Cashout Mergers

1. Cashout Mergers Chapter 10 Part 1

2. Acquisition Contexts for Valuation Issues • Arm’s Length Mergers • Cashout Mergers • Second Step Transaction in Arm’s Length • Sale of Control • Weinberger • Technicolor • Perlman

3. Signal UOP deal • Signal had earlier divested a division, receiving hundreds of millions in cash, so looking for an acquisition • bought 50.5% of UOP, Inc at a large premium over market price. • At the time it named Signal employees as half of the board members and a Signal employee left the firm to become CEO of the subsidiary. • That deal had been completed at $21 a share at a time the UOP stock was selling for $14 per share. • Two years later, having not fully invested the cash, Signal returns to UOP as a possible investment. • Two Signal executives who were also UOP directors do a study of the possible merger and conclude it would be a good investment for Signal at a price up to $24/share.

4. Signal UOP negotiations • There is some appearance of process (at least as compared to Van Gorkom). • The two CEOs discuss price. • The board retains an investment banker to provide a fairness opinion. • Only the independent board members vote. • Shareholder approval would have to occur by a majority of the minority and enough minority shareholders would have to vote so that the total number of shareholder votes exceeded two‐thirds. • really isn’t much room to negotiate beyond what Signal wants to do?

5. Signal UOP questions • Will this deal create new value? • What is the basis for the legal challenge? • How would you have advised Signal so that they would meet their fiduciary duty? • Does Signal have to disclose its best price, that it is a good investment up to $24? • What is the remedy?

6. Weinberger v. UOP: A Cashout Merger • How was 251(a) met? What was the plan of merger? • How was 251(b) met? Approval by the boards • How was 251(c) met? Approval by shareholders • How was 262(b) met? Signal UOP UOP SHs

7. Should Exit Rights Vary with the Context? • How did the majority’s transaction change what the minority had in each case? • What did they have before? And now? • Why should the law protect them? --against forced to go into a new business? -- against being forced out? Loral A Assets Arco Signal UOP L Stock L Stock UOP SHs A SHs

8. Weinberger: Risks to Minority • Is there a risk of majority opportunism? • Is the risk different than in an arm’s length merger? • What protection might the law provide? • Which remedy did the plaintiffs in Weinberger desire? Why?

9. Valuation in Cashout Context • 262(h): “fair value exclusive of any element of value arising from…the merger…In determining such fair value, the Court shall take into account all relevant factors.” • Tri-Continental :“The basic concept..is that the s/h is entitled to be paid for that which has been taken from him, viz, his proportionate interest in a going concern

10. What Does the Exclusion Mean? • “Exclusive of any element of value arising from the accomplishment or expectation of the merger” • “We take this to be a very narrow exception" • “Elements of future value, including the nature of the enterprise…”

11. 262(h) exclusion • DE Sup Ct makes a significant change in the Delaware appraisal statute. • The statute (§262(h)) specifies “the Court shall determine the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger.” • A later sentence of (h) provides “In determining such fair value, the Court shall take into account all relevant factors.” • In putting those two sentences together, the Weinberger court finds the adding of “relevant” in one sentence effectively limits the reach of value arising from the merger so that the excluded term can only be a very narrow exception that would exclude speculative effects from the merger but not effects from the merger that are not speculative. • Not so much statutory construction as reinterpreting statute to deal with new context

12. Changing contexts of mergers -- history • Period 1 – pre-1890s • Unanimous consent required • Period 2 – 1890+ • Statutes amended to allow supermajority approval • Appraisal added as remedy • Value of merger excluded • Period 3 – later in 20th century • More exceptions to appraisal • More procedurally complex and more costly to corps • Cash consideration allowed for mergers • Minority no longer opting out of enterprise but being cashed out – possible oppression

13. Weinberger Valuation Issues • Synergy • Minority Discount • Exclusivity • What other remedy might there be? • “We believe that [remedy] is, and hereafter should be, an appraisal as hereinafter defined • “While a plaintiff’s monetary remedy ordinarily should be confined to the more liberalized appraisal proceeding herein established,…

14. Weinberger complications • How are “two elements of fairness” to be read? • Fair procedure & fair price • On the one hand, Weinberger can be read as suggesting that, if the parent allowed the subsidiary to establish an independent negotiating committee that had the right to say “no,” the court could then infer that the price resulting from arm's-length bargaining was also fair. • Alternatively, court simultaneously and unhelpfully stressed that: • “the test for fairness is not a bifurcated one as between fair dealing and price. All aspects of the issue must be examined as a whole since the question is one of entire fairness.” • Huh?

15. The importance of Weinberger • Controlled corporation shareholders already have a remedy if they believe the price to be paid in a cash-out merger is too low: an appraisal proceeding with precisely the same measure of value as that adopted by the Weinberger court. • Under the Delaware appraisal procedure, a shareholder must jump through a number of procedural hoops, including not voting for the transaction and not accepting payment, in order to retain the right to bring an appraisal action. • More importantly, the Delaware corporate statute does not authorize a class appraisal procedure.

16. Importance of Weinberger 2 • In contrast, a breach of fiduciary duty claim can be brought on behalf of all subsidiary shareholders regardless of how they voted or whether they accepted payment for their shares. • Thus, the economics of the litigation process mean that, if a fight about price is limited to appraisal, the controlling shareholder is exposed as to price only with respect to the number of shares for which appraisal rights are perfected, typically a quite small number. • controller can manage its potential risk by conditioning its obligation to close the merger on a certain level of shareholder approval. • In a class action under the Weinberger standard, however, the price exposure extends to all shares acquired through the freeze-out merger without the need for shareholders to take any action at all. • Finally, if the freeze-out merger consideration is stock in the controller or stock in any publicly traded corporation, the minority shareholders have no right to appraisal. • Thus, without a cause of action for breach of fiduciary duty, the minority shareholders in such a transaction may have no remedy at all.

17. Procedural key • If the parent adopts an arm's-length negotiating structure, including an independent negotiating committee with a right to say “no,” and receives the approval of a majority of the minority shareholders, does the standard of review shift to business judgment and therefore relegate shareholders to their appraisal rights as the Weinberger court suggested in footnote 7? • Alternatively, would the appraisal measure of value nonetheless be applied on a class basis because, as the Weinberger court also explained, “the test for fairness is not a bifurcated one as between fair dealing and price” ? • Issues Worked out in two Delaware Supreme Court opinions, Kahn v. Lynch Communications Systems, Inc. (Kahn I) and Kahn v. Lynch Communications Systems, Inc. (Kahn II), involving Alcatel U.S.A. Corporation's freeze-out of non-controlling shareholders in Lynch Communication Systems, Inc.

18. Kahn I • court considered argument that entire fairness review should not apply, and therefore shareholders would be remitted to an appraisal remedy, if the negotiating structure plausibly protected their interests • as, for example, where the merger terms met the approval of a fully empowered, independent negotiating committee and the merger was conditioned upon approval by the majority of the disinterested minority.

19. Kahn I (cont.) • But instead, the Kahn I court held that adopting such a negotiating structure served only to shift the burden of proof to the plaintiff on the issue of the freeze-out's fairness. • The court believed that the controlling shareholder retained the capacity to influence the minority that cannot be procedurally dissipated. • In effect, the court envisioned an implicit threat that, if the non-controlling shareholders did not approve the freeze-out, the controlling shareholder would exercise its operating discretion to their disadvantage.

20. Kahn I (cont.) • Kahn I left open two important issues.   • First, what happens if the transaction structure fails this initial fair-dealing inquiry and therefore does not operate to shift the burden of proof?   • If a transaction has to exhibit both fair dealing and fair price to be entirely fair, then how can the fairness standard ever ultimately be satisfied if, as in Kahn I, the fair-dealing component is not met?   • Second, why should a controlling shareholder allow the creation of a fully empowered negotiating committee if all it gets in return is a burden shift?   • Unless the evaluation of price is somehow different--even without the presumptions of business judgment review--as a result of procedural protections, what is in it for the controlling shareholder?

21. Kahn II • On appeal, the supreme court's assessment of fair dealing took an unacknowledged but major shift. • While in Kahn I the inquiry was whether the independent negotiating committee had been coerced, in Kahn II the inquiry shifted to whether the non-controlling shareholders voting on the freeze-out merger were coerced. • Despite the finding that “the specter of coercion” had impaired the functioning of the independent negotiating committee, the court concluded that • “[w]here other economic forces are at work and more likely produced the decision to sell,” this coercion still may not be deemed material with respect to the transaction as a whole, and will not prevent a finding of entire fairness.  In this case, no shareholder was treated differently . . . nor subjected to a two-tiered or squeeze-out treatment. . . . Clearly there was no coercion exerted which was material to this aspect of the transaction . . . .”

22. Kahn I + Kahn II = ??? • Putting Kahn I and Kahn II together, we are left with something like a two-tiered inquiry concerning the fair-dealing component of the entire fairness standard.   • With respect to whether the burden of proof on entire fairness has shifted to the plaintiff, the appropriate inquiry assesses the presence and true empowerment of an independent negotiating committee. • Fairly read, Kahn I holds that the burden of proof does not shift unless the independent negotiating committee has the right to prevent the transaction. • With respect to the ultimate determination of whether the transactional procedure satisfies the fair-dealing component, the inquiry shifts to whether the inherent coercion and the form of the transaction actually influenced the non-controlling shareholders' votes. • Characterized somewhat less than sympathetically, is fair dealing satisfied despite an unfair, but not structurally coercive, procedure? • Or . . . No harm, no foul is good enough?

23. Future of quasi-appraisal? • See class blog.

24. Cede & Co. v. Technicolor • Where is the value coming from in this transaction? • How much? • Who should get it? • Do minority shareholders need protection?

25. Technicolor

26. Technicolor deal • The target Technicolor was a 20th century American icon. • Unfortunately, T chose to invest in a series of One Hour Photo stores --proved disastrous and the company’s stock fell from $22 to around $8. • At this point, Ronald Perelman, he of Revlon fame, offered to acquire the company for $20, a handsome premium. • He was offering the Perelman plan which contemplated the sale of several businesses and the closing of One Hour Photo, as a contrast to the Kamerman plan then being followed.

27. Technicolor deal 2 • Kamerman, the existing CEO, negotiated with Perelman (an arm’s length negotiation) and they agreed on a price of $23 and the Technicolor board agreed. • The deal was announced as a two step meager with the same consideration in both steps. • More than 83% of the shareholders received cash for the shares in the tender offer. • Those who did not tender knew that a cash‐out merger was coming and that they would receive the same price. • The new controlling shareholders, upon gaining control of the board, set a date for the follow‐on cashout merger.

28. The Technicolor Transaction Step One Step Two • What do we call it? • Why did the planners pick this structure over alternatives? • Is it different than Weinberger? • Should the law’s protection be different? • What are the plaintiffs seeking to accomplish? M&F T M&F Technicolor T stock Macanfor T SHs $23

29. Technicolor: Business History

30. A Brief Review: Legal Protection for Minority Shareholders • Fiduciary Duty • Judicial review of Director’s actions • Deference (BJR), Intermediate, Entire Fairness • Remedy: Rescissory damages or other equitable relief • Appraisal • Fair value of the shares • The Weinberger reading of exclusion • Procedural Limitations

31. Technicolor: Litigation History • January 1983: Merger & Lawsuit • 1988 S Ct.: Ch. Ct should not have required election of remedies before trial • 1990 Ch. Ct trial (47 days) of both claims; battle of experts ($13.14 vs. $62.75)=$21.60 • 1991 Ch Ct on FD: no harm no foul • 1993 S. Ct remand: appraisal should not have been first; entire fairness as standard

32. Litigation History II • Ch. Ct (1994) on FD-entire fairness met • 1995 S. Ct. affirms (contrast to Weinberger) • Ch. Ct (1995) on appraisal • $21.60 again • compound interest @ 10.32% pre-judgment; simple interest @10.5% post-judgment • Excluding what? • 1996 S. Ct. now reverses appraisal

33. Showing Entire Fairness (in Weinberger) • What is the cause of the FD problem? • (it is different than in Technicolor) • How might you eliminate the problem? • Board decision is delegated to disinterested members? • Shareholder decision is delegated to disinterested members? • How much disclosure is required?

34. Appraisal • Fair price--What are we valuing? • In economic terms from last classes • Is market price as relevant in Technicolor as Weinberger? • In legal terms • On what day? • Exclusive of any value arising from merger • What economic category of merger gains might exclusion leave out? • What drives Ch. Ct.? • Why does S.Ct. reverse? • Procedural structure– what does it tell you about purpose?

35. Appraisal • Merger date is after control change and asset restructuring is already underway • What does the court’s opinion do in terms of allocating the gains from the transaction? • As a shareholder, what incentive does it give you to change your behavior? • As a bidder, what incentive does it give to change your behavior?

36. Technicolor appraisal Smart Perleman plan merger Cash flows anticipated Tender offer Dumb Kamerman plan time Merger date/appraissal date

37. The Outcome for Plaintiff • Yet another appraisal • Dec 2003 $23.33 corrected to $21.98 • WACC (equity & debt) 19.89% • When do you get it? • Time value of money; 7% interest after 1991 • Costs? • Compared to what? • The Last Appeal • Praising the Chancellor and upholding his valuation choices • But 1990 decision’s WACC (15.28%) is the law of the case and pre-judgment interest goes through remand • Per share value= $28.41 or $5.6 million for plaintiff • Interest = $46 million