In a recent appraisal action before the Court of Chancery, In re Appraisal of SWS Group, Inc.C.A. No. 10554-VCG (Del. Ch. May 30, 2017), Vice Chancellor Glasscock found that the fair value of the acquired entity, SWS Group, Inc., (“SWS” or the “Company”), was less than deal price as a result of synergies between SWS and the acquiring company, Hilltop Holdings, Inc. (“Hilltop”).  Prior to the merger, SWS was a relatively small bank holding company.

Although the Court acknowledged that “a public sales process that develops market value is often the best evidence of statutory ‘fair value’”, what drove the Court to not rely upon deal price was its finding that “the sale of SWS was undertaken in conditions that make the price thus derived unreliable as evidence of fair value….”  Slip op., at 1.

Per the Court, the sale process of SWS was not a reliable proxy for statutory fair value because, among other things, “the probable effect on deal price of the existence of the [Hilltop] Credit Agreement under which the acquirer exercised a partial veto power over competing offers.”  Slip op., at 30.  Notably, neither side’s expert relied upon the deal price to determine fair value.

The Court was presented with competing discounted cash flow analyses from petitioning stockholders and the Company, along with a less frequently used comparable companies analysis provided by the petitioners.  The latter approach was rejected by the Court given that the sample of comparables chosen by the expert differed in significant ways.

In comparing the competing DCF analyses, the Court noted the way in which each side’s respective expert factored in the projections of the Company’s management.  In determining the appropriate cash flow projections, the Court of Chancery “has long expressed its strong preference for management projections.”  Slip op., at 32.

Of significance, respondent’s expert adopted management projections of the Company, while the petitioning stockholders’ expert made major adjustments to the projections, including extending the projections by two years.  The Court largely adopted the management projections with certain adjustments, which favored the Company’s DCF valuation.

The Court also analyzed the expert’s agreements over certain additional inputs, including equity risk premium, equity beta, and size premium.  After a careful consideration of each input, the Court determined that the fair value of the Company was $6.38/share, down from a merger price of $6.92/share.  Vice Chancellor Glasscock noted “that the fact that my DCF analysis resulted in a value below the merger price is not surprising: the record suggests that this was a synergies-driven transaction whereby the acquirer shared value arising from the merger with SWS.”

Key Takeaway: Appraisal actions in the Delaware Court of Chancery can come at real risk to petitioners when a robust sales process did not take place, management projections are significantly altered, and the sale included large synergies between the seller and acquirer that would be inappropriate to factor into the fair value of the entity.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.