Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., C.A. No. 11448-VCL (Del. Ch. Feb. 15, 2018) (Laster, V.C.)
In the first appraisal decision of a public company following the Delaware Supreme Court’s opinions in DFC and Dell, the Court of Chancery determined the unaffected market price of Aruba Networks, Inc. (“Aruba”), which was more than 30% lower than the price Hewlett-Packard Company (“HP”) paid to acquire Aruba, provided the most persuasive evidence of fair value. It appears unlikely that this decision is the harbinger of a line of cases setting fair value at the unaffected market price. Nonetheless, the decision is a must read for practitioners because it highlights a number of issues at the forefront of appraisal litigation following the Delaware Supreme Court’s forceful application of the efficient capital market hypothesis in DFC and Dell.
Following HP’s acquisition of Aruba for $24.67 per share, Verition Partners Master Fund and Verition Multi-Strategy Master Fund (“Petitioners”) filed an appraisal proceeding. The parties advanced three methods for determining Aruba’s fair value: (1) Aruba’s unaffected market price; (2) deal price; and (3) discounted cash flow.
In addressing the reliability of the unaffected market price, the Court noted that both DFC and Dell endorsed a “traditional version” of the efficient capital market hypothesis, pursuant to which market price is a reliable indicator of fair value when the market for a company’s stock has certain attributes—many stockholders, no controlling stockholder, highly active trading, and widespread information. But the Court observed that there is a “growing body of literature that raises questions about the assumptions undergirding” that traditional version, and suggested that “future appraisal litigants might retain experts on market efficiency” to permit future appraisal decisions to consider “subtler aspects of the efficient capital markets hypothesis.” Noting that the Petitioners had not provided any such expert testimony, however, the Court found that Aruba possessed the attributes of an efficient market identified in DFC and Dell, and concluded that Aruba’s unaffected thirty-day average market price of $17.13 per share was reliable evidence of value.
The Court also determined that the deal price, despite the absence of meaningful competition among potential bidders, was probative evidence of fair value. In reaching that determination, the Court interpreted the Supreme Court’s guidance on deal price to focus on whether the transaction was negotiated fairly, not whether a higher price could have been obtained. The Court then adjusted the deal price downward to account for the value of synergies associated with the merger. Although the Delaware Courts have routinely recognized that such an adjustment may be appropriate, the Court of Chancery has rarely made such an adjustment. And, as the Court recognized, there is considerable difficulty in backing out synergies with precision. That imprecision notwithstanding, the Court concluded that deal-price-less- synergies valued Aruba at $18.20 per share.
Finally, the Court considered each sides’ discounted cash flow method. After identifying issues with each experts’ valuation, the Court rejected the discounted cash flow method here because there was no evidence that the market could not be relied on to ensure fair treatment. As practitioners will note, while consistent with the language of Dell, this is a marked departure from the Delaware Courts’ historical reliance on the discounted cash flow method as probative evidence of fair value, even where there is an efficient market.
After considering the three valuation methodologies, the Court held that Aruba’s unaffected market price provided the most straightforward and reliable method for determining Aruba’s fair value as a going concern. In reaching its decision, the Court noted that both market price and deal-price-less- synergies were probative of fair value. However, the Court noted that the unaffected market price is the direct result of numerous market participants whereas the deal-price-less- synergies involves judgment and uncertainty.
This is an important decision as Delaware Courts begin to apply the teachings of, and address the questions raised by, DFC and Dell. The Court of Chancery followed the Supreme Court’s guidance that market price and deal price are highly probative of fair value, and rejected applying the discounted cash flow method to an arm’s-length merger of a publicly traded company. However, the Court of Chancery noted that a different result may be warranted, where petitioners establish credible objections to the traditional efficient capital markets hypothesis endorsed by the Supreme Court through case-specific expert opinions supported by the weight of social science research. The Court of Chancery also highlighted important shortcomings when considering deal price, specifically the difficult task of backing out synergies and accounting for reduced agency costs.