Monday, February 26, 2018

AOL, Aruba Networks and SWS Group featured in Delaware valuation triple play

By Mark S. Nelson, J.D.

The Delaware Chancery Court produced two intricately detailed valuation opinions during the past week, each one with its unique recital of a multitude of deal quirks and corporate personalities and intrigues. In the AOL, Inc., case, a troubled deal led by a target company’s reluctant CEO was valued using the target’s unaffected market price. Meanwhile, a slightly less troubled deal involving Aruba Networks, Inc., would be valued using discounted cash flow (DCF) analysis. Not to be outdone by two vice chancellors, whose work applied Delaware Supreme Court precedents, the state’s high court also would affirm the work of one of those vice chancellors in a third case involving SWS Group Inc., where the court also had used the DCF method (In re Appraisal of AOL Inc., February 23, 2018, Glasscock, S.; Merlin Partners LP v. SWS Group Inc., February 23, 2018, per curiam); Verition Partners Master Fund LTD v. Aruba Networks, Inc., February 15, 2018, Laster, J.).

All three cases rely on the justices’ opinions in Dell and DFC. In the Aruba Networks case, Vice Chancellor Laster observed that the Supreme Court acknowledged that an appraisal must focus on what is “fair compensation” and not the “highest conceivable value.” Similarly, dissenters are entitled to fair value without being exploited. Moreover, Vice Chancellor Glasscock, in the AOL case, noted that while the Supreme Court’s opinions show a preference for the deal price as the best evidence of fair value, those same opinions do not create a presumption that that is so.

Verizon-AOL deal. The AOL case arose out Verizon Communications Inc.’s efforts to acquire AOL, the former dial-up Internet company that had, since the early days of the Internet, gradually transformed itself into a media and online advertising company. The reconstituted AOL became an attractive target to multiple suitors who eventually lost interest, except for Verizon.

Verizon and AOL negotiated over a period of time and ended up agreeing to a price of $50 per share. Verizon had opened at $47 only to get a counteroffer from AOL of $50; AOL attempted to further negotiate the price upward, but Verizon demurred other than to agree to a reduced termination fee. AOL never received a topping offer from another suitor. The companies’ boards approved the deal, as did AOL’s shareholders.

Vice Chancellor Glasscock initially observed that the Verizon-AOL deal was not Dell compliant, so the deal price could not be the best evidence of fair value. As a result, the court used the DCF analysis ($44.85 per share) and made two additions to reflect growth rates and to include one of three potential deals that the court concluded was in AOL’s “operative reality.” The resulting fair value was $48.70. Moreover, the court observed that the DCF valuation was close to the deal price ($50). Having said that, however, the court acknowledged its observation could be understood to be inconsistent in that the deal process was not Dell compliant and yet the court used the deal price to “check” its math regarding its DCF analysis, which fell below the deal price. The court said deal price can reflect synergies that fair value might otherwise exclude.

Supreme Court affirms SWS Group valuation. The Delaware Supreme Court affirmed the valuation in the case of SWS Group, Inc., in which Vice Chancellor Glasscock also had used DCF analysis to arrive at a valuation. SWS Group was, in the words of its CFO, “a broker-dealer with a bank attached.” SWS Group had few retail deposits like a traditional bank would have, although it did have real estate loans that had soured during the Great Recession, thus prompting the bank to search for a path to stabilize its business prospects. That path was to be acquired by another firm.

With respect to valuation, none of the parties argued for using the deal price because it was either “irrelevant” or included synergies that cannot be accounted for when establishing fair value. The remaining valuation methods included a comparable companies analysis and DCF analysis. The comparables approach would not work, said the court, because there were too many dissimilarities between the benchmark companies and SWS Group. As a result, the court applied DCF analysis and arrived at a valuation of $6.38 per share.

Much as Vice Chancellor Glasscock would later do in the AOL case, the court observed that the DCF analysis produced a valuation below the deal price. According to the court, the SWS Group acquisition was motivated by synergies.

Aruba Networks. Hewlett-Packard Company became interested in acquiring Aruba Networks to bolster its business related to wireless local area networks, Aruba Network’s specialty, although another company dominated that market. Aruba Networks had persuaded its CEO to come out of retirement and sign on for multiple additional stints when the succession planning process failed to identify a successor. The CEO, in part, may have seen a merger as the path back to retirement, although he would later indicate interest in remaining after the HP-Aruba Networks deal closed.

Negotiations proceeded with multiple offers and counteroffers, sometimes involving bruised egos and raw emotions, but ultimately producing a definitive merger agreement for HP to acquire Aruba Networks at $24.67 per share, slightly above the opening bid, and significantly higher than other measures of the company’s valuation. There were no competing bidders for Aruba Networks and both HP’s and Aruba Network’s boards approved the deal, as did Aruba Network’s shareholders.

Vice Chancellor Laster posited three valuation options: (1) the deal price ($24.67); (2) the deal price minus synergies ($18.20); or (3) the unaffected market price ($17.13). The court declined to rely on the DCF analysis, which pitted experts representing the dissenters ($32.57) against those for Aruba Networks ($19.77). According to the court, the dissenters’ expert diverged from the market price and Aruba Network’s expert used dubious methods. The court also rejected the deal price minus synergies standard because it is prone to human error and may include elements to which the dissenters would not be entitled. Ultimately, the vice chancellor decided that the best indicator of value was Aruba Network’s unaffected market price. But in reaching this conclusion, the court emphasized that it was not saying that Dell and DFC mean that market price is the standard for fair value; the court was merely saying the unaffected market price was the best indicator of fair value in this case.

The cases are Nos. 11204-VCG; 11448-VCL; 295, 2017.

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