In re Appraisal of Dell Inc., C.A. No. 9322-VCL (Del. Ch. May 31, 2016) (Laster, V.C.)
In this memorandum opinion, the Delaware Court of Chancery resolved the long-running litigation over the buyout of Dell Inc. (“Dell”), valuing the company at nearly $4 per share over the transaction price. Vice Chancellor Laster held, after a full trial on the merits, that the fair value of Dell was 28% higher than the price paid for it by founder Michael Dell and Silver Lake Partners, even though the deal price was a nearly 30% premium over Dell’s market price. The Court did so despite acknowledging that, in at least five current decisions, the Court “has found the deal price to be the most reliable indicator of the company’s fair value, particularly when other evidence of fair value was weak,” and that Dell’s sale process “easily would sail through if reviewed under enhanced scrutiny.”
In June 2012, Dell’s stock price had shrunk to approximately $12 per share. Mr. Dell, believing that the market had undervalued the Company, approached the Dell board about a possible management buy-out. The Dell board formed a special committee, with full powers to negotiate on behalf of the Company and consider other strategic alternatives or other matters it determined to be advisable. In July 2012, management presented its projections to the board, projecting the Company was worth $25 billion more than the then current market capitalization of $15 billion. Management subsequently revised its projections downward in September 2012. The special committee’s financial advisors prepared a stand-alone valuation of Dell at the time that included a DCF range of $20 to $27 per share using the September projections, and a DCF range of $15.25 to $19.25 per share using the Street’s consensus case. It also stated that a financial buyer applying an LBO pricing model at 3.1x leverage and assuming a 20% five-year IRR would likely pay a price of approximately $14 per share. KKR and Silver Lake submitted initial proposals, but KKR dropped out following Dell’s underperformance in third quarter 2013. Silver Lake then submitted a proposal of $12.70 cash per share, which it increased to $12.90. The special committee set a target price at $13.75 per share, and, on February 6, 2013, accepted an offer from Silver Lake of $13.65 cash per share with Mr. Dell rolling over his shares at a lower per share valuation with an additional cash investment. The proposed deal would result in Mr. Dell owning approximately 75% of the Company following the transaction.
The proposed transaction with Mr. Dell included a 45-day go-shop period. Dell’s special committee approached 60 potential strategic acquirers, which resulted in Carl Icahn proposing a leveraged recapitalization bid and Blackstone proposing a $14 cash per share (which was later withdrawn). Silver Lake raised its offer to $13.75 cash per share plus a cash dividend immediately preceding the merger of $0.13 per share. The special committee and the Company’s board approved the transaction and Dell’s unaffiliated shareholders voted in favor of the transaction. The merger was completed on October 29, 2013, with certain Dell shareholders exercising their appraisal rights. A full trial on the merits was subsequently held.
After the trial, the Court ruled that the sale price was not a reliable indicator of fair value. The Court specifically indicated that three factors contributed to the deal price being below fair value: (1) the use of an LBO pricing model to determine the original merger price, (2) the “compelling” evidence of a significant “valuation gap” between the long-term value of Dell in the view of Dell’s management and the market price of the Dell stock, and (3) the lack of “meaningful” pre-signing competition. First, The Court began by noting that because the transaction was a management buyout “management’s additional and conflicting role as buyer  present different concerns than true arms’ length transactions.” The Court was concerned that, because the only active bidders were financial buyers, as opposed to strategic buyers, the transaction price reflected the constraints of an “LBO pricing model” wherein financial bidders focus only on short term internal rates of return. In the Court’s view, the Dell special committee “as a practical matter negotiated without determining the value of its best alternative to a negotiated acquisition” because an LBO pricing model solves backwards from a desired internal rate of return. The Court found that fair value under the appraisal statute requires more long term considerations, such as asset value and prospective earnings. Second, as a result, the Court found evidence of a “valuation gap between the market’s perception and the Company’s operative reality.” A major consideration, in the Court’s view, against the “short-term, quarter-by-quarter results” focus of an LBO pricing model was the Company’s recent $14 billion in investments that had not yet generated their anticipated results. Third, the Court found that there existed limited pre-signing competition for the Company. The Court opined that even though the special committee was empowered to say no to Silver Lake’s offer, the special committee lacked the meaningful threat of an alternative deal.
The Court then held that problems existed in the post-signing go-shop phase that resulted in a deal price below fair value. These problems included the size and complexity of Dell as a Company, the “winner’s curse” of asymmetrical information between insiders and potential bidders, and Michael Dell’s personal value to the Company. As a result, the Court concluded that Dell failed to establish by a preponderance of the evidence that the outcome of the sale process offered the most reliable evidence of fair value. Even considering all these factors, the Court found the outcome of the sale process sufficiently probative to rule out the petitioners’ claim that Dell shares were worth $28.61 (more than twice the deal price).
The Court then turned to both side’s DCF analysis generated by their respective experts. The parties’ experts’ different DCF analyses resulted in values that differed by 126%, which was primarily caused by the different projected cash flows used. The Court ultimately determined to use its own inputs, based on forecasts from the Company’s expert, and conduct its own DCF analysis, which resulted in a price of $17.62 per share.