February 10, 2021

Appraisal: Del. Supreme Court Affirms DCF-Based Fair Value Determination

It’s fair to say that the last few years haven’t been kind to discounted cash flow analysis when it comes to Delaware appraisal proceedings. Generally, Delaware courts in recent years have typically used the deal price or other market-based measures as the most reliable indicators of fair value in situations where the process appears to have been sound. But the Delaware Supreme Court’s recent decision in SourceHOV Holdings v. Manichean Capital, (Del.; 1/21), is a reminder that DCF still has a role to play in situations where there are significant questions about the process.

In Manichean Capital, the Court upheld a prior Chancery Court decision holding that under the circumstances of that case, a DCF analysis was the appropriate method for determining the fair value of the dissenting shares.  This Shearman blog explains the Court’s reasoning:

The Court of Chancery had explained that the circumstances surrounding the business combination that triggered the appraisal rights “disqualif[ied] market evidence as reliable inputs for a fair value analysis,” leaving the court to consider competing expert opinions on a DCF valuation.  Moreover, the Court of Chancery largely adopted petitioners’ analysis, which it found more reliable than that of respondent’s expert.

Explaining its reliance on a DCF analysis instead of market evidence, the Court of Chancery highlighted that the company’s “deal process (or lack thereof) undermine[d] any reliance on deal price as an indicator of fair value.”  In particular, the court noted that the company’s board did not hold a single formal board meeting to consider the transaction or solicit offers from other parties after it received the initial overture.  The court also noted that the privately held company’s equity was not traded in an efficient market and, therefore, its unaffected market price could not be relied upon as an indicator of fair value.

Naturally, the Court had to grapple with two competing expert reports that reached very different conclusions with respect to the DCF analysis.  It noted that the company’s expert’s use of a novel approach in calculating its equity beta raised credibility issues not present in the petitioners’ expert report, which used the more standard approach of calculating the company’s beta based on publicly traded comparable companies.

The Court ultimately accepted the petitioners’ approach to the DCF analysis, with the exception of an adjustment for the size premium, which resulted in an appraised value of $4,591 per share, or approximately 9.4% higher than the $4,177 per share deal price.

John Jenkins