Delaware Chancery Court Parses Valuation Methods in Battle of the Experts
By: David L. Forney and Zane A. Madden
In William Richard Kruse (the “stockholder”), v. Synapse Wireless, Inc. (the “Company”), C.A. No. 12392-VCS (Del. Ch. July 14, 2020), the Delaware Court of Chancery (the “Court”) held that, after its review of the evidence as factfinder, the Company had carried its burden of proving a reliable appraisal of its fair value related to its 2016 merger transaction. As is typical in appraisal disputes, each party’s expert presented wildly different valuations. In this lengthy case, the Court nevertheless analyzed each proposed valuation model on its own merits and did not engage in compromise jurisprudence in order to achieve a sense of fairness for one party. In coming to its conclusion, the Court adopted the Company’s discounted cash flow valuation method, eschewing all other methods as unreliable in this case. The Court’s value was almost half of the merger transaction value upon which the stockholder exercised its appraisal rights.
In 2012, McWane Inc. (“McWane”), a non-party to the litigation, gained control of the Company via merger. Under the 2012 merger agreement, McWane had the ability to purchase stockholder shares for $4.997 per share, something McWane did periodically over the following years. Importantly, on March 31, 2014, McWane filed a complaint related to the 2012 merger, alleging losses due to a series of breaches by the sellers. The parties settled the litigation in December 2015. The negotiated settlement agreement gave McWane, among other things, an immediately exercisable call option to purchase shares at $0.42899 as opposed to the previously agreed $4.997.
In 2016, due to the Company’s sustained poor performance, McWane decided to initiate a merger and buy out all of the remaining minority shareholders. In connection with the merger, McWane offered the same $0.42899 per share to the minority shareholders. All accepted the offer but one — Mr. Kruse. Mr. Kruse filed suit in the Delaware Court of Chancery, seeking a fair value appraisal of his 582,216 shares.
The Court began by stating that the appraisal process is a flexible one that entitled the Court to consider “all relevant factors.” Delaware courts, the Court continued, typically look to market-based evidence of fair value in appraisal proceedings; however, none existed in the current matter with respect to the 2016 merger. In support of this point, the Court found that the 2012 merger price was not probative of the value of the Company because McWane (either due to misrepresentations made by the sellers or due diligence oversights) did not properly understand the finances of the Company. Additionally, the 2012 merger was not subjected to the competitive market via a bidding process or some other comparable process. Because market-based evidence did not exist, the parties resorted to alternative valuation methodologies to value the stockholder’s shares. Each of the experts used several different calculative methods to arrive at vastly varying values for the shares. The stockholder’s expert testified to a fair per share value of $4.1876, while the Company’s expert opined upon an assortment of values ranging from $0.06 to $0.11 per share.
The stockholder’s expert applied three different valuation techniques in his report: a “Prior Company Transactions” analysis, a “Discounted Cash Flow” (“DCF”) analysis, and a “Guideline Transactions (Private)” analysis. The expert, in relying 75% on his prior company transaction analysis and 25% on his DCF analysis, arrived at a per-share value of $4.1876. The Company’s expert employed the same three methods, but reached predictably different conclusions. Instead of testifying to a single valuation of the stockholder’s shares, however, the Company’s expert provided two possible values of $0.06 per share or $0.11 per share.
The Court aired its frustration with the inconsistencies presented in both expert valuations and declared that neither party demonstrated a wholly reliable indicator of the Company’s fair value. As an initial matter, the Court rejected the experts’ prior company transaction analyses because they were based upon the assumption that the 2012 merger provided some insight into the value of the Company. The Court, for the reasons stated above, dismissed that assumption.
The Court similarly rejected each expert’s comparable transactions analysis. This type of analysis, the Court explained, is often unreliable. This was on full display in this case. Despite the experts agreeing on several factors necessary for the valuation, they arrived at values approximately $200 million apart. Additionally, the Court found that each expert made reasonable and convincing objections to the other’s calculation and method. Accordingly, the Court held that neither valuation was probative of the Company’s fair value.
Finally, the Court turned to the experts’ DCF valuations. The Delaware Supreme Court previously found that DCF analysis was the best tool for appraising a company when market-based evidence was unavailable. This analysis requires three inputs: a projection of future cash flows, a terminal value, and a discount rate. Once these inputs are considered, one then adds the company’s available cash and subtracts its debt to arrive at a final value.
After reviewing the testimony, the Court adopted the Company’s free cash flow projections, simply finding them more credible than the stockholder’s projections. The Court arrived at this conclusion after noting that the stockholder’s expert’s analysis contained an error that inflated his projections. Additionally, the Court noted that the stockholder could not mount a persuasive criticism of the Company’s methodology. The Court also adopted the Company’s discount rate valuation of 12% because the stockholder’s expert did not consider the Company’s debt in his calculation. Lastly, the Court adopted the Company’s proposed terminal value calculation, due in large part to the stockholder’s expert making a theoretically impossible assumption in his calculation. He assumed that the Company would grow in perpetuity at a rate of 10%, well beyond the long-term growth rate of the United States economy.
After carefully reviewing the evidence, the Court (after making two minor adjustments) adopted the DCF valuation of the Company’s expert witness, resulting in a per share valuation of $0.228 per share. The stockholder’s shares were appraised at $133,015.09.