The Delaware Supreme Court’s reversal of Chancery Court’s holding provides a reminder that in the sometimes-esoteric world of business valuations under Delaware, fully developing and explaining one’s analysis is critical.
The Chancery Court in In re Appraisal of DFC Global Corp issued a revised opinion in which Chancellor Andrew Bouchard held that the equal weighting of three valuation methods was appropriate because of the inherent “uncertainties and considerations” of each approach to value. The three methods were the deal price ($9.50), comparable companies analysis ($8.07), and a discounted cash flow analysis ($13.33), resulting in a weighted “fair value” of $10.30. Chancellor Bouchard found that as a financial sponsor, the private equity buyer was focused on achieving a certain internal rate of return rather than on DFC’s fair value. Therefore, the Chancery Court reasoned, the deal price should be attributed a mere one-third weighting.
However, the Delaware Supreme Court reversed the lower court’s revised opinion for several reasons. The Supreme Court:
Rejected the concept that a leveraged buyout (LBO) buyer’s winning bid in a contested deal should be negatively impacted by its target IRR: “[A]ll disciplined buyers, both strategic and financial, have internal rates of return that they expect in exchange for taking on the large risk of a merger, or for that matter, any sizeable investment of its capital. That a buyer focuses on hitting its internal rate of return has no rational connection to whether the price it pays as a result of a competitive process is a fair one.”
Rejected the changes Chancellor Bouchard made in the DCF (in which he opted for a higher perpetual growth rate), due to the lack of adequate basis for the change in the record: “With that [growth rate] error corrected, and addressing certain foreign exchange adjustments, the Court of Chancery’s discounted cash flow model would yield $7.70 per share [rather than $13.33.”
Rejected the Chancery Court’s application of equal weight to the three methods and dictated that the trial court must explain its weighting: “[T]he Court of Chancery must exercise its considerable discretion while also explaining, with reference to the economic facts before it and corporate finance principles, why it is according to a certain weight to a certain indicator of value... In this case, the decision to give one-third weight to each metric was unexplained and in tension with the Court of Chancery’s own findings about the robustness of the market check.”
The key takeaway for business valuation from DFC Global Corp is that your calculations and analysis are only as good as the rationale behind them.
Nearly all business valuation engagements depend upon the written word to go beyond the numbers and calculations to properly explain and develop the rationale for methods, assumptions, and calculation. The veracity of any valuation project depends on it. As DFC Global Corp. shows, even Delaware's vaunted Chancery Court needs this reminder (occasionally).
How can Eton help?
The Delaware Supreme Court's ruling in DFC Global Corp emphasizes the importance of thorough and well-explained business valuations. As a business owner or stakeholder, it's crucial to ensure that your company's valuation is backed by solid reasoning and clear documentation.
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