In re Appraisal of SWS Group, Inc.
CA 10554-VCG
| Del. Ch. | May 30, 2017Background
- SWS Group, a small public bank holding company with substantial broker-dealer operations, merged into a Hilltop subsidiary effective January 1, 2015; shareholders received $6.92 per share (cash + Hilltop stock).
- Hilltop and Oak Hill had provided a $100 million loan to SWS in 2011 that included warrants exercisable into SWS stock and a Merger Covenant that could constrain competing bids.
- A Special Committee ran a limited sale process in early 2014; Hilltop submitted the only firm timely offer and the board approved a $7.75 per-share deal (75% stock, 25% cash).
- Petitioners (dissenting shareholders) sought appraisal under 8 Del. C. § 262; their expert put fair value at $9.61/share (80% DCF, 20% comparables); Respondents’ expert opined $5.17/share (100% DCF).
- Chancellor Glasscock declined to treat the deal price as controlling because of process concerns (creditor influence, merger covenant, synergies) and rejected the Petitioners’ comparable-companies work as unreliable.
- The court performed a DCF using management projections (2015–2017), adjusted for earlier-than-projected warrant exercise (reducing interest expense), adopted a 3.35% terminal growth rate, a supply-side equity risk premium (6.21%), beta 1.10, and a midpoint size premium (3.46%), and held fair value = $6.38 per share.
Issues
| Issue | Petitioners' Argument | Respondents' Argument | Held |
|---|---|---|---|
| Admissibility of deal price as indicator of fair value | Sales process was flawed; deal price unreliable | Deal price not used because it includes synergies, but should be a check | Deal price rejected as unreliable on facts (creditor influence, Merger Covenant, synergies) |
| Use of comparable companies analysis | Comparable comps support higher value and warrant 20% weight | Selected comps are not truly comparable given SWS's size/structure | Comparable companies analysis rejected as insufficiently reliable |
| Use of management projections vs. expert extensions | Management projections were too short/optimistic; extend two years to reach steady state | Management projections are the proper starting point; projections already incorporate warrant exercise timing | Court adopts management 3‑year projections and rejects Petitioners’ two‑year extension |
| Treatment of warrant exercises and excess regulatory capital | Warrant conversion created distributable excess capital; include large lump-sum distributions in DCF | Warrant exercise increased regulatory capital but did not create distributable cash; do not assume large distributions that would conflict with management projections | Warrants viewed as part of operative reality, but court declines to assume Clarke’s lump‑sum distributions; defers to management’s treatment and only adjusts interest expense for earlier conversion |
| Interest expense adjustment from earlier warrant exercise | Not specifically contested beyond capital treatment | Earlier exercise reduces interest expense and increases projected net income | Court reduces interest expense for earlier warrant exercise, increasing 2015 & 2016 net income accordingly |
| Discount rate inputs (ERP, beta, size premium) | Use supply‑side ERP; beta ~1.10; smaller size premium based on iterative valuation | Favor historical ERP and a higher beta derived from recent SWS returns; larger size premium using pre-offer market cap | Court adopts supply‑side ERP (6.21%), beta 1.10, and a midpoint size premium (3.46%) resulting in chosen discount rate |
Key Cases Cited
- Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983) (sets scope of merger-related exclusions from fair value)
- Cede & Co. v. Technicolor, Inc., 684 A.2d 289 (Del. 1996) (operative reality and appraisal standards)
- M.G. Bancorporation, Inc. v. Le Beau, 737 A.2d 513 (Del. 1999) (valuation of going concern in appraisal)
- Golden Telecom, Inc. v. Glob. GT LP, 11 A.3d 214 (Del. 2010) (analysis of ERP and valuation methodology guidance)
- ONTI, Inc. v. Integra Bank, 751 A.2d 904 (Del. Ch. 1999) (burden to show comparables are truly comparable)
- Delaware Open MRI Radiology Assocs., P.A. v. Kessler, 898 A.2d 290 (Del. Ch. 2006) (importance of management projections for DCF)