(Article from Securities Law Alert, October 2015)
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On October 21, 2015, the Delaware Chancery Court issued a post-trial decision in an appraisal action brought in connection with the private equity buyout of BMC Software. Merion Capital LP v. BMC Software, Inc., 2015 WL 6164771 (Del. Ch. 2015) (Glasscock, V.C.). The court held that it was “appropriate to look to the price generated by the market through a thorough and vigorous sales process as the best indication of fair value.”
Background
At the outset of its analysis, the Chancery Court observed that the case “present[ed] what has become a common scenario.” The court explained that the buyout involved “a robust marketing effort for a corporate entity result[ing] in an arm’s length sale where the stockholders [were] cashed out, which sale [was] recommended by an independent board of directors and adopted by a substantial majority of the stockholders themselves.” After the sale, “dissenters . . . [sought] statutory appraisal of their shares.” During the trial that followed, “the dissenters/petitioners present[ed] expert testimony opining that the stock was wildly undervalued in the merger, while the company/respondent present[ed] an expert, just as distinguished and learned, to tell [the court] that the merger price substantially exceed[ed] fair value.”
Chancery Court Conducts Its Own DCF Analysis and Determines the Fair Value to Be Slightly Higher Than the Merger Price
The Chancery Court noted that 8 Del. C. § 262 “vests the [c]ourt with significant discretion to consider the data and use the valuation methodologies it deems appropriate.” The court began its analysis with the discounted cash flow (“DCF”) valuation approach, which both parties agreed was “the appropriate method by which to determine the fair value of BMC.” The court’s DCF analysis produced a valuation of $48 per share – slightly higher than the merger price of $46.25 per share. However, the court was “reluctant to defer” to its own DCF valuation because it was based on management projections that were, according to the company’s expert, “historically problematic, in a way that could distort value.” The court was also “concerned about the discount rate” given the “meaningful debate on the issue of using a supply side versus historical equity risk premium.” (Following recent Delaware precedent, the court used a supply side equity risk premium (“ERP”), but recognized that “there is an argument in favor of using the historical ERP.”) Finally, the court used “the midpoint between inflation and GDP as the [c]ompany’s expected growth rate” in accordance with Chancellor Strine’s decision in Global GT LP v. Golden Telecom, Inc., 993 A.2d 497 (Del. Ch. 2010), aff’d, 11 A.3d 214 (Del. 2010), but stated that it did not have “complete confidence in the reliability of this approach.”
Chancery Court Finds the Merger Price to Be the Best Indication of Fair Value Because the Sales Process Was Thorough and Fair
The Chancery Court then considered the merger price. The court explained that in Huff Fund Investment Partnershp v. CKx, Inc., 2015 WL 631586 (Del. Feb. 12, 2015), aff’g, 2013 WL 5878807 (Del. Ch. Nov. 1, 2013), the Delaware Supreme Court held that “the deal price is a relevant measure of fair value” provided “the sales process is thorough, effective, and free from any spectre of self-interest or disloyalty.” Here, the court found that BMC had engaged in “a robust, arm’s-length sales process during which the [c]ompany . . . conducted two auctions over roughly the course of a year, actively marketed itself for several months in each, as well as vigorously marketed itself in the 30-day Go Shop period.” The court deemed meritless petitioners’ claims that an activist investor had pressured BMC “into a rushed and ineffective sales process that ultimately undervalued the [c]ompany.” While the court found that the investor “was clearly agitating for a sale,” the court determined that this “agitation did not compromise the effectiveness of the sales process.”
The court further found that no reduction to the merger price was warranted to account for merger-related synergies as opposed to value that could be “attributed to the corporation as an independent going concern.” The court rejected petitioners’ contention that the court should deduct “tax savings and other cost savings that the acquirer professed it would realize once BMC [was] a private entity.” The court reasoned that “such . . . savings [are] logically a component of the intrinsic value owned by the stockholder that exists regardless of the merger.” The court further found that even if the merger price reflected some merger-related synergies, petitioners had failed to meet their burden to demonstrate that there “were synergies realized from the deal” that “were . . . captured by sellers in the deal price.”
Because “the sales process was sufficiently structured to develop fair value” for BMC, the court held that “the merger price [was] the most persuasive indication of fair value available.”