Laidler v. Hesco Bastion Environmental, Inc., C.A. No. 7561-VCG (Del. Ch. May 12, 2014) (Glasscock, V.C.)
In this memorandum opinion, the Court of Chancery determined the fair value of the petitioner’s stock in a statutory appraisal proceeding arising from the short-form merger of Hesco Bastion USA, Inc. (the “Company”) into the Company’s majority stockholder, Hesco Bastion Environmental, Inc. (“Respondent”).
The Company manufactured and marketed “Concertainer” barriers, which can be deployed as giant sandbags to protect against flooding. In early 2012, after the death of the Concertainer’s inventor, Respondent launched a tender offer for all outstanding shares of the Company. Patricia Laidler (“Petitioner”), a former officer of the Company, rejected Respondent’s tender offer of $207.50 per share and, in doing so, became the sole minority stockholder in the Company. Petitioner then sought appraisal of her 10% interest in the Company pursuant to 8 Del. C. § 262 in connection with the second-step, short-form merger.
At trial, Respondent argued that the tender offer price provided persuasive evidence of the Company’s fair value. The Court rejected this argument, noting the merger was not the result of an arm’s-length transaction where a full market check had been conducted, and thus the tender offer price set by Respondent provided no guidance. The Court also rejected Respondent’s use of a comparable companies analysis to establish fair value. The Court noted that Respondent’s expert conceded that the companies selected for his fair value opinion were not exactly like the Company, and that the same expert had used different companies and transactions in an earlier fair market value opinion prepared for the Company when Petitioner was deciding whether to exercise contractual put rights.
After dismissing these proposed valuations, the Court was left to consider competing expert valuations based on the direct capitalization of cash flow method (“DCCF”). Under a DCCF analysis, a normalized figure for annual cash flows in perpetuity is first determined, and then a capitalization rate by which to divide cash flows is calculated. Employing this method, Petitioner contended that each share of the Company had a fair value of $515, whereas Respondent contended each share was worth $256.20. While noting that discounted cash flow analyses are often employed in Delaware appraisal litigation, the Court found that a DCCF valuation was the more appropriate method for determining fair value in this case. The Court explained that, because the Company’s revenues were largely dependent on natural disasters and weather-related events, the Company never generated forward-looking projections, which rendered a discounted cash flow analysis unworkable.
The parties’ disputes over the Company’s value primarily stemmed from the construction of cash flow figures. Petitioner’s expert gave 40% weight to 2010 revenues, a year of “average to poor” revenues, and 60% weight to 2011 revenues, a year in which revenues were nearly double the historical average. Respondent’s expert, on the other hand, considered both actual revenues from 2009 through 2011, and—at the urging of the former CEO and a director of Respondent—“normalized” revenue figures in which certain “non-recurring” revenues were backed out of the analysis. These omitted revenues arose from purchases related to a faulty dam, a major oil spill, and a 500-year flood. In the end, the Court rejected both approaches, finding that Petitioner provided no explanation for giving more weight to a year of exceptional revenue and that Respondent could not discount all natural disasters as “non-recurring.” Instead, the Court held that the best predictor of future cash flows consisted of actual revenues from 2009 through 2011, weighted equally.
In addition, the Court also considered the potential effect on cash flows resulting from certain events that the experts used in determining what weight to give cash flows in prior years: (a) the potential opening of a production facility, (b) the impending expiration of certain patents that could increase competition in the market, and (c) the termination of a licensing agreement with an affiliate allowing the Company to use certain intellectual property to manufacture and market its products. Because neither expert quantified the effects of these events, the Court declined to undertake its own analysis and instead accepted the parties’ assumption that the events would have an offsetting effect.
After resolving minor differences regarding the applicable tax rate, depreciation figure, and capital expenditure figure, the Court turned to the second step of the DCCF analysis: the proper capitalization rate. Using a build-up model and data published by Morningstar, the Court found that the appropriate industry risk was 5.91% and that the size premium was 6.1%. Finally, the Court accepted Respondent’s more conservative 90% equity to 10% debt capital structure, rather than the 85% to 15% ratio proposed by Petitioner.
Based on these inputs, the Vice Chancellor found that the fair value of each share was $364.24. As a result, Petitioner was awarded $3,642,400 for her 10,000 shares, plus interest at the statutory rate.