Chancery opts for income approach to calculate fair value

BVWireIssue #171-3
December 21, 2016

Thumbs down on the merger price. The Delaware Court of Chancery recently declined to accept the deal price as evidence of fair value, relying instead on the value resulting from a discounted net income analysis—a method both sides’ experts used, with varying emphasis.

The dispute arose out of the 2014 merger of Farmers & Merchants Bancorp of Western Pennsylvania (F&M), a small community bank, with NexTier. The stock-for-stock transaction was based on a 2.17 exchange ratio, which implied a valuation of $83 per share for F&M and a valuation of $180 per share for NexTier.

The court found F&M pursued the merger at the request of the Snyder family, which “stood on both sides of the transaction” because it controlled both F&M and NexTier. There was no auction, and, even though there was a special committee, “the record does not inspire confidence” that an arm’s-length transaction took place. A key member of the special committee “appeared to be working toward a price that would meet the Snyders’ objective to recoup their original investment in NexTier,” the court said. It did not give any weight to the merger price.

Synergy problems: Both sides retained highly qualified trial experts who used market- and income-based approaches to calculate fair value for F&M. This was another instance where experts valuing the same company and using similar methods presented “wildly divergent valuations.”

The petitioners’ expert based his conclusion—$137.97 per share—solely on a comparable transactions analysis. He did perform a discounted future benefits analysis as a cross-check, arriving at a value of $139.45 per share. The court rejected the comparable analysis because the expert failed to account for any synergistic value captured in the eight comparable transactions. “Fair value” under the state appraisal statute means “the value to a stockholder of the firm as a going concern, as opposed to the firm’s value in the context of an acquisition or other transaction.”

In an extended discussion on synergy, the court noted a body of Chancery case law as well as academic studies recognizes the deal price often exceeds fair value “because target fiduciaries bargain for a premium that includes … a share of the anticipated synergies.” The plaintiff expert’s assumption that “bankers who buy other banks don’t pay for synergies” was unsound, the court said. Public statements related to the selected transactions (press releases, proxy statements, database reports) expressly discussed potential synergies.

The company’s expert arrived at his conclusion, $76.45 per share, by using three valuation methods whose results he weighted equally. The court rejected his M&A analysis finding “too much doubt exists over the appropriateness of the comparables.” Also, the guideline public-company valuation was problematic because the selected companies had low trading volumes.

In terms of the discounted net income analyses, the court validated the analysis the respondent’s expert performed by adopting all of the expert’s inputs (projected net income, risk-free rate, equity risk premium, growth rate, excess capital) for its own valuation, excepting the beta variable. By the court’s calculation, F&M’s fair value per share was $91.90.

Takeaway: Daniel Van Vleet (The Griffing Group) was the prevailing expert. Throughout its opinion, the court expressed a concern with “consistency”: whether the expert report was internally consistent and whether the analysis adhered to the principles set down in the Duff & Phelps Valuation Handbook, the Chancery’s own decisions, valuation treatises, and the record of the case. Van Vleet’s analysis better satisfied the demand for consistency and as such was more reliable, the court decided.

The case is Dunmire v. Farmers & Merchants Bancorp of W. Pa., 2016 Del. Ch. LEXIS 167 (Nov. 10, 2016). A digest and the court’s opinion will be available soon at BVLaw.

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