February 2017 | Issue 84
Introduction
A Delaware Chancery appraisal case involving computer company Dell Inc. gave rise to a multitude of valuation measurements. It is instructive to see how the court sorted through them in coming up with its final appraisal conclusion. The case is In re Appraisal of Dell Inc., 2016 Del. Ch. LEXIS 81 (May 31, 2016).
The Merger
In the summer of 2012, Michael Dell, the founder of Dell Inc., began discussing with a number of leveraged buyout firms the possibility of their working with Mr. Dell to accomplish an LBO of Dell.
On October 23, 2012 two buyout firms, Silver Lake and KKR, provided the special Committee of Dell’s board with an indication of interest to acquire the company at $12.50 per Dell share. The Committee turned the proposal down. On December 3, 2012, KKR dropped out of the bidding.
On January 15, 2013, Silver Lake increased its bid to $12.90 per share.
The Committee proposed a sale price of $13.75 per share to Silver Lake. Silver Lake countered at $13.50.
After a concession by Mr. Dell concerning the value of his shares, Silver Lake increased its price to $13.65 per share. The Committee recommended that the Dell board accept it, which they did. The transaction was formalized in a Merger Agreement dated February 6, 2013.
The Go-shop
The Merger Agreement contemplated a 45 day “go-shop” period to allow the solicitation of competing bids.
On February 5, Dell, with the help of Evercore as advisor, began the go-shop process. Within 10 days, Evercore had contacted 60 parties. Companies contacted included Hewlett-Packard, Blackstone and Icahn Enterprises. The go-shop process succeeded in developing two additional bidders, Blackstone and Icahn.
On March 10, Icahn sent a letter to Dell’s board expressing opposition to the Merger and proposing a leveraged recapitalization in its place.
On May 9, 2013, Icahn and Southeastern joined together to propose a modified recapitalization in which stockholders would retain their current holdings and could elect to receive either (i) a distribution of $12.00 per share in cash or (ii) $12.00 worth of additional shares, with the new equity issued at a value of $1.65 per share. This proposal never came to fruition.
After some further negotiation, a shareholders’ meeting was held September 12, 2013 and the merger was approved with a 57% favorable vote at $13.75 per share. A number of shareholders exercised their appraisal rights, thus setting in motion this appraisal action.
The Appraisal Arguments
The merger price was $13.75 per share. The Petitioners claimed that the fair value of the stock was $28.61. The Respondent valued it at $12.68. Both Petitioner and Respondent used a discounted cash flow (DCF) approach to develop their values. The bidders had used something called the LBO model to develop their prices. The LBO model is another method of deriving a value from discounted financial projections. It differs from the DCF cash flow approach in that it solves for the equity rate of return rather than for the value of the entity. Since the equity rates of return used in LBO calculations tend to be high, in the neighborhood of 20% or more,(roughly twice the discount rates used in the DCF method) they tend to produce lower values for a target company than the conventional DCF method.
The court felt that since the LBO method is widely used in the buyout community, there is not a great deal of variation to be found between one buyout firm’s bid and anothers’.
Probative Value of the Sale Process
The court also analyzed the proposition that the transaction price itself provides the best evidence of fair value. The Petitioners’ expert claimed that the Merger undervalued the company by $23 billion. Paraphrasing the court, “if this is the case, why didn’t Hewlett Packard or another technology firm step forward to acquire the company on the cheap?”
In the final analysis, the court felt that the DCF approach produced a value that was closer to Delaware’s idea of fair value than the LBO model does. Therefore, the court calculated fair value by performing a DCF analysis that blended the DCF assumptions of the Petitioner with those of the Respondent, producing a value of $17.62 per share.
The court derived comfort that the deal price was not far from the fair value from the fact that notwithstanding the energetic efforts expended to find another buyer during the no-shop period, the market yielded up only two more bids, and those bids were very little different than those that the Committee already had in hand.
Comparison with Stock Price
All of the prices considered here were well above the contemporaneous market price for Dell stock. This was viewed by the buyers as a “negative bubble” in the Dell stock price brought about by a several- year period of slow growth, heavy capital expenditures and disappointing earnings. This period was expected to be followed in the not-too-distant future by a generous harvest of earnings and increasing value for the company as the capital expenditures bore fruit.
