Your Ancestry Might Be Priceless, But This One Is $32/Share: A Delaware Chancery Appraisal
On January 30, 2015 the Court of Chancery of the State of Delaware issued a decision regarding the fair value of a “family business,” but not your typical family business. Ancestry, Inc. (“Ancestry”) is described as “a pioneer and leader in the online family research market,” having gone public in 2009. Some may be familiar with Ancestry through its popular television show “Who Do You Think You Are?” where celebrities learned more about their own family histories, using research provided by Ancestry. Three years after going public, in 2012 Ancestry’s board began exploring strategic options for the Company.
Ultimately the Company agreed to sell itself to private equity firm Permira Advisors, LLC (“Permira”) for $32 per share, a 40 percent premium to the stock price prior to the auction process. The Petitioners filed to have their interest in Ancestry appraised by the Court rather than accept the $32 per share offer price, arguing that the fair value of Ancestry was at least $42.81 per share. The Respondent maintained that the fair value of Ancestry was $30.63 per share. The Court found that the merger price of $32 per share was the best indicator of Ancestry’s fair value as of the Merger Date, though not before performing a valuation analysis of its own that resulted in a value of $31.79 per share. The Court used the $31.79 per share value as a check on the merger price.
There are three primary take-aways from the Ancestry decision. First, the decision highlights the importance of contemporaneous in-the-ordinary-course-of-business projections. As discussed below, the projections were a significant issue in the matter. Second, merger price is alive and well as a possible outcome, and other valuation methods may be used as a check on that price. While the merger price was used in 2013 by the same Vice Chancellor in another matter to reflect fair value, that matter did not produce a value using any other methodology. Third, and finally, it is important for valuation experts to support all of their assumptions because one never knows what will be challenged. The Court criticized experts in Ancestry for lack of support on a number of different issues.
The first take-away from the Ancestry decision is the importance of contemporaneous projections prepared in the ordinary course of business. While most companies, including Ancestry, typically prepare one-year forecasts, not all companies prepare long-term projections in the ordinary course of business. In fact, the sales process in connection with the Permira transaction was the first time Ancestry had ever prepared long-term projections. Two sets of projections were prepared in connection with the sales process. First, an initial set of “optimistic, even aggressive” projections were prepared in May for the board (the “Initial May Projections”). The board encouraged management to be more aggressive in the projections, and management came up with new projections (the “May Sales Projections”, collectively with the Initial May Projections, the “May Projections”) that were approved by the board, and provided to interested parties during the sales process. The second set of projections (the “October Projections”) were prepared in response to: (i) bidder feedback that the May Projections were optimistic and aggressive, and (ii) feedback that Ancestry’s fairness opinion provider likely couldn’t render a fairness opinion based on the May Projections. The October Projections included two scenarios, A and B.
Projections are important in valuation because they are heavily relied on to estimate fair value under the Discounted Cash Flow (“DCF”) method of the Income Approach. Both the Petitioners’ expert and the Respondent’s expert relied exclusively on a DCF analysis to estimate value, and ultimately the Court prepared its own DCF. For projections, the Petitioners’ expert appears to have used an unequal blend of the “Initial May Projections” and the better of the two scenarios in the October Projections.1
The Court did not find much precision in the Petitioners’ expert’s determination of the blend. The Respondent’s expert used an equal weighting of the two scenarios in the October Projections.
The Court found both sets of projections to be imperfect, though ultimately found that an equal weighting of the scenarios in the October Projections were a better platform on which to base a DCF analysis. However, absent projections prepared in the ordinary of business, in conjunction with other reasons, the Court ultimately found that estimating fair value based on a DCF was more appropriate to use as a benchmark, not as a concluding value. It is possible that had there been a set of projections prepared in the ordinary course of business, the Court would have placed more weight on these projections, as it has done in the past.
The second take-away is that the merger price is alive and well in appraisal matters. Back in 2013 the same Vice Chancellor in Ancestry also relied on the merger price as the sole indication of fair value in Huff Investment Fund v. CKx, Inc., another appraisal matter.2 Both cases are similar in that the Court found both sales processes to produce a reasonable sales price. However, the cases are also different. In the 2013 matter the Court found that the unpredictable business, “render[ed] the apparent precision of the expert witnesses’ cash flow valuation illusory.” In other words, the Court found that the projections were too unpredictable to use as a basis for value. Because neither party presented a reasonable alternative valuation method according to the Court, the merger price was deemed to reflect fair value. The Ancestry decision is important because it relies on the merger price as the indication of fair value, but concurrently uses a set of projections deemed reliable by the Court for purposes of producing a benchmark value. Therefore, the merger price appears to be alive and well as an indication of value regardless of whether projections are unpredictable or not, though relying on the merger price still requires a sales process that produces a reasonable sales price.
The third take-away from the Ancestry decision is a reminder of how important it is for expert witnesses to support each and every assumption and calculation they make, and choose the language around those assumptions carefully. One never knows which assumption or calculation will be challenged, or how the language around that assumption may be interpreted by the Court. For example, both expert witnesses were criticized in the Ancestry decision for different assumptions and calculations. Following is a list of valuation components addressed by the Vice Chancellor, and the Court’s discussion of those components:
- In siding with the Respondent’s expert’s approach of normalizing long-term margins (by setting long-term margins based on an average of projected margins) the Court noted that “while criticizing [the Respondent’s expert’s] approach, the Petitioners offered little in the way of substantive support of [the Petitioners’ expert’s] approach, other than to characterize it as ‘appropriate’ given Ancestry’s consistent trend of increasing margins.”
- In stating that both experts’ DCF analyses “appear to be result oriented riffs on the market price,” the Court criticized both experts. While many valuation practitioners would consider “reconciliation” with another indication of value, in this case the market price, to be a positive activity, the Court stated that “reconciliation” by the Respondents’ expert implied “tailoring” the analysis to fit the merger price. The Court also criticized the Petitioners’ expert for testifying that he “tortur[ed] the numbers until they confess[ed],” with the Court noting that “it is well-known that the problem with relying on torture is the possibility of false confession.”
- In siding with the Respondent’s expert’s approach to use the marginal tax rate in perpetuity, the Petitioners’ expert’s contention that few (if any) companies pay their marginal tax rates in perpetuity was not enough to convince the Vice Chancellor that it was not “overly speculative to apply the current tax rate in perpetuity.”
- In choosing to estimate beta using a weekly observation period, the Court noted that “[the Respondent’s expert] did not adequately explain why, specifically, a weekly input would be inappropriate here.”
- In siding with the Respondent’s expert’s approach to reflect stock-based compensation by accounting for it in expenses, the Court noted that the Petitioners “dispute [the Repondent’s expert’s ] approach, but do not offer a reliable alternative for my consideration.”
The examples above are continuing reminders how important it is to thoroughly prepare the support for each and every assumption and calculation made in a litigation matter. The more support there is for an expert’s position and support contradicting an opposing position, the more likely the position will be viewed favorably by the Court.
While this Client Alert does not address every issue addressed by the Court, there are other issues addressed by the Court that valuation practitioners should review. For example, the Court adopted the approach of using the Ibbotson 2013 Yearbook even though it was not published until after the valuation date. The Court also found that the S&P 500 was a more suitable market proxy that NASDAQ for estimating beta. We strongly encourage the reader to read the Ancestry decision in full and determine for themselves what they consider to be the most important take-aways.
1 The Petitioners’ expert did not rely on the May Projections provided to bidders in his analysis. He contended that the May Projections were so optimistic that potential investors lost confidence in management; thus he focused instead on a prior version of projections prepared in May and shared with the board (the “Initial May Projections”).
2 Memorandum Opinion, Huff Fund Investment Partnership et al. v. CKx, Inc., November 1, 2013. The Vice Chancellor in both matters is Glasscock.