February 20, 2018

Appraisal: Another Very Bad Day for Hedge Funds

Last week, the Delaware Chancery Court ruined the day of yet another hedge fund hoping to hit the appraisal jackpot. In Verition Partners Master Fund v. Aruba Networks (Del. Ch.; 2/18), Vice Chancellor Laster’s award set the stock’s fair value at $17.13 per share, well below the merger price of $24.67.  That’s a 30% haircut, which will definitely leave a mark, as noted in this article. It’s also the third time in less than a year that the Chancery Court has made a fair value award in an appraisal case that was below the deal price.

Consistent with Dell and DFC Global, the Vice Chancellor’s starting point for determining Aruba’s fair value was the deal price.  But this deal involved a strategic buyer, and therefore that price included the value of post-closing synergies. Since synergies were an element of value arising from the “accomplishment or expectation of the merger,” they needed to be excluded from the valuation analysis.

The Vice Chancellor ultimately decided to consider two alternative approaches to fair value – one that focused on the “deal-price-less-synergies,” & one that looked to the unaffected market price of the stock prior to the deal’s announcement. In opting for the latter, he observed that using the deal-price-less-synergies approach required subjective judgment and a significant potential for error. What’s more, in his view, it continued to include an element of value arising out of the accomplishment of the merger:

When an acquirer purchases a widely traded firm, the premium that an acquirer is willing to pay for the entire firm anticipates incremental value both from synergies and from the reduced agency costs that result from unitary (or controlling) ownership. Like synergies, the value created by reduced agency costs results from the transaction and is not a part of the going concern value of the firm. The value belongs to the buyer, although the seller may extract a portion of it through negotiations. Eliminating shared synergies therefore only goes part of the way towards eliminating “any element of value arising from the accomplishment or expectation of the merger.” A court also must eliminate the share of value that accrues from the reduced agency costs.

Vice Chancellor Laster concluded that since the market for Aruba’s stock was efficient, the stock’s unaffected market value prior to the deal was the right approach for determining its fair value – even though neither of the parties argued for that approach, and even though it resulted in a value that was lower that the price that Aruba itself advocated.

Prof. Anne Lipton blogged that Aruba Networks is “Dell’s other shoe” – the possibility that courts may conclude that the market price of a publicly traded company is the best evidence of its value, & that any premium represents value arising out of the merger.  If so, Aruba Networks is yet another body blow to the viability of appraisal arbitrage in Delaware.

As an aside, this opinion is an unusually good read, probably because this deal had “a lot of hair on it” from a process standpoint. There were a couple of years worth of discovery in the case, and what was unearthed led to one of the more candid & entertaining recountings of a deal process that I’ve seen. Read this case if you really want to see how the sausage gets made.

John Jenkins