In 2015, Hewlett Packard acquired Aruba for a negotiated price of $24.67 per share, or about $2.8 billion. Several stockholders sought appraisal. On February 15, the Delaware Court of Chancery found that, for purposes of appraisal, the fair value of the Aruba shares equaled the 30-day average unaffected market price of the shares, prior to announcement of the transaction, which was $17.13, about 30% less than the negotiated price.[1]

The court’s reasoning was driven largely by what the court believed to be directions from the Delaware Supreme Court’s decisions arising from the earlier DFC and Dell acquisitions,[2] including assumptions regarding efficient trading markets. While the court noted that it was “not interpreting Dell and DFC to hold that the market price is now the standard for fair value,” the court weighed heavily the unaffected, pre-announcement stock price after concluding that Aruba’s stock traded in an efficient market. Notably, the final appraised value was less than the amount proposed by Aruba in the proceedings.

Court Analysis

The court reviewed several potential valuation methods, including the unaffected market price for Aruba shares, the deal price (and the deal price less synergies), and discounted cash flow analyses provided by the parties’ respective experts.

Unaffected Market Price. The court noted that, according to DFC and Dell, the unaffected trading price of a company’s shares “provides evidence of the fair value” of the shares for appraisal purposes “if [the] company’s shares trade in a market having attributes consistent with the assumptions underlying a traditional version of the semi-strong form of the efficient capital markets hypothesis.” The court further noted that the Delaware Supreme Court had described a market as “more likely efficient, or semi-strong efficient,” if “it has many stockholders; no controlling stockholder; highly active trading; and if information about the company is widely available and easily disseminated to the market.” The court noted that the Supreme Court in DFC had stated that market prices were “typically viewed superior” compared to other valuation techniques because they “should distill the collective judgment of the many based on all the publicly available information about a given company and the value of its shares.”

Here, the court found evidence of an efficient market for Aruba shares, including, among other things, the following:

• Aruba did not have a controlling stockholder.
• Aruba made public filings in compliance with federal securities laws.
• Thirty-three securities analysts covered Aruba.
• Aruba’s weekly trading volume was 9.5 million shares or 8.7% of total shares outstanding.
• Aruba’s bid-ask spread of 0.055%.
• Aruba’s large public float as a percentage of its outstanding shares (96%).
• There was evidence that Aruba’s stock price reacted quickly to the release of news about Aruba.

The court noted, though, that neither party had proffered an expert opinion on the efficiency of the market for Aruba’s shares, as the court noted was “common” in certain types of federal securities law cases, nor was all the market evidence included in the trial record.

The court also rejected the stockholders’ contention that the buyer had taken advantage of a presumably temporary “trough” in the market for Aruba’s shares. The court noted that the court’s reliance in an earlier appraisal action for Dell on a “valuation gap” between the trading price for Dell and Dell’s “operative reality” had been rejected by the Delaware Supreme Court “in light of the attributes of the market for Dell shares and the implications of the semi-strong form of the efficient capital markets hypothesis,” and that in this case the evidence of market mispricing was “considerably weaker.”

Deal Price and Synergies. The court noted that, pursuant to Dell, the deal price in appropriate circumstances would merit “heavy, if not overriding, probative value,” but that reductions still would be needed to adjust for any value arising from the deal itself, including both synergies and reductions in agency costs (which the court described generally as the “flipside of the benefits of control”). The court noted that Aruba’s negotiators might have had some interests that made them “less effective … than they might have been,” but that, for purposes of appraisal, the issue was whether the stockholders “got fair value and were not exploited,” and that, while stronger negotiations might have been able to get a higher price from HP, they would not have changed Aruba’s standalone value.

The court looked to an estimate of potential synergies provided by an outside consultant to the buyer in connection with the acquisition, and to a general study cited by Aruba’s expert of the extent to which sellers shared in the value of synergies. Based on the midpoint of the range of the portions of synergies shared with sellers, as suggested by the study, the court concluded that the negotiated deal value less the value of such synergies was $18.20 – substantially less than the deal value of $24.67. The court noted, though, the likelihood of the court’s “human error” in making such calculations and the corresponding preference for using “market indications” rather than a “judgment-laden exercise of backing out synergies,” as well as the need to adjust for any remaining “element of value derived from the merger” in the form of agency costs.

Discounted Cash Flow Analyses. The court reviewed discounted cash flow analyses provided by experts for the stockholders and for Aruba, which arrived at values of $32.57 per share (in the case of the stockholders) and

$19.85 per share (in the case of Aruba). Despite the stockholders’ expert’s analysis’ “seemingly strong methodologies,” the court found that the difference between its conclusion and various market indicators created “significant doubt” about its reliability. The court also expressed “concern” with Aruba’s expert’s analysis. More generally, the court noted Dell’s admonition regarding “the hazards that always come when a law-trained judge is forced to make a point estimate of fair value based on widely divergent partisan expert testimony.”

Takeaways

• The court’s finding raises questions for stockholders considering whether to seek appraisal, at least in a seemingly arm’s-length transaction with a strategic buyer where the company’s shares could be seen prior to announcement of the transaction as trading efficiently. The court considered, but rejected, valuation methods traditionally used by courts that were more likely to provide at least the deal price. The Aruba pre-announcement trading price was lower (about 14% lower) than the amount suggested by the company’s own expert’s DCF analysis, which itself was lower (about 19% lower) than the negotiated deal price.
• The court enhances the scope of the arguments and methods that may be viewed as proper approaches to valuing companies for appraisal purposes, where the “governing standard” remains a company’s going concern value. The court noted that, while market value provided the best evidence of fair value for Aruba in the present circumstances, it did not identify any overriding rules and separately evaluated both discounted cash flow and other analyses. Thus, the scope of the potential approaches to valuation is as wide as it has ever been in the appraisal context.
• The court also noted that academics have questioned the efficient market hypothesis (citing, among other things, insights from behavioral economics), that future appraisal litigants might “retain experts on market efficiency” and that future appraisal decisions might “consider subtler aspects of the efficient capital markets hypothesis.” While not stated expressly by the court, such an approach could lead to different results even for a company in the same position as Aruba.

This post comes to us from Morrison & Foerster LLP.  It is based on the firm’s client alert, “Delaware Chancery Court in Aruba Appraisal Finds Fair Value to be the Pre-Announcement Market Price: 30% Below Deal Value,” dated February 22, 2018, and available here.