On February 15, 2018, the Court of Chancery of the State of Delaware issued a decision regarding the fair value of Aruba Networks, Inc. in an appraisal proceeding.1 Vice Chancellor Laster (“VC Laster”) chose a result “no one argued for.” He determined that the fair value of Aruba Networks, Inc. was not the deal price or the price determined by valuation experts—it was the thirty-day average unaffected market price of Aruba’s shares before the deal was announced. This client alert provides a short overview of the case and a discussion of three important take-aways from the decision:
- the importance of the unaffected market price in light of the Delaware Supreme Court’s Dell 2 and DFC 3 decisions
- a reminder that the Court is seeking fair value, not the highest possible value in appraisal proceedings, and
- the importance of well-supported expert analyses.
Hewlett-Packard Company (“HP”) acquired Aruba Networks, Inc. (“Aruba”) in May 2015 for $24.67 per share. Aruba, located in California, “sold components for enterprise wireless local area networks.” Aruba was publicly traded with its common stock listed on the NASDAQ since 2007.
HP first approached Aruba about the possibility of an acquisition in August 2014. HP believed a combination of its wired networking products and Aruba’s products could effectively compete with Cisco. After being approached by HP, Aruba engaged financial advisors who were unable to identify any other interested strategic buyers.
After months of due diligence, by November 2014, no offer from HP was presented to Aruba, and Aruba ended discussions. HP continued to analyze the deal, and engaged consultants McKinsey & Company to study the business case, and financial advisors Barclays Capital to assist with valuations of Aruba. On January 31, 2015, HP sent an offer to Aruba for $23.25 per share, approximately $4 to $14 less per share than Barclay’s valuation indications, which included synergies, based on the discounted cash flow (“DCF”) method. This offer represented a 35.1 percent premium to Aruba’s thirty-day average price.
Aruba countered HP’s offer at $29 per share, to which HP responded with another offer of $24.67 per share on February 9, 2015, which equated to an aggregate consideration of $3 billion. Aruba again countered at $25 per share, but HP did not alter its offer.
On February 25, 2015, the acquisition negotiations were reported by the news. Aruba’s publicly-traded share price increased to $22.24. Aruba’s thirty-day average unaffected market price was $17.13 per share. Ultimately, HP and Aruba agreed to $24.67 per share. Both of Aruba’s financial advisors, Qatalyst and Evercore, opined the deal price was fair to Aruba’s shareholders. Barclays, HP’s financial advisors, valued Aruba between $27.53 and $39.69 with synergies, and opined the deal price was fair to HP. The Court considered the merger to be a “run-of-the-mill, third-party deal.”
Unaffected Market Price is Important
The Court leaned on the guidance from the Delaware Supreme Court in Dell and DFC when reviewing the evidence presented in this case regarding the efficiency of the market for Aruba’s stock. The Court described the publicly-traded price of Aruba as “likely a possible proxy for fair value,” citing Dell. While the petitioners provided evidence of market mispricing, VC Laster regarded “the petitioners’ evidence of market mispricing as considerably weaker than what [he] abused [his] discretion by crediting in Dell.” While the petitioners raised concerns regarding strong quarterly results that the market only learned about commensurate with the announcement of the merger, the Court concluded that “neither side proved that Aruba’s value had changed materially by closing.”
In addition to considering the market price, the Court also considered the deal price and the deal-price-less-synergies value in its analysis. In considering the deal price, VC Laster noted under a circumstance where the underlying market price is reliable, competition and negotiation become secondary, and an arm’s-length deal at a premium over the market price (i.e., what occurred in the Aruba transaction according to the Court) is non-exploitive. VC Laster stated such a result gives stockholders “what would fairly be given to them in an arm’s length transaction,” citing DFC.
However, VC Laster also explained under the DFC decision, it is to be assumed the buyer here (HP) shared some of its synergies in the deal with Aruba’s stockholders. Considering the inclusion of said synergies, as well as the petitioners’ failure to identify a bidder who would pay more than HP’s offer, VC Laster concluded “the deal price in this case operates as a ceiling for fair value.” VC Laster then discusses deal-price-less-synergies as an indication of fair value, and discusses how “the court must exclude ‘any synergies or other value expected from the merger giving rise to the appraisal proceeding itself.’” After expressing the difficulties in quantifying such adjustments, he then calculates a deal-price-less-synergies indication of fair value to be $18.20 per share.
VC Laster then considers the respective merits of the unaffected market price and his calculation of deal-price-less-synergies. He notes the deal-price-less-synergies value is an indirect measure with two significant sources of uncertainty: (i) measurement error, and (ii) the need to back out further elements of value from the merger that may have been shared with seller, namely reduced agency costs from unitary ownership. Because the deal-price-less-synergies approach is an indirect measure that still requires two steps (i.e., backing out synergies and reduced agency costs) that are “messy and provide ample opportunities for error,” VC Laster concludes the unaffected market price is the most appropriate indication of fair value since it distills “the collective judgment of the many based on all the publicly available information about a given company and the value of its shares,” citing DFC.
VC Laster concludes the thirty-day average unaffected market price ($17.13 per share) is the most persuasive evidence of fair value “at least for a company that is widely traded and lacks a controlling stockholder,” which is the case here. In supporting a determination the market is sufficiently efficient to warrant the use of the unaffected market price of Aruba, VC Laster describes the pace at which Aruba’s stock price would adjust to good and bad news. He then offers some of Aruba’s market data measurements, namely: market capitalization, shares in the public float, public float as % of outstanding shares, bid/ask spreads, and equity analyst coverage, as viewed within the framework established by the DFC and Dell cases, to indicate Aruba’s market price provides reliable evidence of its fair value. VC Laster adds “’the price produced by an efficient market is generally a more reliable assessment of fair value than the view of a single analyst,” citing Dell.
Reminder: Fair Value, not the Highest Possible Value
Throughout the opinion, VC Laster reminds the reader the “ultimate goal in an appraisal proceeding is to determine the ‘fair or intrinsic value’ of each share on the closing date of the merger. [And t]o accomplish this task, ‘the court should first envisage the entire pre-merger company as a ‘going concern,’ as a standalone entity, and assess its value as such.’” VC Laster consistently reminds the reader fair value is not the “highest possible bid,” nor the “highest conceivable value,” but rather “whether the dissenters got fair value,” which “entails at minimum a price some buyer is willing to pay.” VC Laster considers the Aruba merger to be at arm’s length, noting that there was no majority shareholder, it was not a management buyout situation, and the board of directors was independent. While the petitioners questioned the negotiating tactics of the financial advisors, the Court notes that Aruba was unable to attract another strategic buyer. VC Laster cites the Dell decision in supporting the deal price as a ceiling here, stating that since ‘“no strategic buyer [was] interested…, it does not suggest a higher value, but a lower one.’”
Expert Opinions Being Well-Founded
While the Court ultimately determined the unaffected stock price was the most relevant indication for purposes of determining fair value, the opinion does address the valuation expert opinions provided by both parties. Both the petitioner and the respondent experts relied on the income approach, specifically the DCF methodology, to determine fair value. The petitioner’s expert opined the fair value of Aruba was $32.57 per share, while the respondent’s expert ultimately opined the fair value of Aruba was $19.75 per share.
VC Laster described the petitioner expert’s methodology, stating: “[h]is model generally adhered to the valuation literature and the teachings of the Delaware courts. From a methodological perspective, his model appears sound.” VC Laster’s concerns with the petitioner expert’s opinion were twofold. First, he noted the divergence and “key contrasts” of the expert’s results from Aruba’s market indications. VC Laster calculates the extent to which the petitioner expert’s opinion is greater than: the deal price (+ 32 percent), the mean of the last batch of unaffected analyst stock price targets (+ 39 percent), the mean of the financial advisors’ final valuation midpoints (+ 21 percent), and lastly, “nearly double Aruba’s thirty-day average unaffected market price.” Second, VC Laster found concern with the beta (an input to the analysis) used by the expert. The Court noted that while the data supported the beta used by the expert, “no one could offer a good explanation as to why the number was so low.”
VC Laster had different concerns regarding the respondent expert’s analysis. The respondent’s expert estimated the fair value to be $19.75 per share at trial, which the Court noted was “serendipitously” just ten cents below the valuation in the expert’s opening report (he had changed course after an evidentiary ruling precluded him from rending an opinion on stock-based compensation). VC Laster described the respondent expert’s “meandering route” to an opinion along with his “unstructured approaches to valuation inputs” as causes for concern. The Court noted that the expert “punted” on the issues of beta and size premium, and “made a significant judgement call by selecting a WACC from a menu of possibilities, rather than calculating a beta to generate a WACC as contemplated by CAPM.” The expert presented 14 possible WACC selections, some based off his own calculations, others from Aruba and HP’s financials advisors, and lastly, some from equity analysts, before choosing a WACC of 11 percent from this list. Finally, the respondent’s expert relied on a set of projections that he had created himself using industry growth rates, and subsequently testified at trial that he did not have any independent expertise to determine whether the industrywide growth rates were a reasonable proxy for Aruba’s expected future performance.
The discussion above is a continuing reminder of the importance for valuation experts to not only rely on a theoretically sound approach, but to reconcile their opinions within the context of market data, as necessary and when available and reasonable. In this case, both valuation experts’ opinions were essentially disregarded and VC Laster selected the unaffected market price prior to the announcement of the merger as the fair value even though “no one argued for this result.”
This article does not address every issue addressed by the Court, and there are other issues addressed by the Court that litigators, board of directors, dissenting shareholders, and valuation practitioners should review. We strongly encourage the reader to read the Aruba Networks decision in full and determine for themselves what they consider to be the most key findings.
1 Verition Partners Master Fund Ltd. v. Aruba Networks, Inc. C.A. No. 11448-VCL. (Del. Feb. 15, 2018).
2 Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd, – A.3d –, 2017 WL 6375829 (Del. Dec. 14, 2017).
3 DFC Glob. Corp. v. Muirfield Value P’rs, L.P., 172 A.3d 346 (Del. 2017).