He is the author of
Fair Value Measurements: Practical Guidance and Implementation 2nd
ed., published by John Wiley & Sons in 2013.