Delaware Supreme Court Rejects “Rote” Reliance on Market Price in Reversing “Troubling” Post-Merger Appraisal Ruling
Citing a “multitude of concerns” with the Court of Chancery’s reasoning, the Delaware Supreme Court this week overruled the trial court’s appraisal valuation in the closely-watched Verition Partners Master Fund Ltd. v. Aruba Networks, Inc. lawsuit. This per curiam opinion by the Court sitting en banc rejected the Vice Chancellor’s use of the preannouncement market price alone to determine the fair market value of Aruba’s shares, reaffirming the importance of considering other information, including the deal price and the factors affecting that deal price.
The case stems from Hewlett Packard’s 2015 acquisition of Aruba, in which it paid $24.67 per share of Aruba stock. That stock was trading at $18.37 per share at the time Aruba’s board initially voted to accept the offer, but over the next two weeks—following news of the deal leaking, and the release of quarterly results that beat analyst expectations—the price jumped to $24.81 per share, above the deal price. After the deal closed several months later, Aruba shareholder Verition filed a Section 262 action in the Court of Chancery seeking an appraisal of its shares. Section 262 appraisal actions require the court to determine the stock’s fair market value “exclusive of any element of value arising from the accomplishment or expectation of the merger.” The court thus must determine “the value of the company to the stockholders as a going concern, rather than its value to a third party as an acquisition.”
Verition argued that its Aruba stock was worth $32.57 per share—well above the deal price—while Aruba countered with a value of $19.10 per share, based on a “deal price less synergies” approach that valued the synergies HP expected to realize from the deal and backed them out of the price HP had agreed to. This $19.10 per share value was also consistent with Aruba’s and HP’s discounted cash flow valuations of the deal. At trial, no party contended that the preannouncement market price of Aruba’s stock was the best measure of the fair value.
After trial, but before any decision was rendered, the Delaware Supreme Court handed down its opinions in DFC Global Corp. v. Muirfield Value Partners, L.P., and in Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd., both high-profile rulings that reversed Section 262 decisions that had appraised the stockholder’s shares at valuations well above the merger’s deal price. These reversals were in part due to what the Court saw as a failure to give adequate weight to market data, including the stock price and the deal price.
Following these decisions, the Vice Chancellor in Aruba sent the parties a letter requesting supplemental briefing on “the market attributes of Aruba’s stock,” referencing the recent Dell decision. Aruba then abandoned its deal-price-minus-synergies position, and argued for the first time that the preannouncement stock price was the best marker of the stock’s fair value, asking that Verition be awarded the stock’s thirty-day unaffected price of $17.13 per share. The Court of Chancery did so, relying solely on that unaffected market price.
In holding that this decision was an abuse of discretion, the Delaware Supreme Court noted that the Court of Chancery’s opinion “seemed to suggest that rote reliance on market price was compelled based on its reading of DFC and Dell.” The Court called this reading of its earlier opinions “not supported by any reasonable reading of those decisions.”
The Court went on to make clear that neither Dell nor DFC require or urge the use of a stock’s market price as the determining factor in appraising its value. Rather, they recognize that efficient market forces lead to valuations that should be given appropriate weight. When a particular market is informationally efficient, “the market price is more likely to be informative of fundamental value.”
In Aruba, through the diligence process HP was aware of information relevant to Aruba’s value that was not known to the public market, including Aruba’s strong quarterly earnings that had not yet been announced when the deal price was agreed to. HP “also had more incentive to study Aruba closely than ordinary traders.” The Court held that a “buyer in possession of material nonpublic information about a seller is in a strong position (and is uniquely incentivized) to properly value the seller when agreeing to buy the company at a particular deal price, and that view of value should be given considerable weight by the Court of Chancery absent deficiencies in the deal process.” The price HP paid thus “could be seen as reflecting a better assessment of Aruba’s going-concern value” than the preannouncement public market price.
The Court concluded by ordering that the Court of Chancery enter final judgment for Verition in the amount of $19.10 per share—the per-share deal price paid by HP, minus Aruba’s valuation of the synergies HP expected from the deal and paid a premium for. Verition thus prevailed on its appeal, but the result was the appraisal Aruba had sought in the first place.
Delaware appraisal cases have struggled in recent years with the relevance of and weight to be given to the company’s unaffected stock price. Appraisal actions historically have heavily relied on discounted cash flow valuations of the going concern, with the parties battling over small changes to inputs such as the weighted average cost of capital, terminal value, and perpetual growth rate that can lead to huge swings in the valuation, and to appraisals vastly greater than the unaffected stock price. Borrowing from the efficient capital market hypothesis used in the federal Rule 10b-5 fraud-on-the-market context, some Delaware courts began using the unaffected stock price as, if nothing more, a reality check on the “fair value” required by Section 262, as long as the stock traded in an “efficient” market. In Aruba, the Vice Chancellor took that one step further, using the unaffected stock price as the sole determinant of fair value. But as the Delaware Supreme Court recognized, the fact that the market for a stock is informationally efficient “d[oes] not imply that the market price of a stock was necessarily the best estimate of the stock’s so-called fundamental value.” Going forward, we expect Delaware courts to revert to using the unaffected stock price as a helpful check on the traditional valuation techniques when the market for the stock is found to be informationally efficient, but not the sole or even primary determinant.