On October 21, 2015, the Delaware Court of Chancery issued a post-trial opinion in an appraisal action in which it yet again found that the merger price was the most reliable indicator of fair value. Vice Chancellor Glasscock’s opinion in Merion Capital LP v. BMC Software, Inc., No. 8900-VCG (Del. Ch. Oct. 21, 2015), underscores, yet again, the critical importance of merger price and process in Delaware appraisal actions. In fact, as we have previously discussed, Merion is just the latest of several decisions by the Delaware Chancery Court over the past six months finding that merger price (following an arm’s length, thorough and informed sales process) represented the most reliable indicator of fair value in the context of an appraisal proceeding. See also LongPath Capital, LLC v. Ramtron Int’l Corp., No. 8094-VCP (Del. Ch. June 30, 2015); Merlin Partners LP v. AutoInfo, Inc., No. 8509-VCN (Del. Ch. Apr. 30, 2015).
Background
In September 2013, BMC Software, Inc., then a global firm specializing in software for IT management, was taken private by a group of investment firms led by Bain Capital, LLC, at a price of $46.25/share. Around the time of the merger, BMC’s business was “stable” but confronting a number of challenges, including shrinking margins and stagnant growth in its Mainframe Service Management business as customers shifted away from mainframe computers and “high levels of competition” in its Enterprise Service Management business. In the ordinary course of business, in or around October 2012, BMC began to create an “annual plan”—financial projections for the upcoming fiscal year that were “limited to internal use and represented optimistic goals that set a high bar for future performance.” Around the same time each year, BMC would begin to prepare “high-level three-year projections that were not as detailed as the one-year annual plan.” Consistent with management’s typical approach, the projections represented optimistic forecasts that also assumed, among other things, the company would continue its pattern of making several smaller (below $300 million) acquisitions each year as a principal way to “grow and compete.” The projections also included stock based compensation expense because such compensation was “an integral part of BMC’s business” and essential to retain talent.
In early 2013, following disappointing quarterly financial results, the company determined to conduct a sales process and solicited bids from potential buyers. This process culminated in BMC entering into a merger agreement on May 6, 2013 with a buyer group led by Bain Capital. The transaction closed September 10.
At trial of the appraisal action brought by dissenting stockholders, the parties offered competing expert testimony on fair value. The stockholders’ expert relied exclusively on a DCF analysis and determined that fair value was $67.08/share, i.e., 145% of the merger price. BMC’s expert relied on a DCF analysis supported by a “reality check” reference to Wall Street analyst reports and a comparable companies analysis, ultimately concluding that fair value was $37.88/share. The court conducted its own DCF analysis, which led it to arrive at a fair value of $48/share. Nonetheless, taking into account “all relevant factors,” as mandated by the appraisal statute, the court held that the merger price of $46.25/share was the most “persuasive indication of fair value.”
Takeaways and Analysis
A court may decide not to credit an expert’s modification to management projections, even where the projections admittedly are prepared on an optimistic basis, unless the expert provides reasonable grounds for the proposed adjustments.
BMC’s expert, who the court ultimately found to be generally “more credible” than the stockholders’ expert, reduced management’s revenue projections by 5% for purposes of his DCF analysis to account for BMC having “historically fallen short of its projected revenues.” He arrived at the 5% figure by calculating the average amount by which the company failed to meet projections. Testimony from BMC’s executives confirmed that management’s projections were “optimistic.” Nonetheless, the court found the expert’s approach “too speculative to accurately account for that bias.” As a result, for its own DCF analysis, the court used management’s “optimistic” projections without a 5% reduction.
On the other hand, the court agreed with BMC’s expert’s assumption that the company at some point would repatriate, and thus be taxed on, off-shore cash even though the company’s Form 10-K stated “its intent to maintain cash balances overseas indefinitely.”
The court reasoned that the overseas cash “represent[s] opportunity for the Company either in terms of investment or in repatriating those funds for use in the United States, which would likely trigger a taxable event.” Arguably, the court’s determination on this point is inconsistent with other aspects of its approach to a DCF analysis. It utilized management’s “optimistic” revenue projections because the suggested alternative 5% reduction was too speculative, and it agreed that future M&A and stock-based compensation expenses should be deducted from free cash flow in the DCF analysis because of the company’s history of incurring such costs and the likelihood it would do so in the future. But, without suggesting an evidentiary basis to so conclude, the court determined that the company’s intent regarding repatriating overseas cash would at some point change from the view expressed in the company’s 10-K.
Even where the court conducts its own DCF analysis, it is likely to find that the merger price arrived at following an arm’s length, fair process is the most reliable indicator of fair value. The court ultimately settled on the merger price as the most reliable measure of fair value, explaining that its approach was supported “where the sales process is thorough, effective, and free from any specter of self-interest or disloyalty.” The court found that BMC’s sales process was fair because, among other things:
- BMC conducted an initial sales process in mid-2012. In July 2012, BMC began exploring potential strategic transactions and, in August 2012, the board received two non-binding indications of interest from financial buyers—Bain Capital at $45-47/share and another potential buyer (the “Alternative Buyer”) at $48/share. No expressions of interest were received from strategic buyers. After posting positive quarterly results, BMC rejected the proposals and stopped exploring a sale at that time.
- BMC conducted a second public sales process in early 2013. In January 2013, following a return to “poor financial results in the third quarter,” it again decided to explore strategic options. In connection with the 2013 sales efforts, which were covered in the media, BMC’s financial advisor contacted potential financial buyers and received three expressions of interest: Bain Capital at $46-$47/share; the Alternative Buyer at $48/share; and one from a new financial buyer (“Buyer A”) at $42-$44/share. Buyer A refused to increase its bid and was not invited to conduct due diligence, and the Alternative Buyer requested a one-month extension of the deadline to make a bid, but indicated that any bid likely would be for an amount less than what Bain had offered.
- BMC actively negotiated for better terms with the lone viable bidder. After Bain submitted a post-due diligence offer of $45.25/share, BMC requested that Bain increase its bid to $48/share and include a 30-day go-shop period. Bain countered at $45.75/share and agreed to the go-shop. After “further pushback” from BMC, the buyers made their “final offer of $46.25/share.”
- The Go Shop Was Active But Unsuccessful. The court observed that as part of the go-shop process, the company contacted seven financial and nine strategic potential buyers, but none made an offer.
- The court had previously favorably assessed the sales process in approving a settlement in a related suit asserting breach of fiduciary duty claims. After the merger agreement was signed, certain BMC stockholders brought Revlon-based fiduciary duty claims against the BMC board, which ultimately resulted in a court-approved settlement in April 2014. In approving the settlement, Vice Chancellor Glasscock characterized the Revlon claims as “weak” and the sales process as “fair.”
Absent direct evidence on the issue, supposed “synergistic payments” to the seller’s stockholders do not necessarily need to be deducted from the merger price to arrive at fair value.
The court stated that the appraisal statute requires a determination of fair value “exclusive of any element of value arising from the accomplishment or expectation of the merger.” This provision, the court found, did not require deduction of synergies resulting from the transaction itself “where the synergies are simply those that typically accrue to a seller.” In effect, the court held, these types of synergies were reflective of the price at which the company could be sold, including “the portion of synergies that a synergistic buyer would leave with the subject company shareholders as a price for winning the deal.” Such synergies are “owned” by stockholders separate and apart from any particular transaction and should not be deducted from, and are not attributable to, the merger. The court also recognized, however, that binding common law precedent requires that those synergies “which cannot be attributed to the corporation as a going concern” must be deducted in order to value the business as an “independent going concern.”
As an example, the court posited a situation where a buyer holds a patent on a bow and then acquires the seller, which holds a patent on arrows. The buyer’s bow patent may make it value the seller more highly that the overall market, but that value “forms no part of the property held by the stockholders of [seller], pre-merger,” and would have to be deducted from the deal price (if that were the measure of fair value) in order to establish statutory fair value. On the other hand, according to the court, tax or other cost savings achievable by any acquirer taking the company private is not “value arising from the merger” and thus “logically” should not need to be deducted under the terms of the statute (although the court noted that under applicable case law, such a deduction may nonetheless be required).
In this case, the court refused to reduce the merger price because of a lack of evidence sufficient to show the portion of deal value attributable to synergies. The court rejected BMC’s argument, based on testimony from a Bain principal, that Bain would have been unwilling to offer the merger price had it not anticipated receiving tax and other cost savings by taking the company private. Such evidence merely reflected Bain’s internal analysis and did not purport, and therefore was insufficient, to establish BMC’s fair value exclusive of deal-related synergies. Presumably, such a showing could only be made by expert or other competent evidence establishing fair value excluding such efficiencies.