Chancery’s controversial Dell fair value opinion: Part 2

BVWireIssue #165-3
June 22, 2016

As we reported in last week’s BVWire, the discounted cash flow analysis discussion takes up relatively little space in the Delaware Court of Chancery’s exhaustive and controversial Dell fair value decision.

At trial, both parties’ experts used a DCF analysis to determine the going concern value of the company on the date the merger closed, October 2013. But because they disagreed sharply over critical inputs, including forecasts and taxes, they reached significantly different outcomes. The petitioner expert’s per share price was $28.61 as opposed to the respondent expert’s $12.68.

Court does DCF: Neither analysis was entirely credible, the court found. The petitioner expert’s result suggested that the merger undervalued the company by $23 billion. “Had a value disparity of that magnitude existed, HP or another technology firm would have emerged to acquire the Company on the cheap,” the court observed. On the other hand, the respondent expert’s result was below the final merger consideration ($13.75 per share, plus a $0.13 special dividend). If, as the court found, the deal price undervalued the company, the respondent expert’s valuation did even more so. The court performed its own DCF by drawing on elements from both experts.

The projected cash flows underlying the experts’ analysis accounted for much of the difference in value, the court said. Both experts used projections an independent third-party expert had prepared at the request of the special committee, after it had started the merger process. The court found the projections “impressively thorough, with over 1,100 assumptions. The resulting model was dynamic and transparent.” At the same time, they were done nine months before the valuation date and never updated. Only the respondents’ expert adjusted them to ensure they had not become stale by the time of closing.

Another credible set of projections was closer in time to the closing date, but the respondents’ expert made adjustments to account for nonrecurring restructuring expenses and stock-based compensation.

Litigation-driven adjustments are somewhat suspect, the court noted. Normally, the Chancery prefers valuations “based on contemporaneously prepared management projections.” In this instance, however, the respondents’ expert “persuasively justified his changes.” The court adopted the projections for its own analysis.

Tax rate: Taxes also figured prominently in the valuations. The petitioners’ expert used a 21% tax rate throughout his forecast period based on rates in the valuations models the company’s financial advisors prepared. The respondents’ expert used a 17.8% rate during the projection and transition periods, but a 35.8% marginal tax rate for the terminal period. He justified the latter by citing to academic literature.

The court adopted the 21% rate. It noted the company had not paid taxes at the marginal rate since at least 2000. In the five years leading up to the merger it paid effective rates of between 16.5% and 29.2%. Its cash tax rates ranged from 9.6% to 24.1%. The low effective rate stemmed from the company’s “indefinite reinvestment election,” meaning it represented to auditors that it planned to defer indefinitely paying U.S. taxes on overseas profits. To suggest, as the respondent expert’s model did, that the company would in the near future pay a marginal tax rate of 35.8%, not to mention perpetually, contradicted historical practice, the court said.

Ultimately, the court arrived at a fair value of $17.62 per share—almost $4 per share more than the deal price.

Read for yourself: BVLaw offers a complimentary download of the court’s opinion, In re Appraisal of Dell Inc., 2016 Del. Ch. LEXIS 81 (May 31, 2016). There will be an extended discussion in the August issue of Business Valuation Update.

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