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Chancery Court: Fair Value Higher than Deal Price Because Management Projections "Unreliable"

Updated: Aug 2, 2023

Executive Summary: The Delaware Chancery Court emphasized the importance of using reliable projections and the appropriate discount rate in the discounted cash flow method of business valuation. The Court also highlighted the significance of market evidence and the need to weight different valuation methods appropriately. The Court also held that the presence of a private equity sponsor does not necessarily result in an artificially inflated deal price, and that synergies should be considered when they can be quantified with reasonable certainty.

In the case of In re Appraisal of PetSmart, Inc., the Delaware Chancery Court was asked to determine the fair value of PetSmart's common stock as of the closing of a merger in March 2015. PetSmart was acquired by a consortium of private equity firms for $83 per share, but some of the company's shareholders dissented from the merger and sought appraisal of their shares in accordance with Delaware law.

After considering expert testimony and analyzing the relevant valuation methodologies, the Court ultimately determined that the fair value of PetSmart's common stock as of the merger was $128.78 per share, significantly higher than the merger price of $83 per share. In reaching this conclusion, the Court made several key rulings:

Reliance on Management Projections: The Court found that PetSmart's management projections were reliable and could be used in the discounted cash flow (DCF) analysis, despite some criticisms by the dissenters' expert. The Court noted that management projections are not entitled to blind deference but should be evaluated based on their credibility and the reliability of the underlying assumptions.

Weighting of DCF and Market-Based Approaches: The Court concluded that the DCF analysis was the most reliable indicator of fair value, given its ability to capture the future earnings and cash flows of the company. However, the Court also considered the market-based approaches, such as comparable company analysis, and assigned them a weight based on their relevance and reliability.

Treatment of Synergies: The Court rejected the dissenters' argument that the merger price included a significant synergy value, and thus was not a reliable indicator of fair value. Instead, the Court concluded that any potential synergies were speculative and not supported by the evidence. Accordingly, the Court did not adjust the DCF analysis to account for synergies.

Control Premium: The Court also rejected the dissenters' argument that a control premium should be added to the fair value, given the private equity firms' acquisition of PetSmart. The Court noted that the merger price already reflected a premium for control, and any further adjustments would double-count this premium.

The case of In re Appraisal of PetSmart, Inc. highlights the importance of using rigorous quantitative valuation techniques and fully-documented valuation reports. The Delaware Chancery Court's reliance on the DCF analysis and its rejection of unsupported synergies and control premiums underscore the need for robust and transparent valuation methodologies. In the context of mergers and acquisitions, dissenting shareholders may seek appraisal of their shares, making it crucial for companies to prepare comprehensive valuation reports that can withstand judicial scrutiny.

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