(Article from Securities Law Alert, February 2015)
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Pursuant to Section 262 of the Delaware General Corporate Law (“DGCL”), stockholders in companies that engage in certain merger transactions may petition the court for an appraisal of “the fair value of [their] shares exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation.” 8 Del. C. § 262. The court may not presumptively rely on the merger price in its appraisal analysis. Golden Telecom v. Global GT LP, 11 A.3d 214 (Del. 2010). Rather, the court must “take into account all relevant factors” when “determining [the] fair value” of the shares. If the court finds that the fair value exceeds the merger price, then the surviving corporation must pay the difference in value to the petitioning stockholders.
In Huff Fund Investment Partnership v. CKx, Inc. (Huff Fund), 2013 WL 5878807 (Del. Ch. 2013) (Glasscock, V.C.), the Chancery Court relied on the merger price in assessing the value of shares of CKx, an entertainment company that owns the rights to American Idol, following Apollo Global Management’s 2011 acquisition of CKx. The court found the merger price to be “the most relevant exemplar of valuation available” given that other valuation methodologies were “either unreliable or unavailable.” On February 12, 2015, the Delaware Supreme Court issued a two-paragraph order affirming the Chancery Court’s appraisal determination. Huff Fund Investment Partnership v. CKx, Inc., 2015 WL 631586 (Del. 2015) (Valihura, J.).
Chancery Court Explains That the Merger Price Is Among the “Relevant Factors” Courts May Consider in Section 262 Appraisal Actions
At the outset of its analysis, the Chancery Court explained that the Delaware Supreme Court “has interpreted the language of Section 262(h) … to preclude the use of ‘inflexible rules’ or presumptions favoring any particular valuation method or analysis.” Huff Fund, 2013 WL 5878807 (citing Golden Telecom, 11 A.3d 214). Under Section 262, courts have “‘significant discretion’ to consider the data and use the valuation methodologies they deem appropriate” (quoting Golden Telecom, 11 A.3d 214). A court “has the latitude to ‘select one of the parties’ valuation models as its general framework, or fashion its own, to determine fair value in an appraisal proceeding’” (quoting Golden Telecom, 11 A.3d 214).
The Huff Fund court recognized that under Section 262 and “the interpreting case law,” courts may not “rely presumptively on the price achieved by exposing the company to the market.” Courts must “evaluate ‘all relevant factors,’ and arrive at a going-concern value inclusive of any assets not properly accounted for in the sale, but exclusive of synergy value that may have been captured by the seller.” Given the “complexity in valuing, marketing and selling an ongoing corporate enterprise,” courts have “[t]ypically… relied on expert valuation, such as those employing discounted cash flow and comparable company analyses, to determine statutory fair value.”
Nevertheless, the Huff Fund court found that “market value―where reliably derived―remains among the ‘relevant factors’ for arriving at fair value” for Section 262 purposes. The court explained that it has “previously recognized that ‘an arms-length merger price resulting from an effective market check is entitled to great weight in an appraisal’” (citing Global GT LP v. Golden Telecom, Inc., 993 A.2d 497 (Del. Ch. 2010), aff’d, 11 A.3d 214 (Del. 2010)). The Huff Fund court also pointed out that “[i]n at least one case involving judicial appraisal under Section 262, the [Chancery] Court decided to place 100% weight on the merger price” (citing Union Illinois 1995 Inv. Ltd. P’Ship v. Union Fin. Grp., Ltd. 847 A.2d 340 (Del. Ch. 2004)).
Chancery Court Determines That the Delaware Supreme Court’s Decision in Golden Telecom v. Global GT LP Does Not Preclude Consideration of the Merger Price in a Section 262 Appraisal Action
The Huff Fund court rejected petitioners’ contention that the Delaware Supreme Court’s decision in Golden Telecom, 11 A.3d 214 stands for “the proposition that merger price is … irrelevant in an appraisal context” and that courts must “accord [the merger price] no weight when determining fair value.”
The Huff Fund court explained that the petitioners in Golden Telecom “asked the Supreme Court to reform Delaware appraisal law by imposing a new presumption in favor of merger price as evidence of fair value.” The Delaware Supreme Court declined to “establish a rule requiring the Court of Chancery to defer to the merger price in any appraisal proceeding.” Golden Telecom, 11 A.3d 214. The Delaware Supreme Court reasoned that “[r]equiring the Court of Chancery to defer―conclusively or presumptively―to the merger price, even in the face of a pristine, unchallenged transactional process, would contravene the unambiguous language of the statute and the reasoned holdings of our precedent.”
The Huff Fund court determined that “the ruling in Golden Telecom―like the appraisal statute itself―is inclusive, rather than exclusive.” Huff Fund, 2013 WL 5878807. The Golden Telecom decision “recognizes that differing circumstances may support reliance on one or another valuation method under the particular circumstances there presented.” Pursuant to the “clear” “holding and rationale of Golden Telecom,” courts have “an obligation to consider all relevant factors” in a Section 262 appraisal action. “[N]o per se rule should presumptively or conclusively exclude any of those factors from consideration[,]” including the merger price.
Chancery Court Holds That the Merger Price Is the Most Reliable Indicator of the Value of CKx’s Shares
In appraising CKx’s shares, the Huff Fund court determined that “the merger price [was] the most reliable indicator of value” given that “no comparable companies, comparable transactions, or reliable cash flow projections exist[ed].” The court found unreliable the “comparable companies” analysis presented by petitioners’ expert because the expert “admitted at trial that he found no companies he could describe as ‘comparable’ to CKx.”
The court also deemed unreliable petitioners’ expert’s discounted cash flow (“DCF”) analysis because it was based on management projections that were “not prepared in the ordinary course of business.” The Huff Fund court explained that “[t]he reliability of a DCF analysis … depends, critically, on the reliability of the inputs to the model.” Management projections “are generally deemed reliable” when they “are made in the ordinary course of business.” However, the Chancery Court “has disregarded management projections where the company’s use of such projections was unprecedented, where the projections were created in anticipation of litigation, or where the projections were created for the purpose of obtaining benefits outside the company’s ordinary course of business.”
Here, the CKx management projections at issue were created “in connection with expressions of interest from potential acquirers” and were based on “an assumption that revenues under the to-be-negotiated American Idol contract would increase by approximately $20 million each year.” The Huff Fund court found that the CKx management projections reflected “little more than guesswork” as to the likely outcome of the American Idol negotiations. The court therefore determined that “[t]he unreliability of the revenue estimates, both including and excluding the $20 million estimate, [was] a serious impediment to creating a reliable DCF analysis.”
“In the absence of comparable companies or transactions … and without reliable projections to discount in a DCF analysis,” the Huff Fund court “rel[ied] on the merger price as the best and most reliable indication of CKx’s value.” The court explained that “[t]he sales process here [had] been challenged, reviewed and found free of fiduciary and process irregularities.” Moreover, “[t]he company was sold after a full market canvas and auction.” Under the circumstances, the Huff Fund court determined that the sales price was “the most reliable indication of CKx’s value.” The Delaware Supreme Court subsequently affirmed the Chancery Court’s appraisal determination.