In a crunch, court adopts company’s DCF model as fair value indicator

BVWireIssue #215-4
August 26, 2020

dissenting shareholder
discount rate, expert testimony, weighted average cost of capital (WACC), cash flow, discounted cash flow (DCF), merger price, statutory appraisal, projections, terminal value, comparable companies method, perpetual growth rate

In a statutory appraisal action prompted by the 2016 buyout of minority shareholders by the controller of a private company, the Delaware Court of Chancery recently found there was no meaningful market-based evidence of fair value and neither expert opinion, based on standard valuation methods, was “wholly reliable.” Forced to decide, the court adopted one expert’s discounted cash flow analysis.

‘Monumentally different valuations’: In 2012, McWane Inc. bought a controlling stake in Synapse Wireless (Synapse), an “internet of things” (IoT) company. IoT was seen as a growth industry, but Synapse never lived up to its promise. The company kept missing management’s projections by a wide margin and became reliant on ongoing funding from McWane to keep operating. The 2012 merger agreements gave McWane a right to buy newly issued Synapse shares at a per-share price based on the 2012 merger, as well as a right, beginning in 2018, to require the remaining minority shareholders to sell their stock to McWane.

In late 2013, McWane sued Synapse, alleging breaches and misrepresentations. The litigation settled in late 2015, with McWane winning a reduction in price of its call option to $0.42899 per share, reduced from the $4.997 per share it paid in 2012. McWane also secured a right to exercise the call option immediately and did so in early 2016. At that time, it acquired ownership of 99.346% of Synapse by offering shareholders $0.42899 per share. The petitioner rejected the offer and asked the Delaware Court of Chancery for a fair value determination under the state’s appraisal statute.

At trial, the parties offered expert testimony. Both experts used the same three valuation techniques (analyses of prior purchases of company stock, comparable transactions analyses, and discounted cash flow models). The experts even “materially agreed on several important inputs,” the court observed. However, “as has become standard fare for appraisal litigation, the experts reached monumentally different valuations,” the court said.

In a nutshell, the petitioner’s expert arrived at a fair value of $4.1876 per share. The company’s (respondent’s) expert declined to provide a single valuation, but his summary values ranged from $0.06 per share to $0.11 per share.

The court rejected the market-based evidence, including McWane’s acquisitions of Synapse stock preceding the 2016 merger. Neither the stock purchases following the 2012 merger nor the 2016 merger took place in a competitive market, the court said. As for the 2012 merger, the court said this transaction was “stale” and did not represent evidence of Synapse’s value at the time of the 2016 merger. Synapse, in 2016, faced different prospects than it did in 2012, the court noted.

‘Dicey valuation method’: The court also rejected the experts’ comparable transaction analyses, calling this approach “a dicey valuation method in the best of circumstances.” The experts’ DCF valuations also had “significant flaws,” the court said. It found particularly troubling both experts’ reliance on management projections, considering Synapse’s consistent failure to meet forecasts.

Normally, the court said, a fact-finder might determine neither party met its burden of proof and neither was entitled to a verdict. However, the statute required the court to provide a fair value appraisal. Therefore, the court decided to rely on the company expert’s DCF (with a slight adjustment), noting the expert “credibly made the best of less than perfect data to reach a proportionately reliable conclusion.”

The fair value of the company on the merger date was $0.228 per share, the court concluded—a notable drop from the $0.42899-per-share price McWane had offered to the dissenting shareholder in the context of the squeeze-out merger.

A digest of Kruse v. Synapse Wireless, Inc., 2020 Del. Ch. LEXIS 238 (July 14, 2020), and the court’s opinion will be available soon at BVLaw.

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