Comment: Finding fair value in merger prices

On October 21, 2015, the Delaware Court of Chancery decided Merion Capital LP v. BMC Software Inc., the largest Delaware statutory appraisal action ever to reach a post-trial decision.

The litigation arose out of the $6.9 billion acquisition of BMC, a software company, by a group of private equity firms led by Bain Capital and Golden Gate Capital. Merion Capital, an appraisal arbitrage fund that had acquired approximately $350 million worth of BMC stock shortly before the closing, sought appraisal, claiming that its BMC stock was worth $180 million more than the deal price, according to its expert’s discounted cash flow analysis of the company. Following a recent line of Delaware decisions, VC Glasscock decisively rejected Merion Capital’s claims and found “the Merger price…to be the best indicator of fair value,” in light of the “robust, arm’s length sales process.”

Historically, Delaware courts have often relied heavily on DCF analyses based on management projections prepared in the ordinary course of business to determine fair value in appraisal proceedings. More recently, appraisal arbitrage firms have relied on this practice to argue that, based on their own experts’ DCF analyses, target companies are worth far more than the price they were sold for – even if that price resulted from a robust arm’s-length sale process.

In a 2010 decision (Golden Telecom), the Delaware Supreme Court noted that, because the appraisal statute requires the Court of Chancery to consider “all relevant factors” when valuing a company, “[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.” This decision led some practitioners to believe that the Chancery Court could not rely on the merger price at all in appraisal proceedings.

But in 2013, VC Glasscock held in the CKx appraisal case that while Golden Telecom may bar a systematic presumption in favor of the merger price, it allows reliance on the merger price where it is the best evidence of fair value in the record. The CKx decision (which was affirmed by the Delaware Supreme Court in a short order) went on to place 100 percent weight on the merger price where that price resulted from a robust, arm’s length sales process, and the DCF method could not reliably measure the target company’s value because the company’s projections were “not prepared in the ordinary course of business.”

Four subsequent Chancery Court decisions have followed this analysis, but until BMC, each of those decisions was careful to note that the relevant target company’s projections were prepared outside the ordinary course of business or were otherwise unreliable. Merion Capital sought to convince the BMC court that projections (and therefore a DCF analysis) should be used instead of the merger price because BMC did prepare ordinary course projections, and therefore could be distinguished from the other recent cases.

But VC Glasscock held that even though BMC created projections in the ordinary course of business, and BMC’s “management was able to reliably predict a significant portion of revenue” due to BMC’s multiyear contracts with customers, the merger price was still the best indicator in the record of BMC’s fair value. In doing so, the court expressed a degree of skepticism in DCF modeling as a decisive valuation technique, at least where the court has confidence that the merger price resulted from a vigorous sale process.
With signs pointing to the possibility that certain investors were beginning to use (abuse?) the appraisal process as a potentially more lucrative replacement for the now ubiquitous fiduciary litigation, the BMC court decision strengthens the ability of companies to argue that Delaware courts should reject challenges to a merger price resulting from a thorough and effective sales process, even where the target company prepared ordinary course projections.

Yosef Riemer and Devora Allon are New York-based litigation partners at Kirkland & Ellis, a law firm.