VERITION PARTNERS MASTER FUND LTD. аnd VERITION MULTI-STRATEGY MASTER FUND LTD. v. ARUBA NETWORKS, INC.
No. 368, 2018
IN THE SUPREME COURT OF THE STATE OF DELAWARE
April 16, 2019
Submitted: March 27, 2019; Court Below: Court of Chancery of the State of Delaware; C.A. No. 11448-VCL
Before STRINE, Chief Justice; VALIHURA, VAUGHN, SEITZ, and TRAYNOR, Justices; constituting the Court en Banc.
Upon appeal from the Court of Chancery. REVERSED and REMANDED.
Michael J. Barry, Esquire, Christine M. Mackintosh, Esquire (Argued), Michael T. Manuel, Esquire, Rebecca A. Musarra, Esquire, GRANT & EISENHOFER P.A., Wilmington, Delaware, for Appellants, Verition Partners Master Fund Ltd. and Verition Multi-Strategy Master Fund Ltd.
Michael P. Kelly, Esquire (Argued), Steven P. Wood, Esquire, Daniel J. Brown, Esquire, MCCARTER & ENGLISH, LLP, Wilmington, Delaware; Marc J. Sonnenfeld, Esquire, Karen Pieslak Pohlmann, Esquire, Laura Hughes McNally, Esquire, MORGAN, LEWIS & BOCKIUS LLP, Philadelphia, Pennsylvania, for Appellee, Aruba Networks, Inc.
Ned Weinberger, Esquire, Derrick Farrell, Esquire, Thomas Curry, Esquire, LABATON SUCHAROW LLP, Wilmington, Delaware, for Amici Curiae Professors Audra Boone, Brian Broughman, Albert Choi, Jesse Fried, Mira Ganor, Antonio Macias, and Noah Stoffman in Support of Appellant and Reversal.
Gregory P. Williams, Esquire, RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware, for Professors William J. Carney and Keith Sharfman as Amici Curiae in Support of Appellee and Affirmance.
In this statutory appraisal case, the Court of Chancery found that the fair value of Aruba Networks, Inc., as defined by
I.
In August 2014, Hewlett-Packard Company (“HP“), a publicly traded company, approached Aruba, another publicly traded company, about a potential combination. Aruba hired professionals and, in addition to negotiating with HP, began to shop the deal. Five other logical strategic bidders were approached, but none of them showed any interest.3 The petitioners did not argue below that private equity bidders сould compete given the synergies a combination with HP or another strategic buyer could garner.4
After several months of negotiations between the two companies, the Aruba board decided to accept HP‘s offer of $24.67 per share. News of the deal leaked to the press about two weeks later, causing Aruba‘s stock price to jump from $18.37 to $22.24. The next day, after the market closed, Aruba released its quarterly results, which beat analyst expectations. Aruba‘s stock price rose by 9.7% the following day on the strength of its earnings to close at $24.81 per share, just above the deal price.5
Not long after the deal leaked, both companies’ boards approved the transaction, and Aruba and HP formally announced the merger at a price of $24.67 per share. The final merger agreement allowed for another passive market check.6 However, no superior bid emerged, and the deal closed on May 18, 2015.7
II.
On August 28, 2015, the appellants and petitioners below, Verition Partners Master Fund Ltd. and Verition Multi-Strategy Master Fund Ltd. (collectively, “Verition“), filed this appraisal proceeding in the Court of Chancery, asking the court to appraise the “fair value” of their shares under § 262.8 The respondent was Aruba, albeit an Aruba now 100% controlled by HP. In its pretrial and initial post-trial briefing, Verition maintained that Aruba‘s fair value was $32.57 per share,9 and Aruba contended that its fair value was either $19.45 per share (before trial) or $19.75
claimed that Aruba‘s preannouncement stock price was the best measure of fair value at the time of the merger.
Post-trial argument was scheduled for May 17, 2017, but the Court of Chancery postponed the hearing “once it became clear that the Delаware Supreme Court‘s forthcoming decision in DFC [Global Corp. v. Muirfield Value Partners, L.P.12] likely would have a significant effect on the legal landscape.”13 After this Court issued its opinion in DFC, the Court of Chancery allowed the parties to submit supplemental briefing on the opinion‘s implications, and the parties submitted simultaneous briefs on September 15, 2017. Both parties continued to argue for their preferred fair value calculation, and neither party advocated for the adoption of the stock price, though Aruba did contend that the stock price was now “informative” of fair value and lent support to its argument that fair value as of the time of the merger was in the $19 to $20 per share range.14 And the parties hewed to these positions during post-trial oral argument.
On December 14, 2017, this Court issued its opinion in Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd.15 reversing the Court of Chancery‘s appraisal decision in that case. Six days later, the Vice Chancellor in this case—who was also
the trial judge in Dell—sent the parties a letter on his own motion. In the letter, the Vice Chancellor requested supplemental briefing on “the market attributes of Aruba‘s stock” in part because he “learned how many errors [he] made in the Dell matter.”16
The parties submitted simultaneous briefs in response to the Vice Chancellor‘s sua sponte request on January 26, 2018. In its brief, Aruba abandoned deal price minus synergies as its main benchmark and argued for the first time that its preannouncement stock price was “the single most important mark of its fair value.”17 Accordingly, Aruba asked the Court of Chancery to award the thirty-day unaffected market price of $17.13 per share.18 Aruba‘s brief focused mainly on how the market for its stock was efficient.
On February 15, 2018, the Court of Chancery issued its post-trial opinion finding that the fair value under § 262 was $17.13 per share.19 In its opinion, the Court of Chancery considered three different valuation measures: first, the “unaffected market price” of Aruba‘s stock before news of the merger leaked; sеcond, the deal price minus the portion of synergies left with the seller; and third,
the two expert witnesses’ valuations, which were
In weighing the valuation methodologies, the Court of Chancery gave no weight to the parties’ DCF models. The Court of Chancery also determined, based on its own analysis, that the appropriate deal price minus synergies value was $18.20. In reaching that conclusion, the Court of Chancery started with an estimate of the total amount of synergies HP expected to realize. To determine how much of those synergies Aruba‘s stockholders received in the deal price, the Court of Chancery took the midpoint of a study suggesting that “on average, sellers collect 31% of the capitalized value of synergies, with the seller‘s share varying widely from 6% to 51%.”21 This resulted in a deal price minus synergies value of $18.20 per share, $0.90 lower than Aruba‘s own estimate of deal price minus synergies. And although the Vice Chancellor was “inclined to think that Aruba‘s representatives bargained less effectively than they might have,” “indicat[ing] that [Aruba] obtained fewer synergies than the midpoint range and imply[ing] value north of $18.20 per share,”22 he failed to explain why his estimate of $18.20 per share was more reliable than Aruba‘s own estimate of $19.10 per share.
However, the Vice Chancellor did not adopt his deal price minus synergies value, in part because he believed that his “deal-price-less-synergies figure continues to incorporate an element of value resulting from the merger” in the form of “reduced agency costs that result from unitary (or controlling) ownership.”23 To remedy this, the Vice Chancellor elected to rely exclusively on the stock price because he thought he would need to estimate and back out these theoretical “reduced agency costs” from the deal price to arrive at a figure that reflected Aruba‘s value as a going concern. According to the Court of Chancery, using the “unaffected market price” of Aruba‘s publicly traded shares “provide[d] a direct estimate” of that endpoint, which led him to find the sole indicator of fair value to be that “unaffected market price” of $17.13 per share.24 Although § 262 requires the Court of Chancery to assess Aruba‘s fair value as of “the effective date of the merger,”25 the Court of Chancery arrived at the unaffected market price by averaging the trading price of Aruba‘s stock during the thirty days before news of the merger leaked, which was three to four months prior to closing.
III.
We reverse the trial court‘s fair value determination. Under Cavalier Oil Corp. v. Hartnett, the Court of Chancery‘s task in an appraisal case is “to value what has been taken from the shareholder: ‘viz. his proportionate interest in a going concern.‘”26 That is, the court must value the
amount of any value that the selling company‘s shareholders would receive because a buyer intends to operate the subject company, not as a stand-alone going concеrn, but as a part of a larger enterprise, from which synergistic gains can be extracted.”31 For this reason, in cases where the Court of Chancery has used the price at which a company is sold in a third-party transaction, it has excised a reasonable estimate of whatever share of synergy or other value the buyer expects from changes it plans to make to the company‘s “going concern” business plan that has been included in the purchase price as an inducement to the sale.32 No party in this proceeding argued to us that the long-standing use of going-concern value, or its concomitant requirement to excise synergy gains, should be revisited.
Applying the going-concern standard, we hold that the Court of Chancery abused its discretion in using Aruba‘s “unaffected market price” because it did so on the inapt theory that it needed to make an additional deduction from the dеal price for unspecified “reduced agency costs.” It appears to us that the Court of Chancery would have given weight to the deal price minus synergies absent its view that it also had to deduct unspecified agency costs to adhere to Cavalier Oil‘s going-concern
standard.33 As Verition points out, this aspect of the decision is not grounded in the record. Judging by the law review articles cited by the Court of Chancery, the theory underlying the court‘s decision appears to be that the acquisition would reduce agency costs essentially because the resulting consolidation of ownership and control would align the interests of Aruba‘s managers
Indeed, neither party presented any evidence to suggest that any part of the deal price paid by HP, a strategic buyer, involved the potential for agency cost reductions that were not already captured by its synergies estimate. Synergies do
not just involve the benefits when, for example, two symbiotic product lines can be sold together. They also classically involve cost reductions that arise because, for example, a strategic buyer believes it can produce the same or greater profits with fewer employees36—in English terms, rendering some of the existing employees “redundant.” Private equity firms often expect to improve performance and squeeze costs too, including by reducing “agency costs.”37 Here, the Court of Chancery‘s belief that it had to deduct for agency costs ignores the reality that HP‘s synergies case likely already priced any agency cost reductions it may have expected. In short, the Court of Chancery acknowledged that there were estimates of the synergies expected by HP, and the record provides no reason to believe that those estimates omitted any other added value HP thought it could achieve because of the combination. For this reason, Aruba itself presented a deal price minus synergies value of $19.10 per share as one of its suggested outcomes.
As to this issue, Aruba never argued that its deal рrice minus synergies case did not fully account for all the “agency cost” reductions it expected, and the Court of Chancery‘s view that some measure of agency costs had to be accounted for finds no basis in the record. Nor does it find any basis in the corporate finance literature;
given that all the cost reductions HP expected as a widely held, strategic buyer were likely to be fully accounted for by its expected synergies.38 Theory here tracks the facts, and there was no reasonable basis to infer that Aruba was cheating itself out of extra agency cost reductions by using only the cost reductions that were anticipated in commercial reality. However, instead of at least awarding Verition the deal price minus HP‘s estimate of its expected synergies left with the seller, which generated a value that was corroborated
In addition to believing that it had to account for unspecified agency costs, the Court of Chancery also seemed to suggest that rote reliance on market prices was compelled based on its reading of DFC and Dell.40 Like any human perspective, the trial judge‘s broader reading of Dell and DFC is arguable, but the trial judge‘s sense
that those decisions somehow compelled him to make the decision he did was not supported by any reasonable reading of those decisions or grounded in any direct citation to them. Among other things, the trial judge seemed to find it novel that DFC and Dell recognized that when a public company with a deep trading market is sold at a substantial premium to the preannouncement price, after a process in which interested buyers all had a fair and viable opportunity to bid, the deal price is a strong indicator of fair value, as a matter of economic reality and theory. The apparent novelty the trial judge perceived is surprising, given the long history of giving important weight to market-tested deal prices in the Court of Chancery and this Court, a history that long predated the trial judge‘s contrary determination in Dell.41
In this case, for instance, Aruba approached other logical strategic buyers prior to signing the deal with HP, and none of those potential buyers were interested. Then, after signing and the announcement of the deal, still no other buyer emerged even though the merger agreement allowed for superior bids. It cannot be that an open chance for buyers to bid signals a market failure simply because buyers do not believe the asset on sale is sufficiently valuable for them to engage in a bidding contest against each other. If that were the jurisprudential conclusion, then the judiciary would itself infuse assets with extra value by virtue of the fact that no actual market participants saw enough value to pay a higher price. That sort of alchemy has no rational basis in economics.
In fact, encouraged by Weinberger v. UOP, Inc.44 our courts have for years applied corporate finance principles such as the capital asset pricing model to value companies in appraisal proceedings in ways that depend on market efficiency. The reliable application of valuation methods used in appraisal proceedings, such as DCF and comparable companies analysis, often depends on market data and the efficiency of the markets from which that data is derived. For example, it is difficult to come up with a reliable beta if the subject company‘s shares do not trade in an efficient
market,45 and the reliability of
Even before this Court‘s seminal opinion in Weinberger, the old Delaware “block” method used market prices in one of its three prongs.47 In forsaking the Delaware block method as a rigid basis to determine fair value, Weinberger did not hold that market value was no longer relevant; in fact, Weinberger explicitly condoned its use.48 Extending this basic point, DFC and Dell merely recognized that a buyer in possession of material nonpublic information about the 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.49
Likewise, assuming an efficient market, the unaffected market price and that price as adjusted upward by a competitive bidding process leading to a sale of the entire company was likely to be strong evidence of fair value. By asserting that Dell and DFC “indicate[] that Aruba‘s unaffected market price is entitled to substantial weight,”50 the Vice Chancellor seemed to suggest that this Court signaled in both cases that trading prices should be treated as exclusive indicators of fair value. However, Dell and DFC did not imply that the market price of a stock was necessarily the best estimate of the stock‘s so-called fundamental value at any particular time.51 Rather, they did recognize that when a market was informationally efficient in the sense that “the market‘s digestion and assessment of all publicly available information concerning [the Company] [is] quickly impounded into the Company‘s stock price,” the market price is likely to be more informative of fundamental value.52 In fact, Dell‘s references to market efficiency focused on informational efficiency—the idea that markets quickly reflect publicly available
information and can be a proxy for fair value—not the idea that an
of arm‘s length buyers of the entire company to learn more through due diligence, involving confidential non-public information, and with the keener incentives of someone considering taking the non-diversifiable risk of buying the entire entity, the price that results from that process is even more likely to be indicative of so-called fundamental value, it was correct.56
Here, the price that HP paid could be seen as reflecting a better assessment of
knew about Aruba‘s strong quarterly earnings before the market did, and likely took that information into account when pricing the deal. Based on the record evidence, the Court of Chancery could easily have found that HP and Aruba‘s back and forth over price, HP‘s access to nonpublic information to supplement its consideration of the public information available to stock market buyers, and the currency of the information that they had at the time of striking a bargain had improved the parties’ ability to estimate Aruba‘s going-concern value over that of the market as a whole.57 In particular, HP had better insight into Aruba‘s future prospects than the market because it was aware that Aruba expected its quarterly results to exceed analysts’ expectations.58 When those strong quarterly results were finally reported—after the close of the period that the Court of Chancery used to measure the “unaffected market price“—Aruba‘s stock price jumped 9.7%. Indeed, after the market learned
about the strong quarter and the likelihood of a strategic deal with HP, Aruba‘s stock traded at $24.81, $0.14 away from the actual price HP paid. Of course, despite expressing concern about the fact that no other bidder emerged to compete with HP at the $24-plus price range, the Court of Chancery then awarded Verition $7.54 per share less than the $24.67 deal price.
By relying exclusively on the thirty-day average market price, the Court of Chancery not only abused its discretion by double counting agency costs but also injected due process and fairness problems into the proceedings. As Verition argued, the Vice Chancellor‘s desire not to award deal price minus synergies could be seen—in light of his letter to the parties and the overall tone of his opinion and reargument decision—as a results-oriented move to generate an odd result compelled by his personal frustration at being reversed in Dell. Indeed, the idea of awarding the stock price came into the proceedings from the Vice Chancellor himself after requesting supplemental post-trial briefing on the
introduced this issue late in the proceedings, the extent to which the market price approximated fair value was never subjected to the crucible of pretrial discovery, expert depositions, cross-expert rebuttal, expert testimony at trial, and cross examination at trial. Instead, the Vice Chancellor surfaced Aruba‘s stock price as an appropriate measure of fair value in a way that is antithetical to the traditional hallmarks of a Court of Chancery appraisal proceeding. The lack of a developed record on whether the stock price was an adequate proxy for fair value buttresses our holding that the Court of Chancery abused its discretion by awarding the thirty-day average unaffected market price of $17.13 per share.
Thеse procedural issues relate to substance in an important way. The reason for pretrial discovery and trial is for parties to have a chance to test each other‘s evidence and to give the fact-finder a reliable basis to make an ultimate determination after each side has a fair chance to develop a record and to comment upon it. The lack of that process here as to the Vice Chancellor‘s ultimate remedy is troubling. The Vice Chancellor slighted several important factors in choosing to give exclusive weight to the unaffected market price. Under the semi-strong form of the efficient capital markets hypothesis, the unaffected market price is not assumed to factor in nonpublic information. In this case, however, HP had signed a confidentiality agreement, done exclusive due diligence, gotten access to material nonpublic information, and had a much sharper incentive to engage in price
discovery than an ordinary trader because it was seeking to acquire all shares. Moreover, its information base was more current as of the time of the deal than the trading price used by the Vice Chancellor. Compounding these issues was the reality that Aruba was set to release strong earnings that HP knew about in the final negotiations, but that the market did not. As previously noted, Aruba‘s stock price jumped 9.7% once those earnings were finally reported to the public. None of these issues were illuminated in the traditional way, and none of them were discussed by the Court of Chancery in a reasoned way in giving exclusive weight to a prior trading price that was $7.54 below what HP agreed to pay, and well below what Aruba had previously argued was fair value.
This multitude of concerns gives us pause, as does the evident plausibility of Verition‘s concern that the trial judge was bent on using the thirty-day average market price as a personal reaction to being reversed in a different case. In a reargument decision addressing the petitioner‘s argument to this effect, the Vice Chancellor denied that this was the case.60 We take him at his word. However, so too do
come up with a reliable estimate of his own because he wanted to double count agency costs, and also lacked confidence in his underlying synergy deduction.61 Nevertheless, fixing the double counting problem and hewing to the record developed by the parties themselves leaves a reliable estimate of deal price minus synergies,62 which is the one that Aruba advanced until the Vice Chancellor himself injectеd the thirty-day average market price as his own speculative idea. Of course, estimating synergies and allocating a reasonable portion to the seller certainly involves imprecision, but no more than other valuation methods, like a DCF analysis that involves estimating (i) future free cash flows; (ii) the weighted average cost of capital (including the stock‘s beta); and (iii) the perpetuity growth rate. But here there is no basis to think Aruba was being generous in its evaluation of deal price
minus synergies. And, as any measure of value should be, Aruba‘s $19.10 deal price minus synergies value is corroborated by abundant record evidence.63
Aruba‘s real-time considerations65 and Aruba‘s DCF,66 comparable companies,67 and comparable transactions analyses.68
Rather than burden the parties with further proceedings, we order that a final judgment be entered for the petitioners in the amount of $19.10 per share plus any interest to which the petitioners are entitled.