Delaware (Again!) Requires Upward Adjustment To Deal Price In Appraisal Proceeding Despite Objectively Fair Sales Process

A recent Court of Chancery decision adds yet another wrinkle to the appraisal landscape and the potential for appraisal arbitrage. In BCIM Strategic Value Master Fund LP v. HFF, Inc. (Del. Ch. Feb. 2, 2022), the court found that-despite a sufficiently robust sales process that supported ascribing heavy weight to the signing price as a reliable indicator of fair value-the fair value of the target's shares at closing exceeded the deal price. The court reached this conclusion because the value of the target's business increased "significant[ly] and durab[ly]" in the period between signing and closing, while the value of buyer's stock (which comprised a portion of the consideration) decreased 13.9% based on the spot price at announcement compared to the spot price at closing. Perhaps the most surprising aspect of this opinion, which may create opportunity for appraisal arbitrage, was the court's decision to value the stock consideration delivered by the buyer on a spot basis on both the date of announcement and closing - even though a buyer's stock price may be volatile and fluctuate based on a myriad of factors including world events, market dynamics and reaction to the deal. 

With this ruling, the court also expands on the jurisprudence in In Re Appraisal of Regal Entertainment Group (Del. Ch. May 13, 2021) - namely, that the deal price may fail to operate as the ceiling on value in appraisal proceedings where the target's value has increased between signing and closing. While the finding in Regal was predicated on a change in law (specifically, the passing of the 2017 Tax Act), the outcome in this proceeding was the result of target's "dramatic" outperformance in the period between signing and closing and previous holdings of the Delaware Supreme Court that fair value is determined as of the closing, not at the time the merger agreement is executed. In BCIM, because target's outperformance was found to be both significant and durable and supported by market-based evidence presented by experts, the court determined that an upward adjustment to the deal price was warranted. Notably, and distinguishable from the Regal proceeding, the court required an upward adjustment to the deal price even though the increase in target's value did not exceed proven synergies. That result-attributable to buyer's decreasing stock value-may indicate that transactions using mixed consideration are at greater risk for appraisal arbitrage, as previewed above. A more detailed summary of the decision is below, along with some key takeaways and considerations for practitioners. For a more comprehensive overview of appraisal jurisprudence, please see this blog post.

Background and Ruling

This appraisal proceeding arose from the acquisition of HFF Inc. (the "target" or the "Company") by Jones Lang LaSalle Inc. ("buyer"). The acquisition signed on March 19, 2019 and closed on July 1, 2019. In connection with the merger, each share of Company common stock converted into the right to receive $24.63 in cash and 0.1505 shares of buyer's common stock. At signing, the value of buyer's stock implied a deal price of $49.16/share (based on a spot price on the date of signing).

Similar to other recent appraisal proceedings, despite some acknowledged flaws in the sales process, the court found that the process exhibited sufficient "objective indicia" of fairness such that the deal price at signing was the most reliable indicator of fair value. After making that determination, the court found that respondents proved $4.87/share of synergies, resulting in a fair value at signing of $44.29/share.

To determine the target's fair value as of closing, the court calculated the amount by which the target's value increased during the interim period. To make the determination, the court relied on a regression analysis involving prior instances in which the Company had outperformed earnings guidance. Using that analysis, the court determined that the Company's fair value as of closing was $46.59/share, which represented a 5.2% increase ($2.30/share) compared to the fair value at signing (i.e., $44.29/share). That amount, while less than the implied deal value at signing ($49.16/share), exceeded the implied deal value at closing of $45.87/share. The court relied upon the spot price of the buyer's stock at the closing (which as the court noted declined 13.9% from signing) to determine the value of the stock portion of the consideration rather than using any valuation methodology for buyer's stock or even a volume weighted average over 10 or more trading days.

Key Takeaways and Practice Points

"Significant and Durable" Outperformance May Necessitate Adjustment to Deal Price  

The Company's Q1 2019 results (announced in the period between signing and closing) reflected year-over-year increases in revenue of 20.9%, in EBTIA of 80.6%, and in net income of 62.9%. The Company continued to outperform in Q2, with year-over-year revenue growth of 16.5% in the first half of 2019. In finding that the Company's increased performance between signing and closing was "significant and durable," the court focused on two factors: (i) continued outperformance of both internal and external expectations and (ii) testimony from the Company's management that this outperformance would continue. Respondent argued that the Company's outperformance was akin to the outperformance in In Re Appraisal of PetSmart, Inc. (Del. Ch. May 26, 2017), where the court declined to make an adjustment to the deal price. The court rejected that argument, noting that the target's outperformance in the PetSmart appraisal was far more moderate and that PetSmart's management believed the results were temporary, which proved to be true.

Mixed Consideration Deals May Create Potential for Appraisal Arbitrage

It is the use of spot trading prices to measure the value of buyer's stock in a mixed consideration transaction that may create an opportunity for appraisal arbitrage. Had the deal consideration been comprised entirely of cash or had the exchange rate for the stock portion of the consideration been floating, rather than fixed, no upward adjustment would have been warranted because the determined fair value at closing ($46.59/share) was less than the implied deal price at signing of $49.16/share. Additionally, an appraisal proceeding could have been wholly avoided had the transaction been structured as an all-stock deal or had target's stockholders had the right to elect between cash and stock consideration and there was no cap on the amount of stock consideration a stockholder could elect (i.e., each stockholder could elect to receive 100% stock consideration).

After the Regal decision, we questioned whether the holding would lead to more appraisal arbitrage, but theorized that the likelihood was relatively low given petitioners' need to prove that any increase in value exceeded synergies embedded in the deal price. However, as this decision illustrates, if the transaction features mixed consideration and the trading price of buyer's stock decreases between signing and closing for any reason including market dynamics, an upward adjustment may be awarded even where synergies exceed the target's change in value (here, proven synergies were $4.87/share and target's change in value was only $2.30/share).

This decision may also pave the way for appraisal arbitrage in mixed consideration deals more generally, even absent a change in target's value between signing and closing. For example, stockholders may be incentivized to argue that the value of consideration delivered at closing was less than fair value solely due to buyer's stock price decreasing between signing and closing. If respondent can prove that embedded synergies in the deal price exceeded any change in the implied deal value, an upward adjustment is unlikely, but it is unclear how the court would consider such a claim in circumstances where the synergies do not exceed the change in implied deal value. In any event, the court's decision is certainly worth considering when structuring a transaction between two public companies.   

Evidence of Synergies Remains Key Focus in Analysis

This decision further reinforces the need for buyers to carefully document any synergies embedded in the deal price. As discussed in greater detail here, for synergies to reduce the deal price (thereby reducing or preventing any upward adjustment to the deal price), respondent must provide internal documentation to support not only the value of the projected synergies, but also that such synergies were incorporated into the deal price. In this proceeding, the court adopted respondent's proposed synergies ($4.87/share), finding that respondent provided adequate evidence of such synergies, including documentation from financial experts. In the absence of this evidence, the court would have determined an even larger appraisal award.

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