What You See Is What You Get - Merger Price Is Fair Value in Delaware Appraisal Action - A Case Summary
What You See Is What You Get (“WYSIWYG”) is typically associated with the computing world, but on Halloween of this year the Delaware Court of Chancery took a page from the computing world when it determined that the merger price in a transaction represented fair value for purposes of an appraisal action.
The appraisal statute, 8 Del. C. Section 262, provides stockholders who choose not to participate in certain merger transactions an opportunity to seek statutory appraisal through the Court. The more common techniques that Delaware courts have relied on to determine fair value include the discounted cash flow (“DCF”) approach, the comparable transactions approach, and the comparable companies approach. In an October 31, 2013 decision, Delaware Court of Chancery Vice Chancellor Glasscock ruled that the merger price itself was a relevant factor in the determination of fair value, and because of the Court’s concerns regarding the reliability of the other commonly used appraisal methods, the merger price was relied on as the sole indication of value.
The case involves the acquisition of CKx, Inc. (“CKx”) by Apollo Global Management (“Apollo”), the private equity firm. Prior to the merger, CKx was a publicly traded company that focused on acquiring the rights to iconic entertainment properties. As of 2010, CKx’s most significant assets were: (1) 19 Entertainment, which owned American Idol and So You Think You Can Dance; (2) Elvis Presley Enterprises; and (3) Muhammad Ali Enterprises. Of its holdings, American Idol was the most valuable, accounting for between 60 and 75 percent of CKx’s cash flow.
Five consecutive years of declining ratings and increased competition from other music-focused reality shows created significant uncertainty surrounding the American Idol franchise in 2011. In addition, the contract between 19 Entertainment and Fox, American Idol’s network distributor, was set to expire. Although American Idol was a key show for Fox, CKx’s negotiating power was limited. Because Fox held a perpetual license to renew its exclusive contract with American Idol, CKx could not threaten to take the show to a rival network. CKx’s only practical leverage was to refuse to produce more than 37 hours of programming per season, significantly less than the 50+ hours produced in previous seasons.
In 2007, Robert Sillerman, the founder and largest shareholder of CKx, attempted to buy out the public shareholders at $13.75 per share. This bid failed to materialize, however, as the credit market deteriorated and Sillerman was unable to obtain the required financing. Subsequently, CKx was engaged with eight different financial and strategic buyers who expressed interest in the company, but none of these processes resulted in any proposals. CKx concluded that the sale process was harming its business, and publicly announced in October 2010 that “it was no longer discussing a potential sale of the Company.”
This announcement had the effect of generating renewed interest from private equity funds looking to purchase CKx, including Apollo, the Gores Group, and Promethius/Guggenheim. In March of 2011, these three firms submitted offers ranging from $4.50 to $5.00 per share. Upon receiving these offers, the CKx Board decided to again pursue the sale of the company and retained Gleacher as its financial advisor. The board directed Gleacher to run an auction and to solicit interest from third parties, and also structured Gleacher’s engagement letter to provide incentive compensation if the merger price exceeded $5.50.
Ultimately, Apollo submitted a bid of $5.50 per share, and the Gores Group submitted a bid of $5.60 per share. Despite the slightly lower price, the Board selected the Apollo bid due to the uncertain financing of the Gores Group offer.
The Petitioners and the Respondents each submitted expert valuations of CKx. The Petitioners’ expert utilized the DCF approach, the comparable companies approach, and the comparable transactions approach, valuing the company at $11.02 per share, more than twice the sales price. The Respondents’ expert used the DCF approach to conclude on a value of $4.41 per share, below the sales price of $5.50 per share. While each expert’s valuation is very different, the differences are the result of just a few key assumptions.
- First, the experts use different five-year projections. The Petitioners’ expert relied entirely on the revenues forecast in the Management Projections, which included an assumed $20 million increase in licensing fees under the to-be-negotiated American Idol contract. The Respondents’ expert ignored the potential $20 million increase and instead assumed that the fees would grow at 4 percent annually.
- Second, the Petitioners’ expert and Respondents’ expert used long term growth rates of 4 percent and 0 percent, respectively, in their calculation of the terminal value.
- Finally, the experts used different estimates for the weighted-average cost of capital, resulting from the use of different betas and size premia.
In the determination of fair value, Section 262 provides that “the Court shall determine the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation, together with interest, if any, to be paid upon the amount determined to be the fair value. In determining such fair value, the Court shall take into account all relevant factors.”The most common techniques that Delaware courts have relied on to determine fair value include the DCF approach, the comparable transactions approach, and the comparable companies approach. The Court has also relied on the merger price itself as evidence of fair value, “so long as the process leading to the transaction is a reliable indicator of value and merger-specific value is excluded.” The Court cited one example where it had used the merger price itself in an appraisal action (Union Ill. 1995 Inv. Ltd. P’ship v. Union Fin. Grp., Ltd.).
The Court found that “CKx presents significant and atypical valuation challenges,” ultimately rejecting the Petitioners’ expert’s comparable company and comparable transaction approaches due to the fact that the companies and transactions used were not sufficiently comparable to CKx. The Court stated that none of the companies used were of comparable size to CKx, none owned assets resembling those of CKx, and none competed with CKx or used a comparable business model.
The Court also concluded that the DCF analyses of both experts were unreliable measures of CKx’s value. This was based on the uncertainty of the negotiations surrounding the American Idol contract. While acknowledging that all projections involve some level of uncertainty, the Court concluded that “management believed that predicting the outcome of [the American Idol] negotiations would be little more than guesswork.” Because it lacked confidence in the reliability of the cash flow projections under the to-be-negotiated American Idol contract, the Court concluded that a DCF analysis was an inappropriate valuation method for this case. In rejecting the DCF, the Court also reiterated that is has disregarded management projections in the past where: (1) the company’s use of such projections was unprecedented, (2) the projections were created in anticipation of litigation, or (3) the projections were created for the purpose of obtaining benefits outside the company’s ordinary course of business.
Because of the absence of comparable companies and transactions and the unreliability of the cash flow projections, the Court relied solely on the merger price as the best and most reliable indication of CKx’s value. Petitioners did not argue that CKx had not been shopped adequately, or that there was not a competitive process for the transaction. Rather, Petitioners’ counsel had argued in settlement hearings during a class action litigation brought challenging the transaction that CKx had been “shopped more than adequately,” and that “there was a competitive process.”
Petitioners did argue, however, that based in part on the Supreme Court’s decision in Golden Telecom, merger price is irrelevant in an appraisal context and that the Court is required to give it no weight when determining fair value. However, Vice Chancellor Glasscock interpreted Golden Telecom differently than the Petitioners.
In Golden Telecom, the Supreme Court was asked to reform Delaware appraisal law by imposing a presumption in favor of merger price as evidence of fair value. The Court declined to do so, stating “Requiring the Court of Chancery to defer, conclusively or presumptively, to the merger price…would contravene the unambiguous language of the statute and the reasoned holdings of precedent.” Vice Chancellor Glasscock stated that the Court of Chancery has a statutory mandate to consider “all relevant factors” as part of the appraisal proceeding, and the Supreme Court declined to impose a presumption systematically favoring one factor (merger price) over the others. Vice Chancellor Glasscock states that the Petitioners’ argument- that the merger price of CKx should be ignored- is directly at odds with the rationale of Golden Telecom, which holds that the Court has the obligation to consider all relevant factors.
Finally, the Court left the door open to reduce fair value below the merger price if any synergies existed. The Court stated that while the evidence admitted suggested that there were few, if any, synergies for Apollo in the transaction, parties could provide additional evidence on this limited issue. As most followers of Delaware appraisal actions are familiar with, the objective of an appraisal case in Delaware is to determine the going-concern value of the target company’s equity, without regard to any synergies from a proposed transaction.
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