Delaware Court of Chancery Uses DCF Analysis to Appraise Merger Target below Deal Price

 Recently in In re Appraisal of AOL Inc., the Delaware Court of Chancery, in an opinion by Vice Chancellor Glasscock, relied solely on its own discounted cash flow (“DCF”) analysis to appraise the fair value of AOL Inc. below the deal price paid in its acquisition by Verizon Communications Inc. While reiterating that deal price is the best evidence of fair value, and must be taken into account, when appraising “Dell‑compliant” transactions (i.e., those where “(i) information was sufficiently disseminated to potential bidders, so that (ii) an informed sale could take place, (iii) without undue impediments imposed by the deal structure itself”), the court held this was not such a transaction. The court found that certain of the deal protections combined with informational disparities between potential bidders and certain actions of the parties were preclusive to other bidders, and therefore, the court assigned no weight to deal price in its fair value determination.  Applying its own DCF analysis, the court ultimately determined fair value to be approximately 3% lower than the deal price (possibly due to synergies), thus continuing a string of recent appraisal decisions finding fair value at or below deal price.

Background/Holding

In 2015, Verizon acquired AOL for $50.00 per share following several months of discussions and extensive due diligence by Verizon. The deal, which was structured as a tender offer followed by a short-form merger, included a no-shop provision, a 3.5% termination fee and unlimited three-day matching rights. On the same day that the AOL board approved the merger agreement, Verizon, which had stressed the importance of retaining AOL’s talent post-merger, indicated that it was unwilling to proceed with a deal without a post-merger employment agreement with AOL’s CEO, which was thus subsequently agreed.  During the sale process, AOL had declined to conduct a formal auction of the company, though it talked to several other potential purchasers of part or all of the company.  Indeed, AOL engaged with all potential purchasers indicating a serious interest in the company, and certain of those potential purchasers entered into confidentiality agreements with AOL and conducted due diligence.  AOL seemingly did not, however, court, or share information as freely with, such potential purchasers as it did with Verizon, which had 71 days of data room access.  Following announcement of the transaction, AOL’s CEO stated that he was “committed to doing the deal with Verizon” and had given Verizon his “word that . . . this deal [was] going to happen . . . .”  No topping bidders emerged after signing, and more than 60% of AOL’s outstanding common shares were tendered to Verizon in the tender offer.  In the related appraisal action, the Delaware Court of Chancery concluded that the transaction was not “Dell-compliant” because potential bidders may have been precluded from emerging.  Thus, deal price was not entitled to any deference, and instead, the court relied exclusively on its own DCF analysis, finding a fair value of AOL of $48.70 per share ($1.30 below the deal price).

Takeaways

There are several notable aspects of the court’s opinion:

• If the deal process, deal protections and informational disparities among potential purchasers are sufficiently preclusive to the emergence of other bidders, deal price will not warrant deference in the court’s determination of fair value. Here, the court found that AOL’s sale process was not Dell-compliant.  While the court noted that AOL’s decision not to conduct a broad public auction (and therefore limit the front-end sharing of information to potential bidders) was reasonable given the dynamics of its industry, the post-agreement period sharing of information should then be “correspondingly robust,” which it was not.  While the court noted that the termination fee and the deal’s 42-day window between signing and closing did not on their own deter bidders, the fact that such period was constrained by a no-shop provision combined with unlimited three-day matching rights, the AOL CEO’s statements supporting the deal, his post-merger employment with Verizon and Verizon’s extensive access to company information made for considerable risk of “informational and structural disadvantages” for prospective bidders.  Thus, the sale process was not Dell-compliant, which meant the deal price was not entitled to deference in the court’s determination of fair value.
• Even where the court determines that deal price does not warrant deference in its fair value determination, however, it can still serve as a “check” on the court’s analysis. In AOL, the court could not think of a “principled way to use deal price under the circumstances . . . , in a blended valuation of deal price and other valuation metrics” to appraise the fair value of the company; however, the court believed that the deal process was “sufficiently robust” for deal price to be used as a “check” on its analysis.  In the decision, the court observed that its determination of fair value did not “deviate grossly” from the $50.00 per share deal price.  It remains to be seen whether a greater deviation between deal price and a court’s fair value determination would cause a court to revisit its assumptions or methodology.
• Synergies continue to play a role in diverging deal price and appraisal valuations. The court acknowledged the seeming inconsistency between (i) its declining to defer to the deal price in its fair value determination because the non-Dell compliant deal process meant that “the sales price may not capture the full fair value of the Company . . . . ,” and (ii) its ultimate fair value determination (based on its DCF analysis) that was even lower than the deal price.  In addressing this dynamic, the court wrote that “[o]ne explanation for this incongruity is that a deal price may contain synergies that have been shared with the seller in the deal but that are not properly included in fair value.”