Chancellor Andre Bouchard of Delaware Chancery Court is, without question, a very smart man. But even the very smartest people occasionally make mistakes. The chancellor made one when he first calculated a discounted cash flow value for the payday lender DFC Global in an appraisal action by DFC shareholders protesting the company’s $9.50 per share sale in 2014 to Lone Star Capital, a private equity firm. Bouchard made a single clerical error that led him to peg DFC’s fair value at $10.21 per share.
DFC’s lawyers at Gibson Dunn & Crutcher spotted the mistake and asked Chancellor Bouchard to fix the erroneous input. If he did, the firm said, he’d come up with a fair value for the company that was actually lower than the price Lone Star paid. The chancellor agreed to recalculate – but in addition to fixing the mistaken input, Bouchard adjusted DFC’s projected long-term growth rate way up, to a number even higher than the top of the range proposed by the plaintiffs’ expert. The offsetting changes brought the recalculated valuation back in line with Chancellor Bouchard’s original, mistaken analysis.
Gibson Dunn is now arguing at the Delaware Supreme Court that the chancellor’s tinkering shows just why appraisal litigation – in which shareholders dissatisfied with buyout prices ask Chancery Court to come up with a fair price for their stock – has become a big problem for companies trying to sell themselves.
The best indicator of fair value isn’t spreadsheet calculations by judges picking amongst variables advocated by the different sides’ experts, Gibson Dunn said in its brief for DFC. Fair value, it said, is what a buyer is willing to pay for a company in a robust, transparent and untainted sale process – like the one Chancellor Bouchard determined DFC to have run. The payday lender faced potentially ruinous regulatory uncertainty in the U.K., its biggest market. Its investment bankers shopped the company for about two years, reaching out to dozens of potential buyers and opening DFC’s books to several serious bidders even as the company kept revising its projections downward. In the end, only Lone Star came through with an offer.
Chancellor Bouchard’s analysis should have ended when he concluded the DFC sales process was untainted, according to DFC. All of the chancellor’s subsequent calculations, mistaken and rejiggered, served only to highlight what Gibson Dunn called “the arbitrariness and imprecision of valuing a company using a speculative, malleable cash-flow model instead of the value proven by a real-world, arm’s-length, conflict-free transaction.”
The firm is calling on the Delaware Supreme Court to use the DFC case to codify the principle that the market is smarter than even the smartest Chancery Court judge. It wants the high court to rule that when buyers have conducted an arm’s-length, conflict-free sale to a disinterested buyer after a robust auction process, the transaction price is, by law, the most reliable measure of value.
That’s a step farther than Delaware courts have been willing to go. Lots of Chancery Court judges have relied on deal prices to determine fair value. As DFC’s brief points out, the Chief Justice of the Delaware Supreme Court, Leo Strine, is in that club. In his 2004 opinion in Union Illinois v. Union Financial then Vice-Chancellor Strine said the competitive auction for Union Financial provided “the most reliable evidence of fair value,” adding, “for me (as a law-trained judge) to second-guess the price that resulted from that process involves an exercise in hubris and, at best, reasoned guess-work.” In a string of four cases in 2015, Chancery judges rejected arguments that companies were undervalued, holding instead that the market had set a fair price.
But in 2010’s Golden Telecom v. Global GT, the Delaware Supreme Court expressly rejected a call to require Chancery Court judges to default to the deal price to assess fair value. “Requiring the Court of Chancery to defer - conclusively or presumptively - to the merger price, even in the face of a pristine, unchallenged transactional process, would contravene the unambiguous language of the statute and the reasoned holdings of our precedent,” the state justices said. “It would inappropriately shift the responsibility to determine ‘fair value’ from the court to the private parties.”
Gibson Dunn insists that DFC is asking for a less sweeping rule than the one the Supreme Court refused to adopt in Golden Telecom, calling for deference to the merger price only “where the transaction involves no insiders and follows a thorough and conflict-free sales process,” its brief said. The merger at issue in Golden Telecom, according to DFC’s brief, would not have met the bar DFC is suggesting because it was not an arm’s-length sale to a disinterested party.
Interestingly, the Vice-Chancellor who declined in the Golden Telecom case to adopt the merger price as fair value was Leo Strine, the same judge who said in Union Financial that it would be hubris for a law-trained judge to assume he is equipped to second-guess bidders in a robust auction process. Which Strine will predominate when the DFC case is decided?
I emailed Stuart Grant and Kimberly Evans of Grant & Eisenhofer, the firm that represented the dissenting shareholders in the DFC appraisal action, but didn’t hear back.