Blueblade Capital Opps. LLC and Blueblade Capital Opps. CI LLC v. Norcraft Cos., Inc., C.A. No. 11184-VCS (Del. Ch. July 27, 2018) (Slights, V.C.)
In this statutory appraisal action pursuant to Section 262 of the DGCL, Vice Chancellor Slights declined to hold that the fair value of Norcraft Companies Inc. (“Norcraft” or the “Company”) was equal to the $25.50 per share merger price (less synergies), and appraised Norcraft’s stock at $26.16 per share, a value approximately 2.5% above the deal price. The case arose from a May 12, 2015 merger whereby Fortune Brands Home & Security, Inc. (“Fortune”) acquired Norcraft for $25.50 cash per share. In the transaction, Norcraft, a cabinetry manufacturing business, merged with an indirect, wholly-owned subsidiary of Fortune, Tahiti Acquisition Corp. (“Tahiti”), with Norcraft surviving as a wholly-owned subsidiary of Fortune.
Mindful of the Delaware Supreme Court’s recent weighting of deal price in DFC and Dell as a “strong indicator” of fair value for a public company that engages in a robust sales process, the Court nonetheless found that the merger price did not reflect the fair value of the Company due to a flawed sales process. Specifically, Norcraft did not engage in a pre-signing market check, and the subsequent 35-day post-signing go-shop period was rendered ineffective as a result of deal protection measures that failed in the Court’s view to provide for a “meaningful market check.”
The Court also found that, prior to signing the merger agreement, Norcraft and its advisors chose not to look past Fortune as a potential merger partner. Although the Court conceded that a single-bidder focus, if made as a strategic choice, would not necessarily undermine the deal process, the Court found no evidence suggesting the decision to focus solely on Fortune was strategic. Even more troubling to the Court was the fact that the Company’s C.E.O., who was conflicted, served as the Company’s lead negotiator throughout the sales process. As the C.E.O. was negotiating with Fortune to buy the Company, he also negotiated benefits for himself, including his future employment with the buyer, waiver of a non-compete covenant, and the possibility of buying one of Fortune’s business divisions for himself. While this was transpiring, the Board of the Company did not form a special committee comprised of independent directors to negotiate with Fortune; nor did it attempt to neutralize the C.E.O’s influence over the sales process.
As to the post-signing go-shop period, the Court determined that it was similarly flawed. Before the go-shop period, it was not widely known that the Company was for sale, disadvantaging possible bidders. Not only did the Company’s board “appear to lack even a basic understanding of the terms and function of the go-shop,” but Fortune’s financial advisors also attempted to contact and dissuade potential bidders from topping Fortune’s bid. Furthermore, Fortune had extracted concessions from the Company that inhibited maximizing value, including giving Fortune an unlimited right under the merger agreement to match a superior proposal by a third-party bidder within four days. In addition, Fortune secured and executed the right to launch Tahiti’s tender offer for all of the Company’s outstanding common stock at $25.50 per share a mere 15 days after the start of the 35-day go-shop period. Given the flawed pre-signing and go-shop period market checks, the Court refused to accord any weight to the deal price in its fair value calculus.
Turning to the efficient market hypothesis, the Court explained that the trial evidence did not support assigning any weight to the Company’s unaffected trading prices to determine its fair value on the merger date. The Company had just completed an IPO 18 months before the merger, and was operating in a niche market. Consequently, it had a limited trading history with sparse coverage by financial analysts. The Court held that these facts precluded a determination that the Company’s common stock was “efficient or semi-strong efficient.”
Unable to rely on either the merger price or the trading price as a reliable indicator of value, the Court also rejected comparable companies and precedent transaction analyses due to an inability to identify any truly comparable companies or precedent transactions that would support a reliable analysis. Instead, the Court applied a DCF analysis to calculate Norcraft’s fair value, incorporating the most credible inputs from both expert witnesses. With regard to certain disputed components of the experts’ DCF analysis, the Court elected not to extend the Company’s five-year projections to ten-years due to the cyclical nature of the cabinetry industry. In addition, in calculating the Company’s weighted average cost of capital, or “WACC,” the Court averaged the experts’ respective estimates of the pre-tax cost of debt and utilized a proxy beta coefficient based on its own set of comparable Guideline Public Companies to determine the relevant cost of equity.
Ultimately, the Court determined the fair value of Norcraft shares at the time of the merger to be $26.16 and, using the merger price as a “reality check,” was “satisfied that the delta between the Merger Price and the DCF value is not so great as to cause me to question whether the DCF value is grounded in reality.”