‘Dell' Ruling Raises Questions Over Fair Value of Buyouts

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By Michael Greene

June 3 — A recent Delaware Chancery Court decision finding that Dell Inc. stock was undervalued in a 2013 management-led buyout clarified that deal price isn't always the best indicator of a company's “fair value” in appraisal proceedings.

In In re Appraisal of Dell Inc., the court—instead of looking to the negotiated merger price—relied on a valuation method known as “discounted cash flow” to determine that some shareholders should have received almost $4 more per share than what company founder Michael Dell and buyout firm Silver Lakes paid (105 CARE, 6/1/16).

The decision raises a really interesting question about how “you value a company,” Ann Lipton, a professor at Tulane University Law School, told Bloomberg BNA. Is a company valued by performing a cash-flow analysis or is it valued by what people are willing to pay for it? she asked.

Not Fair Value

Under Delaware law, investors that choose not to participate in a merger can petition the chancery court for an appraisal of how much their shares are worth.

Before Dell, the chancery court issued several opinions finding that the parties' negotiated price was the best estimate of a company's value under Delaware's appraisal statute (53 CARE 53, 10/23/15). Those decisions did not involve management-led buyouts.

In one such decision involving the appraisal of Ancestry.com Inc. stock, Vice Chancellor Sam Glasscock in January 2015 made several comments about the difficulties “a law-trained judge” faces in resolving appraisal decisions (13 CARE 255, 2/6/15).

However, Vice Chancellor J. Travis Laster identified several factors in the Dell case that he said showed the negotiated price wasn't fair value.

Laster found that the parties' use of a leveraged buyout (LBO) model to determine the deal price had the effect of undervaluing the company. An LBO is where one company buys another using a significant amount of borrowed funds, such as bonds, to finance the deal.

LBO Model Disfavored

Attorneys said in several law firm memoranda that Dell will have a significant impact on future transactions led by management.

“Facts really matter” in appraisal proceedings, Morris James LLP attorneys said in a May 31 blog post, adding that companies pursuing management-led buyouts “will have a hard time doing almost any deal that will be adequate to establish an appraisal value.”

A June 1 memo authored by attorneys at Debevoise & Plimpton LLP observed that in particular, Laster “appeared to call into question whether a financial sponsor requiring a 20% minimum IRR [internal rate of return] could ever be paying ‘fair value,' at least in circumstances where leverage is constrained.”

It is interesting that Laster distrusted LBO figures based on the amount of return sought by Silver Lakes, Lipton said. She observed that the court was concerned that company value based on what people are willing to pay may be unduly impacted by external constraints, such as the buyers' need for financing and the risks associated with the deal.

Lipton added, however, that such constraints are normally what the parties take into account in pricing a transaction.

Distinguishable Ruling

Lipton suggested that the Dell decision wouldn't have much of an impact on appraisal cases involving arm's-length transactions.

“Right off the bat,” this decision was different from others where the merger price was the best indicator of fair value because Dell involved a management buyout, Lipton said. Companies involved in arm's-length deals will be able to distinguish their cases from Dell, she said.

To contact the reporter on this story: Michael Greene in Washington at mgreene@bna.com

To contact the editor responsible for this story: Yin Wilczek at ywilczek@bna.com

For More Information

The decision is available at http://src.bna.com/fyN.