DFC Global Corp. v. Muirfield Value Partners, L.P., No. 518, 2016 (Del. Aug. 1, 2017) (Strine, C.J.)
In this much-anticipated decision, the Delaware Supreme Court reversed and remanded the Court of Chancery’s determination that the “fair value” of the stock of DFC Global Corporation (“DFC” or the “Company”) was approximately 10% higher than the $9.50 per share price Lone Star Fund VIII (U.S.), LLP (“Lone Star”), a private equity firm, paid to acquire the Company in June 2014. While the Supreme Court declined to adopt a bright-line rule requiring complete deference to the deal price resulting from a robust, conflict-free sale process, the Court nonetheless concluded the Court of Chancery abused its discretion in according just one-third weight to the deal price. In reversing the fair value determination, the Court discredited two of the principal factors the Court of Chancery relied upon to justify its departure from the deal price.
DFC is a provider of alternative consumer financial services, predominately payday loans. In the spring of 2012, DFC retained a financial advisor to investigate a sale of the Company. The decision to sell the Company was spurred, in part, by increased regulatory scrutiny of the payday lending industry, high corporate leverage, and issues regarding management succession. Over the next two years, DFC was shopped through a robust sale process involving at least thirty-five financial sponsors and three strategic buyers. At the time of the sale process, however, the payday lending industry was undergoing a major regulatory overhaul, causing significant uncertainty with respect to the Company’s future profitability. Due to such uncertainty, DFC repeatedly adjusted its financial projections downwards throughout the sale process, causing potential buyers to lower their offers or drop out of the process entirely. On March 27, 2014, Lone Star, backing down from its initial offer of $11.00, offered to buy DFC for $9.50 per share. DFC accepted Lone Star’s revised offer, and the deal closed on June 13, 2014.
Following the announcement of the transaction, five DFC stockholders, who collectively owned 4,604,683 shares of DFC common stock, filed separate petitions for appraisal under 8 Del. C. § 262. The petitions were later consolidated into one action, which was tried in October 2015. The petitioners’ expert calculated a fair value of $17.90 per share using a discounted cash flow model, while DFC’s expert calculated a fair value of $7.94 per share based upon an approach that blended the results of a discounted cash flow model and a multiples-based comparable companies analysis. DFC also urged the Court of Chancery to consider the transaction price of $9.50 as the most reliable evidence of fair value.
In its post-trial decision, the Court of Chancery found that the sale process leading up to the acquisition of DFC was “robust” and “arm’s-length.” Acknowledging that it “frequently defers to a transaction price that was the product of an arm’s-length process and a robust bidding environment,” the Court of Chancery declined to do so here because the transaction was “negotiated and consummated during a time of significant company turmoil and regulatory uncertainty” and Lone Star, the private equity firm that ultimately acquired DFC, “focused its attention on achieving a certain internal rate of return and on reaching a deal within its financing constraints, rather than on DFC’s fair value.” The “significant company turmoil and regulatory uncertainty,” according to the Court of Chancery, affected the reliability of management’s projections and, consequently, the discounted cash flow and comparable companies analyses. Ultimately, the Court of Chancery determined DFC’s fair value was $10.30 per share, eighty cents per share more than the deal price, based on an equal weighting of “three imperfect techniques”: a discounted cash flow analysis, a comparable company analysis and the deal price.
On appeal, DFC urged the Supreme Court to adopt a bright-line rule that the deal price is the best evidence of fair value where, as here, it is the product of a robust, conflict-free sale process. The Court, however, declined to adopt such a bright-line rule, citing its decision in Golden Telecom, where the Court held that such an approach was inconsistent with the appraisal statute’s requirement that the Court of Chancery consider “all relevant factors” in determining fair value. Because that statutory language remained unchanged and the Court could not specify the particular characteristics of a sale process that should require deference in all circumstances, the Court declined to overrule Golden Telecom.
The Court concluded, however, that the Court of Chancery abused its discretion in failing to accord greater weight to the deal price in light of the lower court’s finding that the sale process was robust and conflict-free. In particular, the Court held that there was insufficient evidence in the record to support the Court of Chancery’s decision to accord the deal price just one-third weight based on regulatory uncertainty and Lone Star’s status as a financial buyer. According to the Supreme Court, there was no record evidence to suggest that the market – and market participants – could not price regulatory risk. Rather, referencing the company’s receipt of lowered bids following downward revisions to management projections, the decision of some bidders to drop out of the process, and the inability of the company to refinance certain debt, the Court held that the record established that the market was “attuned to the regulatory risks facing DFC” and factored that risk into DFC’s pricing.
Similarly, the Court concluded that the record did not support the Court of Chancery’s conclusion that the deal price did not represent fair value because, as a financial sponsor, Lone Star sought to achieve a specific rate of return on its acquisition of DFC. The Court observed that a buyer’s focus “on hitting its internal rate of return has no rational connection to whether the price it pays as a result of a competitive process is a fair one” particularly where additional factors, such as the absence of topping bidders, concerns about the company’s credit rating, and the inability of the company to meet its own projections, support the fairness of the price paid by a financial sponsor.
The Supreme Court also held that the Court of Chancery erred by increasing the perpetuity growth rate it used in its discounted cash flow model from 3.1% to 4.1% after recognizing on reargument that it had used the wrong working capital figures in its original model. The Court of Chancery’s revisions to the working capital figures would have resulted in the discounted cash flow model yielding a fair value figure lower than the deal price. However, the upward adjustment to the perpetuity growth rate resulted in the Court of Chancery arriving at a fair value similar to its original estimate of DFC’s value. Citing the overly optimistic and uncertain nature of the out-years of the financial projections, the fact that the payday lending industry had already gone through a period of above-market growth, and the lack of any basis to conclude that DFC would sustain high growth beyond the projection period, the Supreme Court held that the Court of Chancery’s adjustment to the perpetuity growth rate was not supported by the record.
Finally, the Court rejected the stockholder petitioners’ argument that the Court of Chancery abused its discretion by relying in part on a comparable companies analysis instead of giving primary, if not sole, weight to the discounted cash flow model. Observing that “this was a rare instance where both experts agreed on the comparable companies the Court of Chancery used and so did several market analysts and others following the company,” the Supreme Court held that giving weight to a comparable companies analysis was well within the Court of Chancery’s discretion.