In many jurisdictions, dissenting minority shareholders have a right to receive the "fair value" of their shares. These appraisal rights provisions protect investors from being shortchanged in minority shareholder squeeze-outs, privatizations and leveraged buyouts, especially when the deal involves company insiders who may have a potential conflict of interest.
A fundamental question in appraisal rights litigation is: Does the merger price provide an accurate estimate of fair value? A recent Delaware Court of Chancery case provides guidance on the use of merger price in shareholder buyouts. (Merion LP et al. v. Lender Processing Services Inc., C.A. No. 9320-VCL, Del. Ch.)
In January 2014, Fidelity National Financial (Fidelity) finalized its acquisition of Lender Processing Services (LPS), a provider of integrated technology products, data and services to the mortgage lending industry. The two companies had ties before the merger. Fidelity had previously owned LPS, but it was spun off as a separate public company in 2008. After the spinoff, LPS and Fidelity occupied separate buildings, but the companies continued to share an office campus, private jets, hangar facilities and server space.
Fidelity initially approached LPS about an acquisition in April 2010. At that time, the board of LPS hired outside advisors to evaluate a potential merger.
In February 2012, Fidelity made an all-cash offer to acquire LPS for $26.50 a share. However, LPS felt its shares were worth $30 each and "decided to explore whether someone might pay more by reaching out to other financial sponsors and strategic buyers."
LPS contacted various third-party buyers, but it received no offers. By May 2012, Fidelity had increased its offer to $29 a share, payable in cash or a combination of cash and stock.
In October 2012, LPS's board hired another consulting firm to evaluate the company and its strategic alternatives. A critical issue that created a bid-ask spread was legal risk from pending investigations and lawsuits related to allegations of "robo-signing," or signing documents without reviewing them.
In January 2013, LPS announced that it had entered into various settlement agreements to resolve these allegations. The market viewed the settlements favorably, with two results:
- The price of LPS stock rose to $24.08, and
- The company received significant unsolicited interest in an acquisition, including an offer from Fidelity for $30 a share, payable with cash and stock. Fidelity's offer included a 30% premium above the average closing price of the stock during the five previous trading days, due to synergies between LPS and one of Fidelity's subsidiaries.
By May 2013 — after the consulting firm had finalized its evaluation and LPS had solicited additional third-party offers — the company entered into a merger agreement with Fidelity for $33.25 a share, payable 50% in cash and 50% in stock. The formula for the stock component included a one-way collar that protected against a decline of more than 5% in the value of Fidelity's common stock and established a floor for the stock component at $15.794 a share.
After adjusting the merger price for post-signing increases in the value of Fidelity's stock, the deal closed at $37.14 a share, a premium of 28% over the stock's unaffected market price on the last trading day before the company reported merger discussions to the news media. The petitioners subsequently filed a statutory appraisal rights action, permitted under the Delaware General Corporation Law, claiming that the company's fair value was $50.46 a share.
Fair Value vs. Merger Price
The Delaware Court of Chancery held that the final merger price was a reliable indicator of fair value. It granted "100% weight to the transaction price" because LPS "ran a sale process that generated reliable evidence of fair value." The court also concluded that there weren't any meaningful comparables to base the market approach on.
The court considered discounted cash flow analyses conducted by both sides' experts, because LPS had "created a reliable set of projections that support a meaningful [discounted cash flow] analysis." After using adjusting inputs from experts for both sides, the court's modified discounted cash flow analysis generated a value of $38.67 a share. That analysis was within 3% of the merger price — which the court found "comforting."
Negotiation Process Is Key
When deciding whether to rely on the merger price as an indicator of fair value, the Delaware Court of Chancery cited previous case law, which cautioned that the dependability of a transaction price "is only as strong as the process by which it was negotiated."
The court was persuaded to accept the merger price based on facts and circumstances of the case, such as the following:
- There was meaningful competition (or threat of competition) during the pre-signing phase among potential buyers.
- The pre-signing competition involved different types of bidders, including financial and strategic buyers.
- All potential buyers had equal access to adequate and reliable information about LPS, contributing to the existence (or perception) of meaningful competition.
- There was no explicit or implicit collusion or favoritism among bidders or between the seller and any bidders.
Although there were historical ties between LPS and Fidelity, the transaction wasn't a management buyout. The court concluded that the ties between the buyer and seller "warranted close examination, but they did not compromise the sale process."
During the seven-month "go-shop" period between signing and closing the deal, no other bidder expressed interest in making an offer or submitted a competing bid to LPS.
Immediately after announcing the merger, Fidelity's stock price rose and continued to rise during the post-signing period. Due to the collar, these increases caused the value of the merger consideration to increase.
Based on these factors, the court decided that the merger price of $37.14 per share was a reliable indicator of fair value at closing. Moreover, the court reasoned that, because of buyer-specific synergies and a post-signing decline in the performance of LPS, the fair value of LPS's stock on the closing date didn't exceed the merger price.
Importance of Appraisal Expertise
In appraisal rights claims, the court is typically granted significant leeway when deciding on the fair value of a dissenting shareholder's interest in appraisal rights claims. There's been a trend in recent cases toward equating fair value with the merger price, but it's not a sure win. A court may also consider the value of a company's assets (net of liabilities), sales of comparable companies or stocks, and discounted cash flow analyses when estimating fair value.
Valuation expertise is important in appraisal rights claims for minority and controlling shareholder alike. For example, in Merion Capital, the seller consulted with valuation professionals throughout the negotiation process to ensure a fair price. Moreover, at trial, appraisal experts testified for both parties, presenting discounted cash flow analyses that the judge used during deliberations to evaluate the fairness of the merger price.
For help valuing a minority shareholder's interest and understanding the relevance of merger price in the context of appraisal rights actions, contact your business valuation advisor.
LOUIS J. CERCONE, JR., CPA, CFE, CFF, ABV, ASA, CVA
Lou is the Managing Director of Brisbane Consulting Group in charge of business valuations, forensic accounting, and litigation support services. He has extensive valuation experience and has served as a financial consultant and expert to attorneys in the economic aspects of matrimonial dissolution. He has been engaged in several forensic accounting cases and has served the judiciary as a court appointed expert and receiver for financially troubled companies. He has testified as an expert witness in State Supreme Court and Federal Court. Lou has also been engaged in the quantification of lost income in determining business interruption claims for insurance adjusters.