In a noteworthy new post-sale appraisal ruling, the Delaware Court of Chancery in BCIM Strategic Value Master Fund, LP v. HFF, Inc.[1] awarded the petitioner additional consideration based on an increase in the value of the target company that arose between signing and closing.  The unique facts of this case, and particularly the sustained outperformance of the target in the interim period before closing, are worth keeping in mind in evaluating the risk that a successful appraisal proceeding can increase the amount of consideration payable in a public company acquisition.  Below we break down the Court’s analysis in determining fair value, how changes in each merger party’s valuation drove the appraisal result, and key takeaways.

The Decision

The case arose in connection with Jones Lang LaSalle Inc.’s (“JLL”) $1.8 billion cash-and-stock acquisition of HFF Inc. (“HFF” or the “Company”), announced on May 19, 2019.  The transaction closed on July 1, 2019, and in the months between signing and closing, the per-share value of the deal consideration declined from $49.16 (based on the price of JLL’s stock at signing) to $45.87 (based on the price of JLL’s stock at closing), as a result of a greater than 13% drop in JLL’s stock price.[2]

Petitioner, a former HFF stockholder, asserted appraisal rights and presented several valuation methods to establish the Company’s fair value, including a traditional discounted cash flow analysis and an adjusted trading price analysis based on the Company’s unaffected trading price before the announcement of the merger, and adjusted based on a model reflecting changes attributable to the Company’s unexpectedly positive financial performance after the announcement.[3]  Petitioner argued for 90% weight on the DCF method and 10% weight on the adjusted trading price, which it argued would have implied a fair value on the closing date of $56.44 per share.[4]  The Company, in contrast, argued that, consistent with the approach endorsed by the Delaware Supreme Court in Dell[5] and Aruba[6], which we have previously discussed here and here, the Court should rely on the implied value of the merger consideration on the signing date, adjusted to deduct an estimate of net synergies embedded in the deal price.[7]

The Court first evaluated HFF’s sale process based upon the following factors:  (i) affiliations with the acquirer, (ii) conflict of interests, (iii) access to public information, (iv) bidder due diligence, (v) negotiations over the merger price, and (vi) the post-signing phase, including the opportunity for potential competing bidders to make a topping bid.[8]  Although the sale process had “flaws” — including that two employee-directors leading negotiations may have had differing interests from stockholders generally (including a focus on ongoing leadership positions in the combined company), that negotiations on price were delayed while executives negotiated governance terms, and that the Company ran a “single bidder” process — the Court found that the sale process was effective.  For instance, the Court found that the employee-directors’ focus on employee retention was important to an acquirer buying a “people” business, and the merger agreement’s bifurcated termination fee was of a size that, even accounting for the potential need to “top” retention agreements in addition to payment of the termination fee, was not preclusive of another bid or coercive of the stockholder vote.

Accordingly, the Court ruled that the deal price was reliable evidence of the fair value of HFF at the time of signing.[9]  The Court then derived an adjustment for synergies by assessing the categories of value that the parties claimed would arise from the accomplishment or expectation of the merger and estimating the extent to which those sources of value were incorporated in the deal price.  Finding that JLL carefully documented its synergies and limited its estimates to amounts that could be deemed certain, the Court agreed with JLL that the deal consideration included $4.87 per share worth of synergies.[10]  Deducting $4.87 from the deal price resulted in an implied valuation for the Company of $44.29 per share as of the signing date.

Under Delaware law, however, the Court must determine the fair value of the target company on the date the merger closes.[11]  Here, the Court found that the implied value of the merger consideration declined substantially between signing and closing, falling from $49.16 per share at signing to $45.87 per share at closing, as a result of a decline in JLL’s stock price, but that the fair value of the Company had increased due to its outperformance in the sign-to-close period.

Undertaking the “difficult task” of evaluating the magnitude of change in the Company’s value between signing and closing, the Court looked at valuation models based upon market price methodologies presented by both parties’ experts.[12]  JLL argued that the Company’s outperformance amounted to merely favorable quarterly results and was not sufficient evidence to justify an adjustment to the deal price, largely pointing to the PetSmart decision, in which the Chancery Court declined to adjust the deal-price-based fair value determination based on post-signing positive results.[13]  The Court rejected this argument, finding that the Company’s outperformance was both more “significant and durable,” than in PetSmart, because in this case the Company’s management believed that its business would outperform both internal and external expectations and this outperformance continued.[14]  The Court, however, could not simply determine the magnitude of this increase in value by looking at the Company’s stock price, because during the sign-to-close period a target company’s stock trades based on the expected deal consideration and likelihood for the announced deal to close, more than on its actual performance.  Instead, the Court estimated the likely percentage change in value that would have been reflected in the Company’s stock price based upon expert testimony involving a regression analysis of prior instances in which the Company had outperformed earnings guidance.  The Court then applied that methodology to the interim period earnings outperformance as compared to a starting valuation equal to the deal-price-less-synergies value it had determined as of signing of $44.29 per share.  The result of that analysis was a 5.2% increase in the value of the Company’s stock as a result of improved performance, or $46.59 per share.  Notably, although the Court’s determination of fair value as of signing was significantly below the deal value as of that time, its determination of fair value as of closing was actually above the value of the deal consideration as of closing ($45.87 per share, or about 1.6% higher).

Key Takeaways

  • Consistent with the seminal Dell decision, if a sale process is not seriously flawed, Delaware courts will rely on the deal-price-less-synergies methodology.
    • Here, after reviewing the record as a whole, the Court ruled that the sale process, while flawed, was effective and the deal price was reliable evidence of the fair value of HFF at the time of signing. The Court stated that it gave due consideration to the deal price, but that post-signing events influenced its judgment.  But rather than using a DCF-based approach to find a higher “fair value,” the Court stated it was using market-based indicators of value.
  • Outperformance that is both “significant and durable” may factor into a determination to increase “fair value.”
    • In PetSmart, that court found that the mere fact of the target’s favorable quarterly results between signing and closing was not sufficient evidence of a long-term trend to justify an adjustment to the deal price.[15] Here, the Court found that the Company’s outperformance was both more “significant and durable” and that these financial results indicated a higher fair value by the time of closing.  This is particularly noteworthy in an environment of increased potential regulatory scrutiny of transactions, which can elongate the interim period between signing and closing.
  • Cash-and-stock deals can have a higher appraisal risk profile.
    • Had the transaction been structured as an all-stock deal, there would have been no appraisal remedy available — even if the value of the target increased significantly between signing and closing. But because this was a cash-and-stock deal, an appraisal remedy was available.  Disparate performance of the acquirer and target company in cash-and-stock deals — even where the cash component is a small percentage of the overall consideration — can increase appraisal risks.  Again, something to consider for transactions that may have a long period between signing and closing.
  • Financial advisors’ views may be used to corroborate a change in performance as it relates to the value of the target company at closing.
    • In reviewing its determination that fair value of the Company changed between signing and closing, the Court noted that JLL’s financial advisor’s opinion, which was based on material, nonpublic information shared with JLL, was that the standalone equity value of the Company was $46.80 per share, “strong corroborative evidence that $46.59 is a persuasive estimate of the value of the Company’s stock at closing.” The Court noted that where the unusual facts of this case caused it to look to expert testimony and statistical analysis to determine the Company’s value based on extraordinary outperformance, Delaware courts view buyers in possession of material nonpublic information to be “in a strong position . . . to properly value the seller.”
  • Valuation outputs diverge in the real world and courts must do their best to determine fair value as of closing.
    • Here, the Court’s approach included “an element of mixing and matching.”  To derive a measure of the post-signing change in fair value, the Court relied on metrics from trading prices, but started with the adjusted deal price as of signing.  The Court acknowledged that this approach is “not perfect, but the perfect should not be the enemy of the good.”[16] The outcome of the case, which resulted in a slight increase to the deal consideration of approximately 1.6% as compared to the closing value of the consideration received by non-dissenting stockholders, suggests the Court may have felt a desire to address the unusual facts of this case, including the Company’s extraordinary outperformance, with a thoughtful approach, while not departing from the market-based approaches to determining “fair value” that the Delaware Supreme Court has indicated are generally a more reliable indicator of value.

[1] BCIM Strategic Value Master Fund, LP v. HFF, Inc. (Del. Ch. Feb. 2, 2022).

[2] Id. at 1.

[3] Id. at 1-2.

[4] Id.

[5] Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd., 2017 WL 6375829 (Del. Dec. 14, 2017).

[6] Verition P’rs Master Fund Ltd. v. Aruba Networks, Inc., 2019 WL 1614026 (Del. Apr. 16, 2019).

[7] BCIM Strategic Value Master Fund, LP at 33.

[8] Id. at 36-52.

[9] Id. at 52.

[10] Id. at 61.

[11] Id. at 29.

[12] Id. at 33.

[13] Id. at 70; In re PetSmart, Inc., 2017 WL 2303599, at 31 (Del. Ch. May 26, 2017).

[14] BCIM Strategic Value Master Fund, LP at 70.

[15] Id.

[16] Id. at 72.