Merger and acquisition deal activity remains robust considering continued global economic growth, low inflation, low interest rates, and record amounts of private equity capital competing with corporate strategic acquirers to drive top-line growth. Increased competition for acquisition targets has led to heightened pressures on boards of directors to ensure that they are not approving overpayment for any new acquisition, and also receiving fair consideration or potentially even more than fair consideration if they are a board member of a selling corporation.
As a result, boards of directors and their legal counsel may be inevitably tasked with obtaining and reviewing fairness opinions in connection with consummating merger and acquisition transactions. How do board members and their counsel know that they have received a strong fairness opinion? What are some factors they should look for in assessing whether or not they have received a strong or weak fairness opinion? When should they make more in-depth inquiries of their opinion provider?
VRC will take a look at the importance of securing a strong fairness opinion and shed light on some fact patterns where Delaware courts have said that board of directors relied upon weak fairness opinions. We will (i) briefly describe fairness opinions and (ii) and briefly review Brenda Koehler v. NetSpend Holdings Inc., a Delaware Chancery Court opinion in which the court discussed a fairness opinion that was viewed as “weak” that the board of directors relied on.
A fairness opinion is an opinion provided by a third-party (an independent valuation firm or investment bank) as to whether a transaction is fair from a financial point of view to a particular party. With respect to a transaction, a fairness opinion seeks to opine on whether one receives “substantial equivalent in value” consideration (Sterling v. Mayflower Hotel Corp., 93A.2d107, 110-14 (Del. 1952)).
In the 1980s, fairness opinions became much more commonplace after the Delaware Supreme Court in Smith v. Van Gorkom indicated that the board had breached its duty of care because of the lack of a fairness opinion or other reliable valuation in a corporate control transaction (Smith v. Van Gorkom (488 A.2d 858 (Del. 1985)).
Delaware Statute Title 8, Section 141(e) of the Delaware Code states directors are “fully protected in relying in good faith…upon such information, opinions, reports, or statements presented to the corporation by any of the corporation’s officers or employees…or by any other person as to matters the officers or employees…or by any other person as to matters the member reasonably believes are within such other person’s professional or expert competence.”
WEAK FAIRNESS OPINIONS VS. STRONG FAIRNESS OPINIONS
Although boards of directors are provided certain protections in Section 141(e) when they reasonably rely upon third-party fairness opinions (even weak opinions) in good faith, it is important that directors be aware of certain fact patterns the Delaware Chancery Courts believe make a fairness opinion a weak fairness opinion.
NetSpend was a public company that provided prepaid debit cards to millions of people who did not have traditional bank accounts. In 2012, NetSpend and Total System Services (TSYS) engaged in negotiations for an all-cash acquisition transaction.
The final “terms consisted of the following: (1) a price of $16 per share in cash; (2) a no-shop provision; (3) a 3.9% termination fee, amounting to approximately $53 million; (4) a 1.9% security breach threshold.” NetSpend’s last trading price was $11.65 on the last trading day prior to their receipt of TSYS’ first indication of interest at $14.50 cash.
In the case, the plaintiff asked the court to enjoin the acquisition of TSYS because the transaction’s “lack of a pre-agreement market canvas, negotiation with a single potential purchaser, reliance on a weak fairness opinion, agreement to forgo a post-agreement market check, and agreement to deal-protection devices including, most significantly, a don’t-ask, don’t waive provision.” The plaintiffs felt the deal “was not designed to produce the best price for the stockholders.”
Although this transaction process was procedurally flawed on many fronts, we will focus on only the fairness opinion and insight that this case can provide boards of directors and their counsel on determining whether or not they may have a weak fairness opinion.
Ultimately, the court identified several factors it believed made the fairness opinion “weak,” even though the fairness opinion was delivered by a bulge bracket investment banking firm:
- The stock price was not a good indicator of the value of the company
- The comparable companies were dissimilar and did not have good utility in estimating the value of the company
- The precedent transactions were old
- The discounted cash flow (DCF) analysis 1) indicated that the TSYS offer was grossly inadequate and 2) was based on financial projections that were outside the range of management’s customary projections.
- With respect to the first factor, the $16 per share merger price was considered 20% below the bottom range of values implied by the DCF. The presence of the anomalous DCF valuation makes the fairness opinion a less reliable substitute for a market check. In fact, the defendants were reduced to arguing that the DCF valuation is unreliable here because NetSpend management typically prepared projections no further than three years out, making the five-year DCF of the fairness opinion speculative.
- Ensure that multiple valuation techniques are used, and these accurately provide a real indication of the subject company’s valuation
- Heighten the level of diligence to confirm that comparable companies and comparable transactions used are truly comparable to the company being valued
- Heighten the level of diligence if the acquisition price is outside of the valuation range for any valuation technique
SO, WHAT’S A BOARD TO DO?
Dicta in Brenda Koehler v. NetSpend Holdings, Inc., provides insight. In this case the court concluded that the Board relied upon a weak fairness opinion that was provided by a major Wall Street investment bank.
Boards of directors and their counsel can improve the likelihood of receiving a more defendable fairness opinion by making specific inquiries of their opinion provider and management:
- As to whether the valuation techniques that are used accurately provide a real indication of the subject company’s valuation.
- As to whether the comparable companies and comparable transactions used are truly comparable to the company being valued.
- If the acquisition price is outside of the valuation range for any valuation technique.
- Reliability of the projections used in the analysis, and their consistency with existing management models.
When working with an outside financial advisor on the development and delivery of a fairness opinion, boards, fiduciaries and/or corporate counsel should ask the following:
- Comparable companies and comparable transactions
- Are the comparable companies truly comparable to the subject company?
- Are these the same companies that the subject company has been compared to in the past?
- What are the differences between the selected comparable companies and the subject company?
- Is the subject company impacted by the same macro factors as the comparable companies?
- Do comparable companies have the same customers and end markets?
- Has the subject company’s financial performance been different from the comparable companies?
- Should the comparable companies be placed into separate classes?
- What are the timeframes of the comparable transactions data?
- Valuation ranges
- Is the acquisition price within the indicated valuation ranges for each of the techniques? If not, with that indication are we receiving less than or more than fair consideration by that valuation range?
- Are there other non-standard valuation methodologies that it may be reasonable to consider?
- Were the projections developed similarly as they have been in the past? If so, please explain the differences.
- Are the projections conservative, moderate or aggressive?
- Are there factors that the board should consider that may not be reflected in the projections?
- How are these projections as compared to previous projections that may have been prepared?
Scrutiny of corporate deal activity has little to no sign of decreasing. If M&A activity remains at a robust level, fairness opinions will become more and more important to boards of directors. Valuation Research Corporation has prepared more than 1,000 fairness opinions, including for transactions valued at more than $10 billion. For more information regarding opinion support, contact your VRC representative.