Recent Trends and Developments in Appraisal Arbitrage

Emir Noe Madrid University of Florida

Abstract

This paper analyzes the recent developments of appraisal arbitrage in the state of

Delaware for appraisal petitions filed from the beginning of 2015 to the end of

2018. There emerges that appraisal arbitrage has significantly slowed in the last

year with appraisal petitions declining from 19% of eligible deals in 2015 to 8.5%

of eligible deals in 2018, reflecting the recent trend of hostile rulings against

appraisal arbitrageurs. Nevertheless, the average and median total raw returns were

11.7% and 14.3%, respectively, and the average and median annualized raw returns

were 14.1% and 5.2%, respectively, due in part to one notorious settlement and the

relatively high Delaware statutory interest rate that offset some of the current

headwinds in the appraisal arbitrage landscape. In fact, eleven cases in the sample

went to trial, resulting for those that had a memorandum opinion issued as of the

time of writing in an average and median fair value appraised of -4.9% and -3.4%,

respectively, compared to the merger price. Furthermore, appraisal petitioners had

an average and median invested capital of $45 million and $15 million,

respectively, with hedge funds still taking most of the action both in terms of

number of appraisals and total dollar volume, confirming the effectiveness of the

recent de minimis amendment that has increased the interquartile range of holding

value of petitioners; however, the prepayment amendment regarding the accrual of

interest has not gathered much steam among respondents. Finally, this paper

analyzes the valuation methodologies of the Delaware Chancery Court and in

specific when it adopts the DCF model and its main parameters.

Introduction

As every arbitrage opportunity fades as more participants exploit it over time, appraisal

arbitrage is heading towards the same direction. In fact, the practice of buying shares of targets in

eligible M&A transactions to exercise the statutory stockholder appraisal right under 8 Del. C. §

262, which allows to petition the Chancery Court of Delaware to appraise the fair value of the

shares of the target company and earn the Delaware statutory interest rate as well, has significantly

slowed in the last year. Despite the rapid rise of such arbitrage practice after the Transkaryotic

case (Jiang, Li, Mei, and Thomas, 2016), which set a precedent allowing appraisal for shares

bought after the record date, a series of amendments to the Delaware corporate statute and recent

rulings by the Court of Chancery in the wake of striking decisions from the Supreme Court of

Delaware have diminished its appeal and opportunities.

This paper contributes to the appraisal arbitrage literature by advancing the study of

appraisal activities in the last four years and by discerning the main parameters of the methodology

used by the Delaware Chancery Court when determining the fair value of a company’ stock.

Furthermore, it analyzes the similarities and differences emerged during the last four years

compared to a former study by Jiang, Li, Mei, and Thomas that encompassed data from 2000 to

2014, providing insights about how the appraisal landscape has evolved in the most recent years.

The sample data were manually collected using the Bloomberg Law database for appraisal filings

and the Securities Data Company database for M&A activity during the sample period. Moreover,

the analysis on the methodology of the Delaware Chancery Court for determining fair value of a

company’s shares was based on the memorandum opinions issued by the Court from 2015 to early

2019, also including previously targeted deals not present in the main sample data, resulting in

nineteen rulings where multiple valuation techniques were adopted.

Analysis of Appraisal Petitions

The analysis is based on one sample constructed from the Bloomberg Law database for all

appraisal petitions filed in the Delaware Chancery Court between the beginning of 2015 to the end

of 2018, where appraisal is the case type in the filing, and another sample from the SDC database

for the eligible merger and acquisitions transactions during the same period, where an eligible

transaction is one where the target company is incorporated in Delaware and either the merger

consideration is all or part in cash or the target is a private company in a stock deal. Also, deals

involving divestitures and repurchases were not included as they are not regarded as relevant M&A

transactions for purposes of appraisal (Hsieh and Walkling, 2005).

Overall, when considering the full sample, 215 appraisal petitions were filed in the

Delaware Chancery Court over the sample period with multiple instances in which several

petitioners targeted the same deal, as there were 136 targeted deals in total; more specifically, the

number of targeted deals based on appraisal date reached the peak in 2016 with 47 targeted and

substantially decreased in 2018 with only 22 targeted, as illustrated by Figure 1. Nonetheless, given

that the SDC database lacks some of the deals, the two samples are merged to find matched cases

and compute the percent of eligible deals targeted. As a result, using the matched cases and using

the effective merger date for a more appropriate comparison, the percent of eligible deals targeted

similarly reached the zenith in 2016 at 19.7% and markedly decreased in 2018 at 8.5% of eligible

deals targeted to levels not seen since 2010 (Jiang et al, 2016). Thus, when compared to the

analogous data of the former study by Jiang et al, the data from these last four years suggest a

reversal in the generally increasing development observed from 2000 to 2014.

This new decreasing trend highlights the new challenges that appraisal petitioners have

faced in the last years, especially starting in the first half of 2018. In fact, the number of filings for

the second half of 2018 is remarkably lower compared to the previous years, as illustrated by

Figure 2, perhaps due to the issue in the first half of 2018 of memorandum opinions on cases, such

as Aruba by the Chancery Court and the affirmation of Clearwire by the Delaware Supreme Court,

that accentuated the negative trend of appraisal litigation with awards well below the merger price

such as -30.6% in Aruba and -58% in Clearwire (Verition Partners Master Fund Ltd., et al. v. Aru-

Figure 1. Deals Resulting in Appraisal Petitions.

Figure 2. Number of Appraisal Petitions Before and After August 15 for each Year.

ba Networks, Inc., CA #11448-VCL [Del. Ch. May 21, 2018], ACP Master, Ltd., et al. v. Sprint

Corporation, et al.; ACP Master Ltd., et al. v. Clearwire Corporation, 382, 2017 & 380, 2017

[Del. Supreme Court April 23, 2018]); in addition, on August 15 of 2018, the decision of Aol by

the Court using the DCF model struck a further blow at appraisal arbitrageurs with an appraised

fair value of -5.8% relative to the merger price (In re Appraisal of AOL, Inc., CA # 11204-VCG

[Del. Ch. August 15, 2018]). Thus, the series of these successive events likely marked the turning

point in the appraisal arbitrage landscape, as illustrated by Figure 2, by signaling to arbitrageurs

that appraisal actions can turn sour even when considering the relatively attractive high Delaware

Statutory Interest Rate that accrues on these cases. In fact, the Court in Aruba specifically affirmed

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

0

5

10

15

20

25

30

35

40

45

50

2015 2016 2017 2018

Number of deals targted by appraisal petitioners (left axis)

Percent of eligible deals targeted by appraisal petitioners (right axis)

0

10

20

30

40

50

60

70

80

90

2015 2016 2017 2018

Before August 15 After August 15

that the recent guidance by the Delaware Supreme Court appeared to “moderate the attractiveness

of appraisal arbitrage” (Verition Partners Master Fund Ltd., et al. v. Aruba Networks, Inc., CA

#11448-VCL [Del. Ch. May 21, 2018]).

To be sure, hedge funds are still the main investor type involved in appraisal actions. In

fact, as Figure 3 shows, they continue to account for most of the appraisal activity based on the

number of appraisal petitions, followed by individual investors, private and public companies, and

mutual funds, in a similar trend as observed in the former study by Jiang et al. Specifically, the

activity of hedge funds and individual investors, which are the two main types of appraisal

petitioners active over the sample period, is illustrated in Figure 4 that shows how hedge funds

still significantly overshadow individual investors, especially in 2015 and 2017.

Also, Table 1 provides a more detailed breakdown of the types of appraisal petitioners, the

number of deals targeted, and the percent of total dollar volume. There emerges that over the

sample period, in a more accentuated trend relative to the former study by Jiang et al, hedge funds

are now the de facto main players in appraisal actions based on holding value, defined as number

of shares for which appraisal is sought times the merger consideration, with an astounding 98.5%

of total dollar volume. However, this figure is likely overestimated as the holding values of

nineteen cases in the sample data, most notably deals involving private companies and confidential

merger terms with undisclosed offer per share, are not available, underestimating the percent of

total dollar volume of individual investors and public and private companies, as they were the main

ones challenging these deals. Moreover, similar with the observed phenomenon in the former study

by Jiang et al, the significant divergence between the number of unique investors and number of

targeted deals highlights that hedge funds are the main repeat players in filing appraisal petitions

in contrast with mutual funds, individual investors, and public and private companies.

Not surprisingly, the top players of appraisal petitions are still all hedge funds. In fact, the

main hedge funds active in the appraisal landscape have slightly changed compared to the former

study. Over the sample period, whereas the main hedge funds based on number of targeted deals

are now Blueblade Capital, Verition Fund Management, and BlueMountain Capital, challenging

together 27.9% of all unique deals, the former top hedge funds are still present in the top ten such

as Merlin Partners, Quadre Investments, and Merion Capital (Jiang et al, 2016); the latter is still

the top player when considering the percent of total dollar volume.

Similarly, law firms representing petitioners and respondents are still very concentrated

with the top three players taking most of the action; in fact, the top three law firms of petitioners

are present in 48% of petitions, while the three top law firms of respondents are strikingly present

in 64% of them. A more detailed breakdown of the top law firms representing plaintiffs can be

seen in Table 3, highlighting that they are still almost the same as observed in the former study

with Grant & Eisenhofer, P.A. as the leader, followed by Prickett, Jones & Elliott, P.A. and Smith

Katzenstein Jenkins LLP; not surprisingly, most of them continue to focus on representing just

hedge funds that usually have a higher invested capital in these appraisal cases. Moreover, the sa-

Figure 3. Percent of Appraisal Petitions Filed by Investor Type.

Figure 4. Number of Appraisal Petitions by Hedge Funds and Individual Investors.

me high concentration can be observed for the law firms of respondents, where Richards, Layton

& Finger, P.A., Morris, Nichols, Arsht & Tunnell LLP, and Potter Anderson & Corroon LLP are

still the leading firms, respectively. On the other hand, as the holding value of individual investors

does not typically exceed $10 million, most seek appraisal pro se and not with these top law firms.

It might be noteworthy to consider that although there is not a close relationship between

premium awarded and background of judge on respective case, most of the judges ruling appraisal

cases in the current bench of the Delaware Chancery Court used to work for the leading law firms

80

16

3 1

Hedge Funds Individual Investors Private and public companies Mutual Funds

0

10

20

30

40

50

60

70

80

2015 2016 2017 2018

Nu

mb

er

of

app

rais

al p

eti

tio

ns

Hedge Funds Individual Investors

Table 1

Investor Types of Appraisal Petitioners and Their Investments (2015-2018)

Type of investor Number of unique

investors

Number of deals

targeted

Percent of total

dollar volume (%)

Hedge fund 69 101 98.5

Mutual fund 2 2 0.7

Individual investor 29 33 0.7

Public and private companies 7 7 0.1

Table 2

Top Players of Appraisal Petitions

Petitioner Investor

type

Number

of deals

Percent of

unique deals

(%)

Percent of total dollar

volume (%)

Blueblade Capital Opportunities LLC Hedge fund 18 13.2 2.4

Verition Fund Management Hedge fund 11 8.1 6.8

BlueMountain Capital Opportunities Hedge fund 9 6.6 11.6

Merlin Partners LP Hedge fund 7 5.1 0.4

Quadre Investments LP Hedge fund 7 5.1 0.3

Arbitrage Fund Hedge fund 6 4.4 3.3

Lion Cash LLC Hedge fund 6 4.4 0.1

Brookdale International Partners Hedge fund 6 4.4 1.3

Merion Capital LP Hedge fund 5 3.7 13.6

Brigade Capital Management Hedge fund 5 3.7 2.6

Table 3

Top Law Firms Representing Plaintiffs

Number of cases Average % of stock

ownership

All

plaintiffs Individuals

Hedge

funds

Other

clients Individuals

Hedge

funds

Other

clients

Grant & Eisenhofer, P.A. 53 1 52 0 n/a 2.41

Prickett, Jones & Elliott,

P.A. 24 1 21 2 2.3 2.17 0.51

Smith Katzenstein Jenkins

LLP 18 0 18 0 3.77

Heyman Enerio Gattuso &

Hirzel LLP 17 0 17 0 5.31

Rosenthal Monhait &

Goddess, P.A. 12 0 10 2 2.70 1.32

active in appraisal cases for petitioners and especially respondents (Delaware Judiciary), further

highlighting the substantial role that these firms have in Delaware corporate law.

Furthermore, the holding value of petitioners is still mainly concentrated in hedge funds,

while small plaintiffs are significantly less active in the sample period due to the statute

amendment of 2016. In fact, when considering all the individual appraisal filings, appraisal

petitioners had an average and median invested capital of $45 million and $15 million,

respectively; however, when aggregated at the deal level, they had an average and median invested

capital of $75 million and $153 million, respectively, with an interquartile range of $3.8 million

and $67.9 million, as Table 4 shows. The higher interquartile range compared to the former study

by Jiang et al likely reflects the change in the amended statute about the de minimis exception that

does not allow appraisal actions for a holding value less than $1 million or less than 1% of the

outstanding shares. In fact, over the sample period, there was a stark decline of small filings, as

twelve or about 6% of them did not comply with the thresholds required by the amended statute

compared to the 32% observed in the former study by Jiang et al, but some of these deals still

qualified for the appraisal remedy because challenged short-form mergers and given that the

amended statute took effect in August 2016 (Paiva, 2017). Moreover, the investment horizon along

with the ownership percent has remained very similar compared to the former study by Jiang et al,

as on average there are 73 days between the merger closing date and filing of first petition, 362

days between an eventual settlement date and filing of first petition, and 884 days, or about 2 years

and five months, between an eventual decision date from the Court and filing of first petition.

Furthermore, the Delaware statutory interest rate, or DSIR, has been increasing over the

years, as Figure 5 illustrates, driven by the Fed that has been increasing the discount rate in the last

year. Moreover, the DSIR not only carries a 500-basis point premium over the Fed discount rate

but is also compounded quarterly (8 Del. C. section 262), making it even higher when considering

the effective rate. To be sure, although the recent trend of the court to award considerations below

the deal price offsets this positive benefit for petitioners, the recent amendment to the statute to

specifically tackle this arbitrage opportunity has not been widely used by respondents. In fact, the

2016 amendment providing respondents the opportunity to tender a prejudgment offer to

petitioners, so as to not make accrue interest on that offer over the litigation period, has not been

widely used; in fact, although the sample period is relatively short to derive a significant inference

based on the relatively recent enactment of the amended statute, over the sample period just a few,

such as in the Kate Spade case, took advantage of this new statute amendment, highlighting that

the initial nebulosity around the amendment and some dubious drawbacks potentially outweigh

the advantage of not making accrue interest (Rice, 2018). In fact, the award of this prejudgment

offer can inadvertently help petitioners pay the initial substantial attorneys’ fees that can easily

reach millions of dollars (Jiang et al, 2016), and the amended statute does not give much detail

about the prepayment process (Rice, 2018), thus so far not gathering much steam based on the

sample data.

Table 4

Appraisal Petitioners’ Invested Capital and Investment Horizon

Value of

invested

capital ($m)

Ownership

(%)

Days between the

effective date and

filing of the first

petition

Days between the

filing of first

petition and

settlement date

Days between the

filing of first

petition and court

decision date

(1) (2) (3) (4) (5)

Mean 75.079 3.67 73 362 884

Std. Dev. 153.107 4.9 44 237 180

5% Percentile 0.011 0.01 3 49 667

25% Percentile 3.800 0.39 37 142 778

50% Percentile 13.706 1.37 77 344 870

75% Percentile 67.877 4.96 118 511 959

95% Percentile 374.373 16.67 120 777 1141

Note. Numbers in columns (1) and (2) are aggregated at the deal level. The cases in the sample period had

only 8 memorandum opinions issued as of the end of February 2019.

Figure 5. The Effective Delaware Statutory Interest Rate and Yield on the 2-year US treasury.

Regarding the litigation activity, the trend in the sample data is also similar as observed in

the former study by Jiang et al. In fact, the distribution of filings per case by all parties and the

court is still highly skewed with an average and median of 59 and 22 filings, respectively, and with

petitioners making most of the filings compared to respondents, as Figure 6 shows. A more detailed

analysis on the litigation activity is found in Table 5, which clearly illustrates that the litigation

activity rises as the amount of invested capital increases such as markedly indicated in cases with

more than $10 million at stake, or the higher stake group. In fact, the average number of filings by

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

1/1

/20

00

11

/1/2

00

0

9/1

/20

01

7/1

/20

02

5/1

/20

03

3/1

/20

04

1/1

/20

05

11

/1/2

00

5

9/1

/20

06

7/1

/20

07

5/1

/20

08

3/1

/20

09

1/1

/20

10

11

/1/2

01

0

9/1

/20

11

7/1

/20

12

5/1

/20

13

3/1

/20

14

1/1

/20

15

11

/1/2

01

5

9/1

/20

16

7/1

/20

17

5/1

/20

18

Effecitve US2yr Effective DSIR

Figure 6: Number of Appraisal Filings by Party

all parties and the Court in such higher stake cases is 76 in contrast with 28 for cases with less than

$1 million, or the smaller stake group. Interestingly, as observed in the former study, the higher

holding value group indicates whether a case is more likely to be settled or go to trial, as 10 cases

in the larger group went to trial compared to 1 in the medium group and 0 in the lower group,

which had all of its cases settled. To be sure, twenty-five targeted deals were still being litigated

as of the end of February, while the rest were the ones that either settled or went actually to trial.

Also, the type of deal in question also provides insights about the amount of litigation expected,

as minority squeeze-outs, going-private deals, and low premium deals have more active litigation

than the average case based both in number of filings and timeframe; also, as Table 5 illustrates,

minority squeeze-outs and going-private deals are usually more prone to go to trial rather than

being settled in a similar pattern as in the former years (Jiang et al, 2016).

With regards to returns, the recent negative atmosphere against appraisal arbitrageurs has

led to significant lower total and annualized raw returns compared to the ones found in the previous

years. In fact, the average total and annualized raw returns over the sample period were 11.7% and

14.1%, respectively, in stark contrast to the 98.2% and 32.9%, respectively, found in the former

study by Jiang et al. Furthermore, whereas the average and median total raw returns for the trial

subsample were 12.9% and 14.3 %, respectively, they were positive due to the accrual of the

Delaware Statutory Interest Rate on the appraised fair value by the Court; in fact, the average and

median total raw returns from the appraised fair value by the Court were -4.9% and -3.4%,

respectively, while the average and median total raw returns from the interest accrual were 18.1%

and 17.1%, respectively. Thus, over the sample period, appraisal petitioners in cases that went to

trial would have achieved negative total raw returns on average if the Delaware Statutory Interest

Rate did not accrue on these cases, as similarly observed in the former study (Jiang et al, 2016).

0

10

20

30

40

50

60

70

Number of filings by allparties and the court

Number of filings bypetitioners

Number of filings byrespondents

Average Median

Table 5

Information on Settled and Litigated Cases

Stock

ownership

(%)

[standard

deviation]

Average #

Filings by

all parties

and the

court

[standard

deviation]

Average #

Filings by

petitioners

[standard

deviation]

Average #

Filings by

respondent

[standard

deviation]

# Cases

settled

[average #

days to

settlement]

# Cases

resolved

by court

[average

# days to

decision]

Total

#

Cases

(1) (2) (3) (4) (5) (6) (7)

Value of invested Capital

≥$10 million 3.02 75.72 30.64 16.08 48 10

58

[3.38] [132.53] [70.62] [34.32] [360] [911]

$1-10

million

0.75 34.97 12.71 6.49 20 1

21

[1.08] [41.13] [18.46] [10.59] [394] [693]

<$1 million 0.32 28.27 7.92 6.42 22 0

22 [1.01] [27.64] [13.07] [8.17] [313] [0]

Type of deal

Minority

squeeze-out

3.51 86.75 24 9 7 1

8 [5.22] [84.58] [30.43] [11.72] [453] [693]

Going

private

2.37 67.01 23.62 14.21 40 3

43

[3.91] [92.22] [43.11] [23.61] [319] [841]

Low

premium

4.42 57.8 15.83 8.17 6 0

6 [4.66] [67.50] [17.23] [11.65] [317] [0]

Note. The sample does not include ongoing cases and those with undisclosed offer per share.

On the other hand, the settlement subsample is quite small, as most of the settlement terms are

confidential and are not disclosed to the public, except very few cases, perhaps because the

undesired publicity generated by these disclosures could inadvertently spark further appraisal

activity. Therefore, this phenomenon doesn’t allow to comprehensively estimate the returns of all

the cases. However, one exception is the Safeway case, where settlement terms of three hedge fund

petitioners that settled with the respondent were publicly disclosed (Hoffman, 2015); in fact, it was

revealed that they received a merger consideration improvement of 26% relative to the original

merger price at the effective merger date, earning them a 114% annualized return considering the

timeframe between first filing date and settlement date, skewing the return distribution of the sam-

Table 6

Gross Returns # obs Average Std. Dev. Median

Full sample 11

Total raw return (%) 11.7 22.0 14.3

Annualized raw return (%) 14.1 36.8 5.2

Trial subsample 8

Total raw return (%) 12.9 13.9 14.3

Annualized raw return (%) 4.9 5.3 5.2

Total return from value improvement

(%) - 4.9 12.9 - 3.4

Annualized return from value

improvement (%) - 1.9 5.3 -1.4

Total return from interest accrual (%) 18.1 3.9 17.1

Annualized return from interest accrual

(%) 6.7 0.6 6.6

Settlement subsample 3

Total raw return (%) 8.7 15 0

Annualized raw return (%) 38.4 66.7 0

ple, as illustrated in Table 6; also, other two cases revealed that the parties settled for the same

consideration as of that of the merger terms. To be sure, these returns are raw ones and do not

consider the expenses, such as attorneys’ fees and legal expenses, incurred by petitioners, so these

new lower gross returns are more likely to be negative when considering net returns, perhaps

explaining the reversal in the trend of appraisal petitions filed. Nonetheless, the relatively small

sample is likely to be very sensitive to the new rulings that are scheduled to be issued by the

Delaware Chancery Court, as there were four cases in the sample, such as Panera Bread, waiting

a decision of the Court as of the beginning of March 2019.

The Delaware Chancery Court DCF Model

The analysis is based on memorandum opinions issued by the Delaware Chancery Court

and rulings by the Delaware Supreme Court over the period from 2015 to early 2019. The

Delaware Chancery Court issued nineteen memorandum opinions over this period and adopted

multiple valuation approaches for valuing the target company, while the four rulings by the

Delaware Supreme Court, either affirmations or reversals, are used to adjust the dates of the

decisions of the cases in question; the date on cases heard by Delaware Supreme Court are adjusted

to reflect this, and an affirmation would confirm the eventual premium awarded by the Delaware

Figure 7. Premiums and Discounts Ruled by the Court Adjusted by Eventual Ruling of

the Delaware Supreme Court

Chancery Court, while a reversal would void the eventual premium awarded, as illustrated in

Figure 7.

Over the different memorandum opinions, the Court initially describes the relevant factors

surrounding the transaction, such as whether there was a conflict of interests or the sale process

was appropriate, and motivates what circumstances warrant a certain valuation methodology over

another one. In fact, given that each transaction contains a wide variety of different events and

conditions, the Court has considered six valuation methodologies over the nineteen cases,

including precedent transactions, multiple-based valuation based on comparable company, DCF

model, merger consideration, merger consideration less synergies, and trading price of target. To

be sure, although the Court may have considered all these types of valuation methodologies for

appraising the fair value of the target’s shares, it has adopted just four of them and once a

combination of them with equal weights to arrive at a final fair value. Over the sample period, the

Court adopted nine times just the DCF model, five times just the merger consideration, two times

just the merger consideration minus synergies, one time just the trading price, one time using the

breach of fiduciary duty award, and one time giving equal weight to the multiple-based valuation

based on comparable company, the DCF model, and the merger consideration.

With regards to determining whether the sale process was genuine and thus whether to rely

on the merger consideration, the transaction should have been through a competitive and fair

auction by an independent committee that disseminates information to many potential buyers to

be viewed as an arm’s length transaction. That is, the sale process is reliable when multiple and

heterogenous bidders are contacted in pre-signing phase and adequate and reliable information

about the target company was made available to all potential bidders. If one of this characteristics

0% 0%

-1%

20%0% 0% 0% 0% 0%

-8%

-57%

-31%

3%

-3% -6%

60%

11%

158%

0%

-100%

-50%

0%

50%

100%

150%

200%

Public Private

is not met, it is more likely that the Court will not consider the merger consideration as the fair

value of the shares and rather rely on another valuation methodology such the DCF model.

Whereas the merger consideration valuation is straightforward, the other ones are very

sensitive to the inputs decided by the Court. For instance, the amount of synergies created by the

deal and to be subtracted from the merger consideration is quite subjective, but the Court has

recently ruled in appraising Solera that they are 31% of total expected synergies, based on the

median percentage of synergies shared with the seller according to the study How Successful M&A

Deals Split the Synergies by the Boston Consulting Group (In re Appraisal of Solera Holdings,

Inc, CA #12080-CB [Del. Ch. July 30, 2018]). Similarly, the trading price is not fixed as a

valuation parameter, but the Court in Aruba adopted the thirty-day average based on the period

preceding the announcement date, supporting it by citing the article Merger Announcements and

Insider Trading Activity, and thereby advocated the strong-form efficient market hypothesis when

the stock is widely traded and has no controlling stockholder (Verition Partners Master Fund Ltd.,

et al. v. Aruba Networks, Inc., CA #11448-VCL [Del. Ch. May 21, 2018]). Likewise, the multiple-

based valuation based on comparable company is not fixed in stone, but the Court in DFC Global

adopted it, although giving it just a third of the weight to arrive to the final fair share price, using

the median multiple of market value of invested capital to EBITDA of a peer group mostly agreed

on by parties (In Re Appraisal of DFC Global Corp, CA # 10107-CB [Del. Ch. July 8, 2016]).

However, the most used valuation approach was the DCF model, as each party usually uses it to

defend the respective valuations that usually diverge significantly as researchers have noted, “for

respondents’ experts, the median valuation was 16% below the merger price, and the mean was

22% below. For petitioners’ experts, the median valuation was 78% above the merger price, and

the mean was 186% above” (Korsmo and Myers, 2016).

When the court adopts a DCF model for establishing the fair value of the shares in question,

the court usually adopts the DCF model of the party with the least far-fetched assumptions, usually

that of the respondent, and makes adjustments on the major divergences between the parties. In

fact, although the court usually just addresses the main areas of disagreements between them,

usually taking the midpoint of the parties’ assumptions when both are deemed reasonable but

conflicting, there are still insights into which parameters the Court tends to view as reasonable.

Over the sampled cases, which are those ruled between 2015 and early 2019, the capital asset

pricing model adjusted with a size premium is usually deemed reasonable for deriving the required

rate of return of equity; the risk-free rate is usually the yield on the 20-year US treasury bond as

of the effective merger date; beta is usually smoothed and computed with weekly observations

over a two-year period preceding the effective merger date, but a peer median beta with unlevering

and relevering using Hamada equations is usually used for private companies; the size premium

and the equity risk premium, which is usually a supply-side one, are derived from valuation

handbooks such as those from Ibbotson and Duff & Phelps. Cashflows projections are usually

based on those of management, and these are deemed reliable when have been recurrently done by

management in the ordinary course of business over the years and not just for the purpose of a

sale. In fact, when they are deemed unreliable, the court usually does not employ a DCF analysis

or does not give it much, if any, weight in the calculation of the fair value of the shares. Relatedly,

the Court in Lender Processing Services has noted that over the long-run capital expenditures

should equal depreciation, so a company that has had lower depreciation than capital expenditures

in the former years of the effective merger date should have higher depreciation amounts in the

future, and vice versa (Merion Capital L.P., et al. v. Lender Processing Services, Inc., CA #9320-

VCL [Del. Ch. December 16, 2016]). Furthermore, the cost of debt is usually the yield to maturity

observed on a benchmark company or index based on the credit rating of the company as of the

merger date, similarly with the capital structure that is usually computed as the observed one and

not the target one, as the court prioritizes to appraise the respondent as a going concern as of the

merger date. Another contentious area is the choice of the perpetuity growth rate for calculating

the terminal value, but the Court has usually set the boundaries between the projected long-term

inflation rate as the floor and the projected long-term Nominal GDP growth rate as the ceiling with

usually a midpoint between them deemed reasonable; the Court has usually found that the risk-

free rate on a long-term US treasury bond is a potential proxy for the long-term nominal GDP

growth rate and, thus, ceiling for the perpetuity growth rate, as the court has noted that a company

cannot grow indefinitely at a higher rate than the economy for it would be bigger than it at the end.

Finally, the tax rate is usually the marginal tax rate of the company, although the Court calculated

the effective tax rate for a petitioner in a targeted deal involving a S corporation (Nathan Owen v.

Lynn Cannon, et al., C.A. NO. 8860-CB [Del. Ch. June 17, 2015]), and the working capital is

usually debated over how much cash is excess cash with the Court usually awarding some excess

cash considering eventual taxes on repatriation of foreign profits.

Conclusion

Thus, despite many characteristics of the appraisal landscape still mirror those observed in

the past, as observed in the former study by Jiang et al, appraisal arbitrage has been under

significant pressure in the last year with multiple rulings awarding petitioners a consideration well

below that of the merger and thus offsetting the attractive Delaware Statutory Interest Rate

accruing in these cases, significantly slowing the activity in the second half of 2018. Although

appraisal arbitrageurs earned positive total and annualized raw returns over the sample period, net

returns might have been even negative when considering the attorneys’ fees and litigation expense.

Further, although the Court has considerable discretion in adopting valuation models and their

inputs, it has established precedents for some key parameters, especially in the DCF model, that it

deems reasonable and that thus provide insights for appraisal arbitrageurs when evaluating the

potential success of bringing forward an appraisal action. Thus, the recent hostile trajectory taken

by the Delaware Chancery Court does not bode well for the future of appraisal arbitrageurs,

limiting the scope and nature of exercising the appraisal remedy for exploiting this once

burgeoning activity.

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