Wednesday, July 13, 2016

Fair value of DFC shares higher under revised valuation method

By Amy Leisinger, J.D.

In this appraisal action, the Delaware Court of Chancery found that neither the specific valuation methodology proposed by dissenting shareholders following a merger nor that proposed by the company itself is inherently reliable. Instead, the court determined that calculating the fair value of the company’s shares involves three separate pieces: a discounted cash flow model, a comparable company analysis, and the transaction price. The company sold its shares to a private equity buyer for $9.50 per share in June 2014, but, under the more appropriate valuation framework, the fair value was $10.21 per share when the transaction closed, the court found (In re Appraisal of DFC Global Corp., July 8, 2016, Bouchard, A.).

Merger transaction. In 2013, DFC Global Corp. was operating its payday lending business in ten countries through more than 1,500 retail storefront locations and online platforms. It faced significant competition and was subject to differing regulations in each jurisdiction that could increase the cost of doing business. As various regulatory changes came into play, DFC was forced to cut earnings guidance and provide adjusted EBITDA guidance but stated that it was “hopeful” its market share would increase as competitors with difficulties operating under stricter regulations exited the market and noted its past success in adapting to regulatory change.

During this time, DFC retained a firm to investigate selling the company to a financial sponsor and received non-binding indications of interest from two companies. After revised projections and citing regulatory uncertainty, the acquiring private equity firm lowered its offering price to $9.50 per share, and DFC’s board approved the transaction.

Share price battle. Former DFC shareholders petitioned the court to appraise the fair value of shares they held when the company was sold, alleging that the sale occurred at a discount during a period of regulatory uncertainty that temporarily depressed the company’s market value. Using a discounted cash flow model based on management’s most recent five-year projections, the shareholders’ expert calculated a fair value of $17.90 per share. The company’s expert, however, used a blended discounted cash flow model and a multiples-based comparable company analysis and found a lower fair value of $7.94 per share.

Appraisal method. The court noted that it will often defer to a transaction price negotiated in an arm’s-length process but found that a price is reliable only when the market conditions leading to the transaction are conducive to fairness. The DFC transaction was negotiated and consummated during a period of turmoil and uncertainty, the court found, and this raises questions regarding both transaction price and financial projections. However, neither of the metrics proposed to value DFC is completely reliable, according to the court. As such, the court stated, the most reliable determinant of DFC’s fair share value is a blend of three “imperfect” approaches: a discounted cash flow model incorporating certain methodologies made by each expert; the comparable company analysis performed by the company’s expert; and the final transaction price.

The court noted that the experts disagreed on numerous points regarding construction of a discounted cash flow valuation of DFC, including, among other things, factors used to calculate the weighted average cost of capital, the method of unlevering and relevering beta, the appropriate premium for company size, and the applicable tax rate. In its analysis to calculate beta, the court used Bloomberg five-year smoothed betas for the six peer companies the experts agreed on and for DFC itself and accounted for the negative reaction to earning reductions and adjustments in connection with the size premium. The court accepted the firm’s expert’s comparable company methodology and its valuation of $8.07 per share and took note of the deal price of $9.50 per share.

Determining that all three valuation metrics provide equally meaningful insight into DFC’s value, the court concluded that the fair value of DFC at the time of the transaction was $10.21 per share. The shareholders are entitled to this amount, as well as interest accruing from June 13, 2014, at the rate of 5 percent over the Federal Reserve discount rate, the court stated.

The case is No. 10107-CB.

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