Dunmire v. Farmers & Merchants Bancorp of Western Pennsylvania, Inc., C.A. No. 10589-CB (Del. Ch. Nov. 10, 2016) (Bouchard, C.)
In this post-trial appraisal opinion, the Court of Chancery held that a discounted net income model, not the transaction price, was the most reliable determinant of fair value of the shares of a community bank – Farmers & Merchants Bancorp of Western Pennsylvania, Inc. (“F&M”) – that had merged with another community bank in a stock-for-stock transaction. The Court valued the shares of F&M at $91.90 per share (as compared to the deal price of $83.00).
F&M merged into NexTier, Inc. (“NexTier”) at the encouragement of the Synder family, which controlled both F&M and NexTier and stood on both sides of the transaction. F&M did not consider any other bidders. As such, the Court characterized the merger as “not the product of a robust sale process.” Plaintiffs were members of the Dunmire family who held a minority interest in F&M as of the date of the merger. The Dunmires’ expert valued F&M at $137.97 per share, approximately 66% above the deal price. F&M’s expert valued the company at $76.45 per share, roughly 8% below the deal price.
As is common in appraisal proceedings, the Court observed, the parties had submitted “wildly divergent valuations of the same company even when using similar methodologies.” The Dunmires’ expert had reached his conclusion based in large part on a comparable transactions analysis and cross-checked his figure with a discounted future benefits analysis using F&M’s 2013 adjusted net earnings. F&M’s expert used three valuations that he weighted equally to obtain his valuation: (1) a capitalized net income method based on F&M’s projected net income for twelve months, (2) a comparable transactions analysis, and (3) a guideline public company analysis.
The Court explained that, under the circumstances, the transaction price and other analyses the experts used were not reliable indicators of fair value. While other cases have found that the merger price is the best indicator of fair value, the Court concluded it was not a proper indicator here because the merger was not the product of an auction, no third parties were solicited, a controlling stockholder stood on both sides of the transaction and, although a special committee negotiated the deal, the “the record [did] not inspire confidence that the negotiations were truly arms-length.”
The Court found the comparable transactions analysis used by the Dunmires’ expert to be unreliable because the expert did not adjust for synergies incorporated in the merger prices of the eight banks selected for the analysis. Additionally, the Court expressed concerns over the comparables employed by F&M’s expert.
The Court held that, while there were math differences between the respective discounted future benefit analysis and capitalized net income method components of the experts’ analyses, “they both derive[d] a value for F&M based on a single year of net earnings to project an earnings stream using a constant long-term growth rate, and they both use[d] the Capital Asset Pricing Model to derive a discount rate in order to determine the present value of that earnings stream.”
The Court determined that, based on the information presented by both parties’ experts, the fair value of F&M could reliably be determined from a discounted net income analysis that “(1) projects a stream of earnings for F&M using a single year of its earnings as a starting point and applying a constant long-term growth rate, (2) determines the present value of that earnings stream using a discount rate calculated in accordance with Capital Asset Pricing Model, and (3) applies certain adjustments based on F&M’s capital structure, principally to account for excess cash on its balance sheet.”
In utilizing the discounted net income model, the Court determined the projected net income of F&M for the twelve month period after the closing of the merger, used the F&M expert’s annual perpetual growth rate, calculated a discount rate using the Capital Asset Pricing Model, and used the F&M expert’s excess capital estimate adjustment. Following this calculation, the Court valued F&M at $70.5 million (or $91.90 per share), representing an increase of 10.7% compared to the merger valuation.