A Defeat, but Not a Rout, for Appraisal Arb

arbThe law firm Wachtell Lipton, for decades now a powerful advocate for corporate managements against stockholder activists and other challengers, takes an almost triumphalist view of a recent Delaware court decision in the matter of Ancestry.com. I can’t agree that managerial triumphalism is warranted here.

But let’s look at what happened, and then get back to the issue of what it means.

The opinion was a defeat for the petitioners, who had sought to persuade the judge that the fair value of the stock of Ancestry was well above the $32 that was paid to the stockholders who tendered in its sale to Permira Advisors.

Auction and Valuation

Permira’s acquisition of Ancestry, a company with a flagship genealogy website and certain other assets, began in an auction process in hush-hush style in May 2012. Like much so begun, this auction soon became public knowledge. Somebody blabbed and Bloomberg published an article in the subject in early June of that year.

Ultimately, seven potential buyers submitted non-binding preliminary indications of interest. Permira was one of the three highest bidders, chosen for the due-diligence round.

It appears from the court’s account that when they started doing their diligence, the potential buyers also started getting nervous. It at last occurred to them that genealogy is a niche market, there are only so many people ready to devote a lot of time to family history, and many of them were already subscribers so: how much further could the company grow? Also, the duly diligent research led to concerns about subscriber retention. One of the three initial hopefuls dropped out as a result of such issues.

Permira stayed in there, and outbid its remaining competitor, offering $32 a share. This represented a significant premium (41%) on the pre-announcement price, and Ancestry had the benefit of an ‘out’ clause in the event of a topping bid. The announcement, on October 22, produced no topping bid, and the deal closed in December.

Delaware’s appraisal statute provides dissenting stockholders with an opportunity to receive the judicially determined fair value of their stock. Thus, the court via Vice Chancellor Sam Glasscock III (above) wasn’t really free to say simply, “the buyer and seller agreed on $32 a share in an arm-s length transaction between sophisticated parties, so we’re staying out of it.” It couldn’t say that because section 262 of the General Corporation Law is quite clear that a dissenting stockholder given certain minimal conditions “shall be entitled to an appraisal by the Court of Chancery of the fair value of the stockholder’s share.” That wording is quite clear, and doesn’t allow for a “let’s wash our hands” attitude.

The resulting trial involved dueling experts: William Wisialowski (for the Petitioners, arguing that the fair value of Ancestry was between $42.97 and $43.65) and Greg Jarrell (for the Respondents, defending the price at which the deal closed). Much of the court’s opinion reads like a run-down of precisely the sort of disputes to which valuation experts gravitate. Thus: Jarrell normalized EBIT margins; Wisialowski did not. Wisialowski used a discount rate of 10.96%; Jarrell used 11.71%, because they differed on the beta. Further, Jarrell accounted for the expense of Ancestry’s practice of providing stock-based compensation. Wisialowski did not, testifying that “adding the future stock trading price adds yet another level of assumptions which are difficult to prove” to the analysis.

Glasscock and Wachtell

The court’s opinion suggests that Glasscock regrets the necessity of going over such issues at all, especially with a statute that doesn’t allow him the crutch of assigning either party a unique burden of proof. The statute “purports explicitly to allocate the burden of proof to the petitioner and the respondent, an allocation [that is] not meaningful.”

The vice commissioner sided with Jarrell, and thus with the respondents. He found that Jerrell’s approach on a range of topics is “the most reasonable and I adopt his methodologies,” which meant adopting his results.

Wachtell has put out a memo on the case that describes the court as finding “that the merger price was the best indication of Ancestry’s fair value.” That would make it a very sweeping win for the sorts of corporate managers who Wachtell’s usual clients. And a defeat for those who seek alpha through the sort of “appraisal arbitrage” that may have been at work here.

BUT … that isn’t quite what the court said. As I read the opinion, the court would have liked to say something like that, but it acknowledged that the statute won’t allow it. It confined itself in the end to a narrow ruling on the facts before it, preferring one expert’s model over the other’s. So it is a safe bet that situations like this will arise again. And sometimes the appraisal arbs will win.

 

 

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