Cede v. Technicolor

Cede & Co. v. Technicolor

• Where is the value coming from in this transaction?

• How much?

• Who should get it?

• Do minority shareholders need protection?

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, of Revlon fame, offered to acquire the company for $20, a handsome premium.

• Perelman plan – sale of several businesses and the closing of One Hour Photo

– contrast to the Kamerman plan then being followed.

Technicolor deal 2• Kamerman, existing CEO, negotiated with Perelman (an arm’s

length negotiation)

• agreed on a price of $23 ; 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 shares in TO.

• 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 follow on cash out merger.‐

Technicolor plaintiffs• holders of about 4% of the Technicolor shares

– had been purchased in June when the stock was selling for about $10

– most of the way down from its high of $22 to its low of $8.37 in September prior to the Perelman offer.

• now being offered $23 by a bidder who intended to change how Technicolor does business

• Their response is not to sell at $23 and to file for appraisal for fair value they say is more than $23. – (BOD in an arm’s length negotiations agreed to this price (2.5 times the prior

market price) and the great majority of shareholders have concurred by tendering.)

• plaintiffs believe they have a claim to a greater share of the gains being created by this change in control

Technicolor: Long 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

• 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

Technicolor holding• Under the merger statute plaintiffs are entitled to

the fair value as of the day of the merger. What date is that?

• turns out to be a day in late January, 1983, about six weeks after the closing of the tender offer – presumably the soonest a shareholder’s meeting could

be held under notice provisions provided by state law and disclosure required by federal securities law.

• What had happened in those six weeks?

Technicolor holding 2• As trial court noted, Perelman began to dismember a “badly conceived

mélange of businesses” – one division retained

– One Hour Photo and other under-performing divisions sold.

• Are shareholders are entitled to any gains arising from the replacement of the Kamerman plan by the Perelman plan?

• The court below took economic approach looking at future value that would not exist but for the takeover.

• But the Supreme Court took a more literal view– Accorded plaintiff the full proportionate value of its shares as of late January

so that “value added to the going concern by the “majority acquirer,” during the transient period of a two step merger, accrues to the benefit of all shareholders.” (Casebook at 325).

Appraisal

• So . . . 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?

Technicolor appraisal timeline

Tender offer

mergerSmart Perleman plan

Dumb Kamerman plan

Merger date/appraissal date

Cash flows anticipated

time

Target value

Protracted litigation history• more than 20 years in length

• Illustrates interaction of the statutory appraisal remedy and the common law fiduciary duty claim after Weinberger.

• Not a particularly positive commentary on DE

• two lengthy trials conducted by two different chancellors of Delaware.

• The valuation determined in each ($21.60 and $21.96) were each below the value offered by MAF

• Note: Delaware’s appraisal statute puts the risk of a valuation that is lower than the transaction value on the plaintiff

• Cf. Model Business Corporation Act which requires the corporation to provide an estimate of fair value, which is paid prior to litigation and cannot be recaptured.

Ultimate outcome for Plaintiff• after almost a quarter of a century the plaintiffs finally

achieved a value higher than what they have been offered in 1982.

• Even better for them (and more of a windfall), the Supreme Court also continued forward the prejudgment interest rate from the 1990 determination so that it also covered the second half of the litigation period as well (even though inflation, for example, was not the same).

• The result was an interest payment that much exceeded the fair value.

Valuation techniques

In re Emerging Communications, Inc. Shareholders Litigation

Emerging Tech deal

• Somewhat complicated• ATN owned Virgin Island wired telecom

service – valuable• Because of BOD deadlock, Prosser & Prior

decided to split ATN into ECM (52% owned by Prosser; rest publically held)

• And other NewCo

ECM deal

Innovative Com Corp (LLC)

(owns 52% ECM)

ECM

Merge into sub

Changed into

Innovative Com Corp (LLC)

(owns 52% ECM)

ECM

Public ECM s/h

Type of going public deal ECM goes private deal

Deal issues• With change of structure, the investment bank and the law firm that had been

hired to represent Emerging in buying now shifted to represent the majority shareholder entity on the other side of the transaction.

• Who was looking out for the minority shareholders? – A special committee of directors, a newly hired law firm, and a new investment banking

firm.

• The three member special committee of directors was headed by Richard Goodwin, former close adviser to President Kennedy, and two others directors, one living in Indonesia and the other in England.

• Time zones alone meant it was difficult for all members of the committee to confer even by phone– even the faxes that Goodwin sent to the other members were transmitted by Prosser’s

secretary that the Court found “was to give Prosser access to the Committee’s confidential deliberations and strategy.” (Casebook at 349)

Valuation

• Section III of the court’s opinion contains both “Fair Price” and “Fair Value”

• First is from an entire fairness analysis under common law claims based on fiduciary duty

• Second is the statutory term that the court is required to determine in an appraisal setting.

• The court has told us that in this case they are one and the same.

Valuation (cont.)• focus is on DCF

– (comparable company analysis being subordinated because of the lack of comparable companies).

• The same three key inputs that were the focus on chapter 9: – (a) cash flow for a specified period; – (b) cash flow for the terminal period; and – (c) the discount rate.

• work through the “value drivers” that the court sees as shaping the valuation opinions of the expert on either side—

• see how the valuation process is developed by each of the experts to support his valuation conclusions.

Valuation – DCF projections• Which set of projections should be the basis for DCF?

• There had been a set of projections in March and another in June – One for ECM-Innov. Merger, another for going private transaction

• Court notes (page 338) that the defendant had modified the June projections;

• Effect was “to depress the cash flows that management had contemporaneously prepared.”

• defendant’s expert seemingly arbitrarily increased forecasted the CapEx (Capital Expenditures).

• What effect on the cash flow and the valuation?

• The court points out very directly “a negative growth in cash flow and ‐“a consequential decrease in [the expert’s] overall valuation.”

DCF:Value Drivers in Determining the Discount Rate

• experts on the two sides had a difference in discount rate of three percentage points– Which side wants what? How does WACC come in?

• remember—the higher the discount rate, the lower the valuation of the company. (339)

• (three examples show how experts can be expected to differ and how lawyers have to be prepared to argue the finance as well as the law. )

• court notes that wrt/ cost of equity, – a small stock premium, a super small stock premium and a hurricane ‐

premium account for most of the difference between the two experts on this part of the valuation.

Court on fair value• Having analyzed the valuation opinions, the court opines the

fair value is $38.05 as opposed to the $10.25 offered in the cash out‐– testimony to large differences that sometimes show up in conflicted

interest cases.

• As to the impact of market price, ($7/share), the court disposes of the testimony of noted economist (author of A Random Walk Down Wall Street) and a leading proponent of the efficient market theory and valuation

• court finds the stock market price merits little or no weight and DE law supports him.

Fair dealing?• Not so much

• Recall -- entire fairness review under fiduciary duty looks at fair dealing as well as fair price.

• Here timing, initiation, and structure all work against the defendants.

• Prosser flipped the deal – seems worrisome.

• he diverted the knowledgeable investment banker and law firm from the company to himself – judge didn’t like that.

• Goodwin was faxing his own committee members through the secretary of the person with whom he was supposed to be negotiating – pretty lame

Remedy• what we have here is a deal that clearly fails both the statutory fair

value standard and the common law fiduciary duty standard

• In this case, appraisal action and the fiduciary duty claim provide equivalent financial returns

• a fiduciary duty claim can be be different than appraisal however.

– For example, appraisal must be filed only against the company while the defendants in a fiduciary duty action are usually the directors (with the result that insurance may be involved differently).

– Appraisal has been interpreted only to involve a legal issue of valuation and courts have sometimes had difficulty with reduction in value caused by director action (but see how the court deals with this in the short form mergers . . . ).