Delaware Chancery Court Update

Delaware Chancery Court Update

When it comes to setting valuation law precedent (and reminding us of pre-existing precedent), no venue is more important than the Delaware Chancery Court. The sheer volume of companies incorporated in Delaware make it the natural venue for the majority of corporate shareholder value actions, and the sheer volume of cases have made the chancellors (judges) some of the most sophisticated on valuation issues. Several recent Delaware are notable. The following is a discussion of those cases, the Court’s findings, and insights to their implications on corporate valuations.

Golden Telecom, Inc. v. Global GT LP, 2010 WL 5387589 (Del. Supr.)(Dec. 29, 2010)

Golden Telecom is a Russian telecommunications firm that merged into Lillian Acquisition, Inc., a wholly-owned subsidiary of Vimpel-Communications after a tender offer in February 2008. Golden remained as the surviving entity and all tendering Golden shareholders received $105 per share. Golden’s two largest shareholders collectively owning 45% also owned 65% of Vimpel. Other Golden shareholders sought appraisal and the Court of Chancery valued Golden at $125.49 per share in an opinion by Vice Chancellor Strine. The Delaware Supreme Court affirmed the decision.

The principal matter facing the Delaware Supreme Court was whether the merger price itself was presumptive proof of fair value. In an efficient market, Golden argued, Delaware courts should defer exclusively to the merger price in statutory fair value appraisals or, at the very least, regard it as a rebuttable “presumption” of fair value.

The Delaware Supreme Court dismissed this argument as too simplistic. The state business statutes require the courts to account for “all relevant factors” in making an independent determination of fair value. Further, Delaware case law specifically defines “fair value” as the value to a shareholder in the firm as a going concern rather than its value in a merger or other transaction. Accordingly, the court stated that “there is no basis for a court, in a statutory appraisal proceeding, to conclusively, or even presumptively, defer to a merger price as indicative of ‘fair value.’” Further, such a presumption would “inappropriately shift the responsibility to determine ‘fair value’ from the court to the private parties.”

In refusing to give weight to the merger price as a market-tested price, Vice Chancellor Strine noted several facts and circumstances specific to the case:

• The committee that negotiated the merger never engaged in any active market check either before or after signing the merger agreement;

• Golden’s two largest stockholders had a larger interest in doing what was best for Vimpel based on their far more substantial stake in Vimpel versus their stake in Golden;

• Equity analysts reaction to Golden’s merger price was negative suggesting they felt the price was low; and

• Vimpel’s stock price reaction was positive after the merger was announced, also suggesting they felt the price was low.

The Delaware Supreme Court also rejected the dissenting shareholder’s claims that the company should have been bound by the financial information it used during the merger process. Such a “bright line” rule would constrain the flexibility of the appraisal process as well as the “significant discretion” given to the Court of Chancery to decide fair value. It would also “pay short shrift to the difference between valuation at the tender offer stage—seeking ‘fair price’ under the circumstances ... and valuation at the appraisal stage, seeking ‘fair value’ as a going concern.”

The Delaware Supreme Court affirmed Vice Chancellor Strine’s use of discretion as it related to his rulings on a number of other valuation issues:

One Valuation Method was Deemed Acceptable

While experts for both parties conducted a discounted cash flow (DCF) analysis, a comparable companies market analysis and a comparable transactions market analysis, neither expert gave substantial weight to the market-based analyses due to the relative lack of comparable Russian telecom transactions. Vice Chancellor Strine agreed and centered his analysis and based the award on the DCF analysis alone.

Equity Risk Premium (ERP)

Golden’s expert used an ERP of 7.1% based on the Ibbotson SBBI long-term historical average, citing various supporting literature. Global’s expert used an ERP of 6.0% based on his experience, relevant literature, and the SBBI supply side figure, noting that past relationships between stocks and bonds may not continue in the future. Vice Chancellor Strine adopted Global’s ERP of 6.0% stating while both positions enjoyed significant support, in his view the supply-side ERP was better supported by the current views of the relevant professional community.

Beta

Golden’s expert used a beta of 1.32 based on Bloomberg five-year weekly historic data and the facts that Golden’s beta had been relatively stable over time and its operating and capital structure was not expected to change significantly. Global’s expert used a beta of 1.2 citing MSCI Barra data and arguing that forward-looking data was more reliable. Vice Chancellor Strine adopted a beta of 1.29 based 2/3rds on Bloomberg data and 1/3rd on industry beta, giving no weight to the Barra data. His reasoning was that there was an absence of empirical data that the Barra beta was superior, Global’s expert had used historical beta in another recent case, and the lack of visibility as to how the proprietary Barra model works.

Terminal Growth Rate

Golden’s expert used a terminal growth rate of 3% based on his assumed but unsupported rate of inflation in Russia. Global’s expert used a terminal growth rate of 5% which was the mid-point between the forecasted long-term Russian GDP growth of 6.2% and the forecasted Russian inflation rate of 3.9%. Vice Chancellor Strine adopted Global’s 5% rate noting:

• A 3% rate was unsupported and unduly pessimistic given Golden’s track record and growth prospects;

• Using the U.S. as a corollary, the telecom industry in the U.S. outpaced GDP; and

• The inflation rate “is the floor for a terminal value estimate for a solidly profitable company that does not have an identifiable risk of insolvency.”