In re Appraisal of PetSmart, Inc., Consol. C.A. No. 10782-VCS (Del. Ch. May 26, 2017) (Slights, V.C.)
In this post-trial appraisal opinion arising from a going-private transaction in which the public stockholders of PetSmart Inc. (“PetSmart”) were cashed out for $83 per share, Vice Chancellor Slights held that the deal price was the best indicator of the fair value of PetSmart’s shares as of the closing of the Merger. In reaching this conclusion, the Vice Chancellor declined to adopt any of Petitioners’ proffered discounted cash flow analyses.
The Court approached the parties’ competing positions by reducing them to the following three questions: “(1) was the transactional process leading to the [m]erger fair, well-functioning and free of structural impediments to achieving fair value for [PetSmart]; (2) are the requisite foundations for the proper performance of a DCF analysis sufficiently reliable to produce a trustworthy indicator of fair value; and (3) is there an evidentiary basis in the trial record for the Court to depart from the two proffered methodologies for determining fair value by constructing its own valuation structure?”
The Court first determined that the merger price was a reliable indicator of fair value because “the process employed to facilitate the sale of PetSmart, while not perfect, came close enough to perfection to produce a reliable indicator of PetSmart’s fair value.” PetSmart considered and explored all of its strategic options, including remaining a standalone company. It “announced to the world” that it was pursing strategic alternatives including a potential sale, putting “the whole universe of potential bidders” on notice. Its financial advisor, J.P. Morgan Securities, LLC contacted twenty-seven parties, including three potential strategic acquirers. Fifteen of those parties signed non-disclosure agreements and thirteen of them also received in-person presentations from management. Ultimately, PetSmart received indications of interest from five bidders, which resulted in three final bids, including a joint-bid between two of the five initial bidders. The Court found no evidence that any bidder was favored. Although the PetSmart board determined not to include Petco, PetSmart’s primary competitor, during that process – a decision the Court found to be within the board’s business judgment – PetSmart remained open to including Petco if it made a real indication of interest. It did not. Despite positive uptrends in PetSmart’s business before the merger closed, no party made a topping bid. Finally, the Court noted that PetSmart’s fully-informed stockholders overwhelmingly approved the merger.
In determining that the merger price was a reliable indicator of PetSmart’s fair value as of the time of the merger, the Court rejected, among other things, Petitioners’ argument that a financial bidders’ “LBO model” rarely if ever will produce a fair value. The Court noted that the private equity bidders did not know whether they were bidding against strategic bidders or other financial sponsors and that various financial sponsors made different bids. The Court stated as follows: “while it is true that private equity firms construct their bids with desired returns in mind, it does not follow that a private equity firm’s final offer at the end of a robust and competitive auction cannot ultimately be the best indicator of fair value for the company.”
The Court rejected the petitioners’ argument that a three-month period between the signing of the merger agreement and closing rendered the deal price stale. The Court noted that PetSmart’s business had shown positive uptrends prior to the merger, but also considered post-closing evidence of PetSmart’s performance and determined that the positive uptrends prior to the merger were short-term and not indicative of a long-term trend affecting the company’s going concern value as of the time of the merger.
Despite acknowledging that a DCF analysis is often considered the “gold standard” of valuation tools, the Court did not apply it in this case for several reasons. First among them, the Court determined that PetSmart’s management projections were not a reliable forecast of PetSmart’s future performance. Management did not have a history of creating long-term projections. The projections were not created in the normal course and were instead created to aid in the auction process—and under intense pressure from the PetSmart board to be aggressive, with the expectation that the projections would be discounted by potential bidders. Moreover, the Court noted, even management’s short-term projections proved historically unreliable. Rejecting petitioners’ attempts to provide a DCF analysis based on alternative projections, and concluding there to be no reliable basis on which to construct its own valuation model given the lack of reliable projections the Court ultimately held that the merger price represented the fair value of PetSmart’s stock as of the date of the merger.
PetSmart is also notable because the Vice Chancellor addressed the use of deposition testimony in post-trial briefing, a topic recently addressed by Vice Chancellor Laster in ACP Master, Ltd. v. Sprint Corp., 2017 WL 75851, at *3 (Del. Ch. Jan. 9, 2017). In ACP, Vice Chancellor Laster held that the use of deposition testimony from a party’s own witness was inadmissible hearsay under Court of Chancery Rule 32. In PetSmart, the Court allowed the company to cite deposition testimony from its witnesses who did not testify at trial under Court of Chancery Rule 32(a)(3)(B), which permits the use of deposition transcripts “by any party for any purpose” in lieu of live witness testimony when “that witness is out of the State of Delaware, unless it appears that the absence of the witness was procured by the party offering the deposition.” Here, the Court concluded that even if PetSmart could have brought the witnesses to testify at trial, the testimony was admissible because the witnesses were “out of the state of Delaware” and, in the absence of any evidence it had “actively [taken] steps to keep the deponent from setting foot in the court-room,” PetSmart did not “procure” their absence. For the same reasons, the Court also held that PetSmart demonstrated that the witness was “unavailable,” and their deposition testimony not inadmissible hearsay for the purposes of the Delaware Rules of Evidence 804(a)(5) and 804(b)(1).