July 24, 2020

Appraisal: Chancery Applies DCF to Determine Squeeze-Out Fair Value

When I taught law school, I absolutely hated grading exams. It was a frustrating and humbling (am I really this bad a teacher?) process, and an extremely time consuming one to boot. I was sometimes tempted to use the grading approach that many law students suspect their profs use – just throw the exams down the stairs and sort out the grades based on where they land.  While I managed to resist that temptation, when I read Vice Chancellor Slights’ opinion in Kruse v. Synapse Wireless, (Del. Ch.; 7/20), I wondered how he resisted what must have been a similar temptation in reaching his decision in this appraisal proceeding.

In many respects, the case presented a worst case scenario – it involved a minority squeeze-out of a private company at a price of approximately $0.43 per share with no market check or competitive sales process. Both parties pointed to valuation analyses prepared by their competing experts, which resulted in wildly divergent valuations. The petitioner’s expert opined that each Synapse share was worth $4.1876 at the time of transaction, while Synapse’s expert provided a valuation range of $0.06 to $0.11 per share.  Vice Chancellor Slights acknowledged that this left him in a bind:

When dueling experts proffer wildly divergent valuations, the resulting trial  dynamic presents difficult and, frankly, frustrating challenges for the judicial appraiser. This case presents another, more fundamental challenge; after carefully reviewing the evidence, it is difficult to discern any wholly reliable indicators of Synapse’s fair value. There is no reliable market evidence, the comparable transactions analyses both experts utilized—a dicey valuation method in the best of circumstances—have significant flaws and the management projections relied upon by both experts in their DCF valuations are difficult to reconcile with Synapse’s operative reality.

In the typical litigation context, the lack of fully reliable evidence might lead the factfinder to conclude that neither party carried their burden of proof and neither party, therefore, is entitled to a verdict. But “no” is not an answer in the unique world of statutory appraisal litigation. If the parties fall short in their respective burdens, the court must still reach an answer—a fair value appraisal must still be provided.

This is the point at which I’d likely have opted to throw the two valuations down the stairs. Admirably, the Vice Chancellor didn’t do that. Instead, he dutifully slogged through the competing DCF valuations, and concluded that Synapse’s expert “credibly made the best of less than perfect data to reach a proportionately reliable conclusion,” while the petitioner’s expert did not.

As a result, with the exception of relatively minor adjustments to Synapse’s expert’s conclusions about the amount of its debt and available cash, the Vice Chancellor adopted that expert’s approach to the DCF analysis and concluded that the fair market value of the company’s shares was approximately $0.23 per share – nearly 50% below the purchase price.

John Jenkins