Last week, the Delaware Court of Chancery issued its first significant appraisal decision applying the Delaware Supreme Court’s recent Dell[1] and DFC[2] opinions, which we’ve previously discussed here and hereSee Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., C.A. No. 11448-VCL (“Aruba”).  Although Dell and DFC both emphasized that deal price will often be the best evidence of fair value in appraisal actions involving open, competitive, and arm’s-length mergers of publicly traded targets, neither case involved a merger where the transaction resulted in significant synergies,[3] which are excluded statutorily from the determination of fair value.[4]  Picking up where those cases left off, the court in Aruba, despite finding that the deal price was the product of an uncompetitive and flawed process, nonetheless found fair value to be significantly below deal price because the merger resulted in significant synergies.  The court instead found fair value to be equal to the pre-announcement market trading price of the public shares, which was 30% below the deal price.  Subject to any appeal from this decision, Aruba continues, and in the context of strategic mergers expands upon, the trend of substantially reducing appraisal risk for buyers of public companies.

The Aruba appraisal action arose out of the May 2015 acquisition of Aruba Networks Inc. by Hewlett-Packard Company (“HP”).  Following a three-day trial, the court issued a 129-page opinion finding that the fair value of Aruba shares was the average unaffected market price of $17.13 per share, more than 30% below the deal price of $24.67, and lower than the $19.75 discounted cash flow (“DCF”) valuation that Aruba’s expert proposed.

On deal price, the court found several issues with the sale process that led it to conclude that Aruba could have obtained a higher price, including that HP knew it had no competition for Aruba and that Aruba’s bankers “catered” to HP and were “less effective negotiators than they might have been.”[5]  Noting, however, that Dell makes clear that “[t]he issue in an appraisal is not whether a negotiator has extracted the highest possible bid,” but “whether the dissenters got fair value and were not exploited,”[6] the court determined that the transaction “looks like a run-of-the-mill third-party deal” and “[n]othing about it appears exploitive.”[7]  The court also pointed out that regardless of whether Aruba could have captured a larger share of the value of expected synergies from HP with a better process, that would not have changed Aruba’s standalone value, which is what the court is required to consider in an appraisal.[8]  Thus, the court determined that, “given the inclusion of synergies, there is good reason to think that the deal price exceeded fair value and, if anything, should establish a ceiling for fair value.”[9]
On market price, the court noted that the market for Aruba’s unaffected public shares had the “attributes associated with market efficiency” identified in Dell – including that it had “many stockholders; no controlling stockholder; highly active trading; and . . . information about the company [wa]s widely available and easily disseminated to the market” – which the Delaware Supreme Court has explained indicate that the market price is “likely a possible proxy for fair value.”[10]  Although the Court of Chancery suggested that, in a future case, “a case-specific expert opinion supported by credible evidence and the weight of social-science research” could show that the market was inefficient despite the presence of these indicia of efficiency, there was no such evidence in this case.[11]

Consistent with DFC and Dell, the court eschewed reliance on a DCF analysis, both because of concerns about the methodology used by each expert as well as the wide range between the two results.[12]  The court acknowledged that, as an alternative to relying on the deal price or unaffected market price, it could attempt to “back out” synergies from the deal price to arrive at a fair value determination, but stated that “[t]he Delaware Supreme Court’s expressed preference in Dell and DFC for market indicators over discounted cash flow valuations counsels in favor of preferring market indicators over the output of a similarly judgment-laden exercise of backing out synergies.”[13]  For this reason, the court found that the unaffected market price provided the most straightforward and reliable method for determining Aruba’s fair value as a going concern, as it “provides a direct measure of the collective judgment of numerous market participants,” as to the fair value of the shares exclusive of any element of value arising from the merger, whereas the deal-price-less-synergies method is “messy and provide[s] ample opportunities for error.”[14]

One final point about the court’s analysis bears emphasis.  In deciding to rely exclusively on the unaffected market price, the Court of Chancery recognized that such price excludes both expected synergies arising from the merger and the benefits of control (since shares trading on a national exchange include a minority discount).[15]  Although longstanding Delaware precedent holds that it is inappropriate for the court to apply a minority discount in determining fair value in an appraisal,[16] the court interpreted that precedent as applying only to cases involving a controlling stockholder.[17]  Where there is no controlling stockholder, the court reasoned that, like synergies, the benefits of control “aris[e] from the accomplishment or expectation of the merger,” and thus are statutorily excluded from fair value.[18]

Aruba’s holding, of course, may not be extended to transactions involving privately-held companies, companies trading on markets that can be demonstrated to be inefficient, take-private transactions with a controlling stockholder, or acquisitions by financial buyers without synergies.  But absent an appeal or if affirmed on appeal, the decision will have a substantial effect on appraisal litigation involving widely held and actively traded public companies – perhaps more so than even Dell and DFC.

[1] Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd., – A.3d –, 2017 WL 6375829 (Del. Dec. 14, 2017).

[2] DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017).

[3] See Dell, 2017 WL 6375829, at *13; DFC, 172 A.3d at 371.

[4] 8 Del. C. § 262(h) (“Through such proceeding the Court shall determine the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger . . . .”).

[5] Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., – A.3d –, 2018 WL 922139, at *96-98 (Del. Ch. Feb. 15, 2018).

[6] Id. at *52 (citing Dell, 2017 WL 6375829, at *24).

[7] Id. at *87; see also id. at *2 (“The petitioners proved that the Company’s negotiators might have done better, but there is no reason to believe that they left any of Aruba’s fundamental value on the bargaining table.”).

[8] Id. at *44.

[9] Id. at *87.

[10] Id. at *25-27.

[11] Id. at *24.

[12] See id. at *52-53 (petitioners’ method led to a $32.57 valuation, while Aruba’s method led to a $19.75 estimate).

[13] Id. at *126 (citing Dell, 2017 WL 6375829, at *26; DFC, 172 A.3d at 388).

[14] Id. at 125-28.

[15] Id. at *3.

[16] See DFC Global, 172 A.3d at 367-68 (citing Cavalier Oil Corp. v. Harnett, 564 A.2d 1137, 1145 (Del. 1989)).

[17] Aruba, 2018 WL 922139, at *23.

[18] Id. at *3; 8 Del. C. § 262(h).