Z. Christopher Mercer, ASA, CFA, ABAR, Founder and CEO of Mercer Capital, maintains a business valuation-themed blog at ChrisMercer.net. This guest post first appeared on Chris’s blog on June 3, 2016.
Dell Inc. engaged in a management buyout (“MBO”) in October 2013 that effectively took the Company private, leaving Michael Dell in control (75% of its stock) with a financial sponsor (25% of its stock). The majority of shareholders tendered their shares, and received the offered consideration. Certain shareholders dissented, setting in motion an appraisal proceeding in Delaware to determine the (statutory) fair value of their shares of Dell Inc. as of the day prior to the merger. This week, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery filed an opinion in In Re: Appraisal of Dell Inc. determining the fair value of the dissenters’ shares. This post looks to see who the “winners” and the “losers” were in the appraisal action, and in the transaction itself.
The Transaction in Brief
The opinion’s 114 pages provide a fascinating look into how Dell Inc. bought out its public shareholders (other than its chairman, Michael Dell, and shares associated with him) in the 2013 transaction. The transaction actually originated in June 2012 when Mr. Dell was approached by an institutional shareholder regarding the possibility of engaging in an MBO of Dell’s other shareholders, since Mr. Dell controlled about 15% of Dell Inc.’s then public shares.
The transaction price in 2013 was $13.65 per share, plus a dividend of $0.13 per share paid just prior to closing, for a total consideration of $13.78 per share. There were 1.8 billion shares to be acquired, so the deal price at the proxy price (issued May 31, 2013) was $24.7 billion. Initially, owners of more than 36 million shares were thought to have perfected their rights to dissent. T. Rowe Price Associates had custody of just over 30 million shares, and other holders had about 5.2 million shares.
In a companion decision issued May 11, 2016, Vice Chancellor Laster ruled that the shares held by T. Rowe Price had not been properly perfected, as described here. T. Rowe Price is now attempting to find a resolution to this error as noted in the Wall Street Journal (subscription required), which is quantified below. That left about 5.2 million shares, only a small fraction of the 1.8 billion shares involved in the 2013 transaction, subject to the appraisal process that concluded with the companion decision. Furthermore, this was a big win for Dell Inc.
The Process in Brief
A special committee of Dell Inc.’s board was appointed to oversea the proposed MBO in August 2012. The special committee retained two investment banks and one consulting firm to assist in the acquisition. There were substantial negotiations with the ultimate financial sponsor leading to a few increases in the price being offered.
The Court observed that even though the Dell special committee worked long and hard, there was no attempt to determine the fair value of the shares, which is the type of value required under the Delaware appraisal statute, prior to the transaction. Quoting Finkelstein v. Liberty Digital, Inc., the Court noted:
The concept of fair value under Delaware law is not equivalent to the economic concept of fair value. Rather, the concept of fair value for purposes of Delaware’s appraisal statute is a largely judge-made creation, freighted with policy considerations.
The special committee apparently believed that the long negotiation process should have determined fair value. Suffice it to say that the court’s review concluded that the process, while conscientious and thorough in many respects, was flawed and did not bring about “fair value” in terms of transaction pricing. The Company negotiated with only one financial sponsor prior to signing the merger agreement, and did not solicit bids from any strategic acquirers. Essentially, Vice Chancellor Laster concluded that by not getting competitive bids in the initial phase leading to the merger agreement, the special committee lost any negotiating leverage it once had.
There was a “go shop” provision in the merger agreement which allowed for competing bids under limited circumstances. Because of the complexity of the deal, the 45-day go shop was probably inadequate (but of normal length, nevertheless). Discussions were held with one strategic buyer during the go shop period, but no bid resulted. Competing bids were developed by two other investors, but these were not accepted.
The Court’s Conclusion
After reviewing the appraisals provided by two academics for the respective sides, Vice Chancellor Laster crafted his own appraisal within the general bounds of the two, which had widely different conclusions ($12.68 per share versus $28.61 per share). There were numerous sets of projections and a couple were thought by the Court to be more credible. The Court’s process included:
- Selecting two sets of forecasts as the most credible.
- Determining that the terminal growth rate would be 2.0% (from a range of 1% to 2%), noting, however, that it could be higher.
- The tax rate was an issue. One expert opined, based on Dell’s history of sheltering foreign earnings from U.S. taxes, that the appropriate tax rate was 21%. The other expert used a 17.8% tax rate for the finite forecast period and a 35.8% rate for the terminal value. The Court favored the 21% rate because of credible evidence it was appropriate.
- The Court also made decisions regarding excess cash, working capital requirements and restricted cash, deferred taxes and other liabilities.
Putting the components together, the Court concluded that the appropriate weighted average cost of capital (“WACC”) was 9.46%. There is insufficient information in the decision to replicate the Court’s analysis.
The Court then prepared two discounted cash flow calculations reaching a lower bound of $16.43 per share and an upper bound of $18.81 per share. The conclusion of fair value was reached by equally weighting the two indications, resulting in a fair value of $17.62 per share. I adjust that by the pre-merger dividend of $0.13 per share that was paid to all shares and conclude that the adjusted fair value was $17.75 per share.
Who Won? and Who Lost?
Compared to the adjusted proxy price of $13.78 per share, the Court’s conclusion was $3.97 per share, or 29% higher. Several commentators have already discussed this difference, and inferring it a win for the dissenters. However, there were few dissenters. See here and here as examples.
Let’s look at the economics of the transaction in light of the adjusted proxy price of $13.78 per share and the adjusted fair value of $17.75 per share. We’ve looked at percentage differences. Now look at the actual dollars involved for both the dissenters and for the opportunity costs incurred by the T. Rowe Price shareholders as result of the failure to perfect their rights.
The Court’s ruling pertained to only 5.2 million shares, or 0.15% of the 1.8 billion shares in the merger transaction. In the top part of the figure above, we show that the total proceeds for the dissenters will be $108 million, consisting of the $17.75 per share adjusted fair value plus about $3.00 per share of interest since October 2013. The difference between this total and the adjusted proxy price of $13.78 per share is about $72 million, so the litigation gain to the dissenters is about $36 million. That’s real money, but it pales relative to the opportunity cost borne by the shares held by T.Rowe Price that were disallowed.
In the lower part of the table, we see that T. Rowe Price owners lost out on $3.97 per share of increase from the adjusted proxy price to fair value, or some $123 million. They also lost out on the $3.00 per share of interest for another opportunity cost of $93 million. That’s a total opportunity cost of $216 million that was not paid by Dell Inc. That’s even more money. Hopefully, T. Rowe Price will be able to resolve this favorably for its mutual fund owners. Efforts are underway (WSJ subscription required) at this time, which would likely eliminate or reduce potential litigation over the matter.
The real win for Dell Inc. came, however, not from these results. The real win came when the great majority of shares were voted for the merger and their owners accepted the $13.78 per share adjusted proxy price.
In the upper portion of the second figure, we see that the transaction at the adjusted price per share was $24.7 billion. Had the transaction occurred at Vice Chancellor Laster’s adjusted fair value conclusion of $17.75 per share, it would have been a $31.9 billion deal. The difference is $7.2 billion, and that’s real money. Offset that with $36 million to be paid incrementally to the dissenters and the $7.1 billion “savings” for Dell Inc. That’s still real money, and the real victory for Dell Inc.
Why did so many shareholders not dissent? The preponderance of the former public shareholders were institutional owners. The Court speculated that they may have preferred to take their money and run to reinvest rather than wait with an illiquid asset pending the determination of fair value by the Delaware Chancery Court. There was also great uncertainty over the future of Dell, and analysts were down on the company. Dell Inc.’s performance leading to the beginning of negotiations and on through closing did not inspire confidence in the minds of short-time investors. Michael Dell had a longer-term view, which prevailed. It looks like he won this one.
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