Submitted: January 17, 2018
Stuart
M. Grant, Mary S. Thomas, and Laina M. Herbert, of GRANT
& EISENHOFER P.A., Wilmington, Delaware, Attorneys for
Petitioners.
Kevin
R. Shannon, Berton W. Ashman, Jr., and Christopher N. Kelly,
of POTTER ANDERSON & CORROON LLP, Wilmington, Delaware;
OF COUNSEL: William Savitt, Ryan A. McLeod, Andrew J.H.
Cheung, Nicholas Walter, and Courtney L. Shike, of WACHTELL,
LIPTON, ROSEN & KATZ, New York, New York, Attorneys for
Respondent.
MEMORANDUM OPINION
GLASSCOCK, Vice Chancellor
Each
block of marble, Michelangelo believed (or purported to
believe) contained a sculpture; the sculptor's job was
merely to pitch the overburden to reveal the beauty within.
Early jurists believed (or purported to believe) something
similar about common law; that it existed in perfect form,
awaiting "finding" by the judge.[1]By contrast, even
Blackstone would expect that statutory law would be an
explicit, if blunt, tool of justice; manufactured, rather
than revealed. Our appraisal statute, Section 262 of the
DGCL, [2] is an exception. Broth of many cooks and
opaque of intent, it provides every opportunity for judicial
sculpting.[3]
The
latest pitching of stone from the underlying statutory body
occurred in our Supreme Court's recent decisions in
DFC and Dell.[4] Those cases, in distilled form,
provide that the statute requires that, where a petitioner is
entitled to a determination of the fair value of her stock,
the trial judge must consider "all relevant factors,
"[5] and that no presumption in favor of
transaction price obtains. Where, however, transaction price
represents an unhindered, informed, and competitive market
valuation, the trial judge must give particular and serious
consideration to transaction price as evidence of fair value.
Where information necessary for participants in the market to
make a bid is widely disseminated, and where the terms of the
transaction are not structurally prohibitive or unduly
limiting to such market participation, the trial court in its
determination of fair value must take into consideration the
transaction price as set by the market. I will refer to
transactions compliant with such conditions by the shorthand
"Dell Compliant." In sum, while no
presumption in favor of transaction price obtains, a
transaction that demonstrates an unhindered, informed, and
competitive market value is at least first among equals of
valuation methodologies in deciding fair value. Where a
transaction price is used to determine fair value, synergies
transferred to the sellers must be deducted, to the extent
they represent "element[s] of value arising from the . .
. merger" itself.[6]
This
matter is before me seeking a post-trial finding of the fair
value of AOL Inc. ("Respondent, " the
"Company, " or "AOL") under the appraisal
statute. Because the seminal cases referenced above issued
during the pendency of this matter, I asked the parties to
supplement the briefing to reference the instruction that
DFC and Dell supply. I note that,
throughout that helpful briefing, both the Respondent and
Petitioners continue to advocate for my reliance on financial
metrics rather than transaction price.[7] Applying the
Dell criteria of information distribution and
barriers to entry with respect to market participation in
evaluating whether the transaction here is Dell
Compliant, I find the matter a close question. AOL was widely
known to be in play, the Company talked to numerous potential
purchasers in relation to the sale of part (or all) of AOL,
the no-shop period running post-agreement was not protected
by a prohibitive break-up fee, and the actions of the AOL
unaffiliated directors appear compliant with their fiduciary
duties. No topping offer emerged. Nonetheless, the merger
agreement was protected by a no-shop and matching right
provisions. Moreover, the statements made by AOL's CEO,
who negotiated the deal, in my view signaled to potential
market participants that the deal was "done, " and
that they need not bother making an offer.
Market
participants at this level are not shrinking violets, nor are
they barnacles that are happy players during a favorable
tide, but shut tight at its ebb. Nonetheless, I find the
unusually preclusive statements by the CEO, in light of the
other attributes of this transaction, such that I cannot be
assured that a less restrictive environment was unlikely to
have resulted in a higher price for AOL. Accordingly, I am
unable to ascribe fair value solely to market price.
Having
rejected transaction price as the sole determinant of value,
I find myself further unable, in a principled way, to assign
it any weight as a portion of my fair value
determination. It is difficult, in other words, to ascribe to
a non-Dell-Compliant sales price (on non-arbitrary
grounds) 25%, or 75%, or any particular weight in a fair
value determination. Therefore, I take the parties'
suggestion to ascribe full weight to a discounted cash flow
analysis. I relegate transaction price to a role as a check
on that DCF valuation: any such valuation significantly
departing from even the problematic deal price here should
cause me to closely revisit my assumptions.
After
consideration of the experts' reports provided by the
parties, and after addressing the differences between the
parties in the proper construction of a DCF valuation, in
light of the evidence at trial, I find that the fair value of
AOL stock at the time of the merger was $48.70 per share.
This is my post-trial decision on fair value; my reasoning
follows.
I.
BACKGROUND
A.
The Company
AOL was
a well-known[8] global media technology company with a
range of digital brands, services, and products that it
provided to advertisers, consumers, subscribers, and
publishers.[9] AOL underwent significant changes in both
perception and fortune after its apex in 2002, when it had
more than twenty-six million subscribers in the United States
and $9 billion in revenues.[10] AOL spun off as a public
company from parent Time Warner in 2009, with Tim Armstrong
named as Chairman and CEO.[11] After the spin-off, AOL
shrank, ultimately to five million subscribers.[12] AOL faced
substantial competition by 2014 and found itself in need of
extensive consumer data to shift its desired focus to the
online advertising industry.[13] In order to compete, AOL
purchased a number of "content" and
"adtech" companies, such as the Huffington Post,
TechCrunch, Thing Labs, Inc., Adapt.tv, and
Vidible.[14] These and other purchases allowed AOL to
reposition itself as an ad tech company.[15]
AOL
organized itself into three segments: Membership, Brands, and
Platforms.[16] The Membership Group included the legacy
dial-up internet and search services.[17] The Brands
Group included the Huffington Post, TechCrunch, MapQuest, and
other content providers.[18] The Platforms Group provided
automated online advertising services for advertisers and
publishers across multiple device and media
formats.[19] As with other companies of similar size,
AOL was closely followed by numerous analysts.[20]
B.
Initial Discussions and Negotiation
Similar
to other boards of directors, the AOL board of directions
(the "AOL Board" or the "Board")
"regularly review[ed] and assess[ed] the Company's
business strategies and objectives, " in order to
"enhanc[e] stockholder value."[21] The AOL Board
frequently considered many types of transactions and
partnerships with other companies.[22] "In addition, the
Company and its representatives [were] routinely approached
by other companies and their representatives regarding
possible transactions."[23] Several of those included
inquiries from Silver Lake, [24] Tomorrow Focus, [25] Axel
Springer, [26] Providence Equity, [27] and Hellman
& Friedman.[28]
In June
2014, at the request of Verizon Communications Inc.
("Verizon"), AOL CEO Armstrong and Verizon CEO
Lowell McAdam "discussed ongoing and emerging trends in
their respective industries" at a media finance
conference.[29] In October 2014, Verizon management
contacted AOL to propose an initial meeting regarding
"potential partnership opportunities" and the two
CEOs met again that November.[30] A Verizon subsidiary and AOL
entered into a confidentiality agreement in late
November.[31]
In
early December, representatives of AOL and Verizon met over
three days to discuss "several potential collaborative
opportunities, " although McAdam informed Armstrong that
"Verizon had no interest in the acquisition of the
entire Company or of a majority interest in the
Company."[32] In addition, AOL held a preliminary
discussion with Comcast, a global telecommunications
conglomerate, "regarding a potential transaction
involving all or part of AOL's businesses" on
December 9, 2014.[33] McAdam and Armstrong spoke again by
phone in mid-December 2014 and met in mid-January 2015 to
"explore a joint venture."[34]
AOL
management discussed a potential Verizon transaction with the
AOL Board during their January 2015 meeting.[35] In January
2015, rumors about a potential transaction involving AOL
leaked and caused AOL's stock price to
rise.[36]
In
February 2015, Verizon presented AOL with a high-level term
sheet for a potential joint venture and the parties met
several times to discuss it that February and March and
continue with due diligence.[37] Verizon was not the only
suitor for a deal with AOL. An AOL executive emailed
Armstrong on February 20, 2015 that:
Given the [Verizon] news in the press, the [AT&T]
President of Advertising has express [sic] a very strong
interest in having broader strategic conversation with us.
They want a bite at the apple and don't want to be boxed
out by [Verizon]. If we are going to move forward here we
should engage at the CEO level is my view.[38]
Armstrong
responded:
I know . . . the [AT&T] CEO well - but we should discuss
this . . . . We need to be ethical (not suggesting you were
suggesting that - and know this is natural with press and BD
- but me calling CEO of AT&T feels like a bridge too
far).[39]
Armstrong
described his rationale for this answer during trial:
Q. And why did you say that calling the CEO of AT&T in
these circumstances was a bridge too far?
A. Well, I think that from where we were at the time period
and knowing what we knew about AT&T and knowing what we
knew about Verizon, the risk of having Verizon walk away at
this point was much higher than the upside of trying to get
AT&T involved when they were clearly outsourcing their
core business in our core area to us, overall. So it just did
not seem like a smart move.
Q. Why were you concerned that a contact with AT&T might
cause Verizon to walk away?
A. I think one is Verizon was upset about the leak. And I
think in the situation in a deal negotiation where, you know,
we're in negotiations with Verizon, AT&T is not a
real candidate, and we go to them, [Verizon CEO and Chairman
McAdam], I think, is a very ethical person and somebody that,
you know, he would take this the wrong way and we would risk
losing the deal.[40]
Armstrong
explained during his deposition that the AT&T overture
was not "somebody senior at AT&T speaking for
AT&T. This [was] somebody at the division that [AT&T
was] looking to outsource to us, talking to one of our
lower-level [business development]
people."[41] In a later explanation to Verizon
executive Marni Walden about these discussions with AT&T,
Armstrong described these as "advanced discussions to
launch a new strategic partnership. At the core of the
discussions was AT&T's content and service portal,
which has been powered for Yahoo for many
years."[42]
Fox, a
multinational mass media corporation, also contacted AOL to
express interest in AOL's platforms and brands businesses
on February 26, 2015.[43] Private equity firm General Atlantic
contacted AOL in March 2015 "to discuss an acquisition
of certain of the Company's assets" and entered into
a confidentiality agreement on March 7, 2015.[44] General
Atlantic conducted limited preliminary diligence on these
assets.[45] Fox entered into a confidentiality
agreement with AOL and listened to a presentation by AOL on
March 9, 2015.[46]
C.
Sales Process
On
March 25, 2015, Verizon proposed obtaining majority ownership
of AOL for the first time.[47] The AOL Board began to meet
weekly to "review the deal landscape, including the
potential transaction with Verizon."[48]
AOL
declined to conduct an auction. Fredric Reynolds, AOL's
lead director, explained why AOL did not pursue an auction
during his deposition:
Q: Could you please explain why, in your view or in the view
of the board as a whole, you thought it was not desirable for
AOL to run an auction?
A: Again, I think, if I wasn't clear, I think in a
business that has to do with technology and content, that
it's a very fragile business, and letting the world know
that you're for sale impacts your relationship with your
-- with your competitors for sure, but also with your
partners, be they publishers, being the search companies,
being the talent that you want to attract.
Those are all very difficult relationships that I think are
almost impossible to be managed if a media company or a
technology company is for sale.
I -- I don't recall any large technology or large media
company ever putting itself up for sale. I think, as
evidenced last week, AT&T buys Time Warner. There was not
an auction of that. It's just a very, very --it's
unusual, but technology and media companies don't have
hard assets, they don't have long-term contracts that
make airplanes or iPhones or anything like that. It's all
ephemeral.[49]
Reynolds
stated that "the company was not for sale and it was
purposeful that it not be for sale"[50] and that the
Board did "not auction[] the company. We had had no
intention of auctioning the company."[51]
Discussions
between AOL and Verizon continued in early April, and McAdam
"raised the possibility of a 100% acquisition of the
Company with Mr. Armstrong" on April 8,
2015.[52] Comcast entered into a confidentiality
agreement with AOL that day, but declined to proceed any
further with a transaction.[53]
On
April 12, 2015, AOL management discussed the Verizon
transaction with the Board, including "the emphasis that
[Verizon] . . . put on their ability to retain the
Company's management."[54] The Board "requested
that Mr. Armstrong keep the Board apprised of these
discussions as they progressed" but authorized further
discussions with Verizon regarding both the transaction and
management retention.[55] AOL opened a data room to Verizon on
April 13, 2015.[56]
Verizon's
counsel engaged AOL's counsel in a discussion on April
14, 2015 about "the importance to Verizon of retaining
the Company's CEO and others on its management team and
Verizon's desire to engage in a discussion with Mr.
Armstrong regarding such future employment
arrangements."[57] AOL's counsel informed Verizon that
"Verizon's views had been discussed with the Board
and that the Board had authorized Mr. Armstrong to engage in
such discussions."[58] McAdam and Armstrong met again on
April 17, 2015 to "discuss the potential integration of
AOL and its personnel into Verizon's
business."[59] During this period, Fox made several
diligence calls to AOL, but did not contact AOL for further
information.[60]
Verizon
sent a draft merger agreement to AOL on April 22,
2015.[61] The AOL Board met on April 26, 2015 to
discuss the draft agreement, the deal landscape, "the
possibility of seeking alternative offers, "
Verizon's "emphasi[s] . . . [on] the retention of
the Company's management team, " and AOL's
continued retention of Allen & Company ("Allen &
Co.") as its financial advisor.[62] AOL returned a revised
draft merger agreement to Verizon on April 27, 2015 that
proposed changes to a number of terms, including termination
rights, the non-solicitation provision, antitrust approval,
and others.[63] Verizon management spoke with Armstrong
on April 30, 2015 about "the importance to Verizon that
AOL's talent continue at the Company following the Merger
and indicated that employment arrangements would be
structured by Verizon to include compensation opportunities
tied to the performance of the Company and in aggregate
amounts at least comparable to current compensation
opportunities."[64] However, "[n]o specific details of
such compensation arrangements were
discussed."[65]
AOL and
Verizon exchanged draft agreements on May 1 and May 3,
2015.[66]The AOL Board discussed these drafts and
"the importance that Verizon was placing on the
retention of the Company's management team and
Verizon's desire for employment and retention
arrangements" on May 3, 2015.[67]
On May
4, 2015, a consortium including, among others, General
Atlantic, Axel Spring SE, and Huffington Post CEO and founder
Arianna Huffington, submitted a letter to AOL indicating its
willingness to purchase a 51% stake in AOL's Huffington
Post asset for approximately $500 million.[68]
On a
May 7, 2015 phone call, Verizon informed AOL that Verizon
"was planning to submit a formal offer to acquire the
entire Company."[69] The AOL representative indicated that
AOL expected a price per share "in the 50s" but the
Verizon representative indicated that it would be "in
the high 40s."[70] Verizon also indicated that it would
present Armstrong with a specific employment
proposal.[71]AOL reported financial results that beat
analysts' expectations on May 8, 2015.[72]
On May
8, 2015, a Verizon representative made an oral offer of
$47.00 per share for AOL.[73] An AOL representative
countered and Verizon agreed to pay $50.00 per share in
cash.[74] Verizon stated that "there was no
further room for negotiation with respect to the offer price
and that if this price was not of interest, Verizon was
prepared to withdraw its offer."[75] Verizon
submitted a written offer at $50 later that day. The AOL
Board discussed the offer, and counsel from the two companies
negotiated certain terms.[76]
Armstrong
phoned a Verizon representative on May 9, 2015 to request a
higher price but was told "that there was no further
room for negotiation with respect to the offer price, "
although Verizon agreed to lower the termination fee from
4.5% to 3.5%.[77] The AOL Board discussed the developments
that same day.[78]
The
parties exchanged additional draft agreements and Verizon
delivered a draft employment letter offer to Armstrong on May
10, 2015.[79] "Mr. Armstrong had no conversations
with Verizon regarding the draft letter prior to the
conclusion of the Company's next Board
meeting."[80]
On May
11, 2015, the AOL Board discussed the Verizon merger
agreement with management and its legal and financial
advisors.[81] The Board then "unanimously voted
to approve the Merger Agreement."[82] Later that
day, "Verizon informed Mr. Armstrong that they were
unwilling to proceed with a transaction without his agreement
to terms" of employment and Armstrong and Verizon came
to an agreement.[83]
The
Verizon board of directors also approved the merger
agreement, which was executed on May 11, 2015 (the
"Merger Agreement" or
"Agreement").[84] The deal was announced on May 12,
2015.[85] According to Armstrong, "a couple
of days after [the] Verizon acquisition was announced,
AT&T terminated contract negotiations and asked us to
stop all development on product and content based on general
sensitivities to competitor concerns, data separation,
etc."[86]
In a
CNBC television interview on the day the merger was
announced, Armstrong gave this account of how the Verizon
deal came together:
Interviewer: Hey, Tim, couple of quick things. Help us with
this first. Was there an auction? Give us back story here.
Meaning, who went to whom? How did this happen?
Armstrong: You know, basically, this happened in a very
natural way and no auction. Basically over the course of time
I sat down last summer at the Sun Valley conference and we
talked about where the world was going and we have been big
partners and we were kind of reviewing what the companies
were doing together. That sort of kicked off sort of a
natural progression to where we are today and I think
facilitated by Nancy of Allen and Company and David Shapiro
we were able to basically bring this deal together in a way
that I think was incredibly natural. If you look at the two
visions on the companies and the platforms and both companies
were doing the same thing.
Interviewer: It's trading slightly above the premium
right now. you didn't shop this to anybody else?
Armstrong: No, I'm committed to doing the deal with
Verizon and I think that as we chose each other because
that's the path we're on. I gave the team at Verizon
my word that, you know, [w]e're in a place where this
deal is going to happen and we're excited about it.
. . .
Interviewer: Not to push you on it, but why not pursue an
auction?
Armstrong: You know, Andrew, I think the process of where we
are as a company right now and the process we went through
and knew you guys covered, lots of rumors about AOL in
general. So, if somebody, we have always been a public
company and been available. If somebody wanted to come do a
deal with us, they would have done it. The Verizon deal was
built around the strategy of where we're
going.[87]
D.
Merger and Subsequent Events
The
Merger Agreement contained a no-shop provision, a 3.5%
termination fee of $150 million, and unlimited three-day
matching rights.[88] Stockholders were informed that the
Merger Agreement allowed for the "ability to accept a
superior proposal."[89] Verizon was "[p]repared for
market action but expect[ed] limited interest from
media/technology strategics and financial sponsors" due
to its assessment of a "limited interloper risk given
[the] current sale status with [a] lack of full company
buyers."[90] No topping bidder emerged.[91] More than 60%
of AOL's outstanding common shares were tendered and the
merger closed on June 23, 2015 (the "Valuation
Date").[92]
The
Petitioners filed for appraisal rights under Section 262 of
the DGCL.[93]Six appraisal petitions were filed, which
are consolidated in this action.[94] The parties and experts
agree that a DCF analysis is the most appropriate valuation
method in this matter.[95] My analysis follows.
II.
WAS THE SALES PROCESS DELL COMPLIANT?
The
appraisal remedy was created by statute to allow dissenting
stockholders an "independent judicial determination of
the fair value of their shares."[96] Because
neither party bears the burden of proof, "in reality,
the 'burden' falls on the judge to determine fair
value, using 'all relevant
factors.'"[97] The fair value of those shares is
"exclusive of any element of value arising from the
accomplishment or expectation of the merger or consolidation,
"[98] and calculated based on the
"operative reality of the company"[99] as of
"the date of the merger."[100] The court should view
the company as a standalone "going
concern"[101] or an "on-going enterprise,
occupying a particular market position in the light of future
prospects."[102] Because the court values the
"corporation itself, " a minority
discount[103] and "any synergies or other value
expected from the merger giving rise to the appraisal
proceeding itself must be disregarded."[104]
Accordingly, petitioning stockholders are given their
"proportionate interest" of the value of the
corporation on the date of the merger, plus
interest.[105]
Because
each transaction is unique, "[a]ppraisal is, by design,
a flexible process."[106] However, "the clash of
contrary, and often antagonistic, expert opinions" with
"widely divergent views" is a common feature of the
genre.[107] As further described below, there is
"no perfect methodology for arriving at fair value for a
given set of facts."[108]
The
Supreme Court has "reject[ed] requests for the adoption
of a presumption that the deal price reflects fair value if
certain preconditions are met, such as when the merger is the
product of arm's-length negotiation and a robust,
non-conflicted market check, and where bidders had full
information and few, if any, barriers to bid for the
deal."[109] Indeed, the Supreme Court doubts its
ability "to craft, on a general basis, the precise
pre-conditions that would be necessary to invoke a
presumption of that kind.[110] That said, the Supreme
Court in DFC stated:
Although there is no presumption in favor of the deal price,
under the conditions found [in DFC] by the Court of
Chancery, economic principles suggest that the best evidence
of fair value was the deal price, as it resulted from an open
process, informed by robust public information, and easy
access to deeper, non-public information, in which many
parties with an incentive to make a profit had a chance to
bid.[111]
A.
The Sales Process Was Not "Dell Compliant"
The
question before me is whether the sales process here is
Dell Compliant. A transaction is Dell
Compliant where (i) information was sufficiently disseminated
to potential bidders, so that (ii) an informed sale could
take place, (iii) without undue impediments imposed by the
deal structure itself. In other words, before I may consider
the deal price as persuasive evidence of statutory fair
value, I must find that the deal process developed fair
market value. I conclude that, under the unique
circumstances of this case, the sales process was
insufficient to this task, and the deal price is not the best
evidence of fair value.
The AOL
Board made a deliberate decision that stockholder value would
not be maximized through an auction, and instead decided to
pursue potential bidders individually by direct contact
through bankers and other sources. Given the dynamics of
AOL's particular industry, this decision appears
reasonable. However, if front-end information sharing is
truncated or limited, the post-agreement period should be
correspondingly robust, so to ensure that information is
sufficiently disseminated that an informed sale can take
place and bids can be received without disabling impediments.
Despite
statements by AOL's leadership that AOL was not for sale,
the persistent market rumors seem to indicate that the market
understood that the Company was likely in play. AOL was
well-covered by analysts, traded frequently, and generally
known in the market. AOL approached, and was approached by, a
number of potential buyers of some (or all) of the Company,
several of whom entered into confidentiality agreements and
conducted due diligence.
AOL
appears to have engaged with anyone that indicated a serious
interest in doing a deal.[112] On the front end, the
market canvas appears sufficient so long as interested
parties could submit bids on the back end without disabling
impediments.
However,
here my concern arises. Immediately after announcement of the
transaction, Armstrong gave a public interview and stated:
I'm committed to doing the deal with Verizon and I think
that as we chose each other because that's the path
we're on. I gave the team at Verizon my word that, you
know, [w]e're in a place where this deal is going to
happen and we're excited about it.[113]
Armstrong's
post-Agreement statements to the press about giving his
"word" to Verizon could reasonably cause potential
bidders to pause when combined with the deal protections
here. In Dell, by comparison, the merger agreement
included one-time matching rights until the stockholder vote;
a forty-five day go-shop period; and termination fees of
approximately 1% of the equity value during the go-shop or
approximately 2% afterward.[114] Here, a termination fee of
3.5% and a forty-two day window between agreement and closing
would probably not deter bids by themselves. But that period
was constrained by a no-shop provision, combined
with: (i) the declared intent of the acting CEO to consummate
a deal with Verizon, (ii) the CEO's prospect of
post-merger employment with Verizon, (iii) unlimited
three-day matching rights, and (iv) the fact that Verizon
already had ninety days between expressing interest in
acquiring the entire company and signing the Merger
Agreement, including seventy-one days of data room access.
Cumulatively, these factors make for a considerable risk of
informational and structural disadvantages dissuading any
prospective bidder.
In
Dell, after the "bankers canvassed the interest
of sixty-seven parties, including twenty possible strategic
acquirers during the go-shop, " the "more likely
explanation for the lack of a higher bid [was] that the deal
market was already robust and that a topping bid involved a
serious risk of overpayment, " which "suggest[ed]
the price [was] already at a level that [was]
fair."[115] Here, given Armstrong's statements
and situation, together with significantly less canvassing
and stronger post-agreement protections than in
Dell, I am less confident that is true. I cannot say
that, under these conditions, deal price is the "best
evidence of fair value . . . as it resulted from an open
process, informed by robust public information, and easy
access to deeper, non-public information, in which many
parties with an incentive to make a profit had a chance to
bid."[116]
B.
Deal Price as a Check
"The
dependability of a transaction price is only as strong as the
process by which it was negotiated."[117] I find
the deal price is not sufficient evidence of fair value to
warrant deference, but it is still useful to an extent. I
will use it as a "check" in my determination of
fair value, although I decline to give the deal price
explicit weight in that determination. Given the process
here, a determination of fair value via financial metrics
that results in a valuation grossly deviant from deal price,
under these circumstances, should give me reason to revisit
my assumptions. In this way, the deal price operates as a
check in my determination of fair value.[118]
The
parties have not suggested a principled way to use deal price
under the circumstances here, in a blended valuation of deal
price and other valuation metrics, and none occurs to me.
Instead, the parties agree, and I concur, that a discounted
cash flow analysis is the best way to value the
Company.[119] I turn to that now.
III.
FAIR VALUE AND DISCOUNTED CASH FLOW ANALYSIS
A.
Use of Discounted Cash Flow Analysis
Under 8
Del. C. § 262, to determine "fair value,
" a court must value a corporation as a "going
concern" according to the corporation's
"operative reality" as of the date of the
merger.[120] Further, a court "must take into
consideration all factors and elements which reasonably might
enter into the fixing of value, " and consider
"facts which were known or which could be ascertained as
of the date of merger."[121] The court retains
discretion to use "different valuation
methodologies" so long as the court justifies that
exercise of discretion "in a manner supported by the
record before it."[122] The court must derive the
fair value of the shares "exclusive of any element
arising from the accomplishment or expectation of the
merger."[123]When using a DCF analysis, "this
Court has recognized that management is, as a general
proposition, in the best position to know the business and,
therefore, prepare projections" in the "ordinary
course of business."[124] With these general
principles in mind, I turn to my valuation of AOL.
I rely
primarily upon a DCF analysis, as "[b]oth experts agree
that the DCF is the best and most reliable way to value AOL
as a going concern as of the merger date."[125] A DCF
analysis, "although complex in practice, is rooted
around a simple principle: the value of the company at the
time of the merger is simply the sum of its future cash flows
discounted back to present value."[126] Further,
a DCF analysis "is only as reliable as the inputs relied
upon and the assumptions underlying those
inputs."[127] However, "the use of math should
not obscure the necessarily more subjective exercise in
judgment that a valuation exercise
requires."[128] I also acknowledge the Dell
court's recent delineation of the weaknesses of the
method:
Although widely considered the best tool for valuing
companies when there is no credible market information and no
market check, DCF valuations involve many inputs-all subject
to disagreement by well-compensated and highly credentialed
experts-and even slight differences in these inputs can
produce large valuation gaps.[129]
The
Petitioners hired a well-qualified academic, Dr. Bradford
Cornell, a visiting professor at the California Institute of
Technology, as their expert witness. Cornell performed a
financial analysis, and concluded that the fair value of AOL
stock was $68.98 per share.[130] For reasons not necessary
to detail, however, the Respondent questioned Dr.
Cornell's impartiality in this matter, and the
Petitioners seem content to use the DCF model presented by
the Respondent's expert as a starting point for my
analysis. Accordingly, I start with the DCF valuation
provided by that expert, Professor Daniel Fischel, and
consider the Petitioners' limited arguments that certain
assumption or inputs in that valuation must be changed.
Fischel
opined that the fair value of AOL stock was $44.85 per
share.[131] The Petitioners' disagreements
with the Fischel analysis are limited, although the effects
of that disagreement on the calculation of fair value are
vast. The parties dispute only four items: (1) the proper
cash flow projections for the DCF; (2) the operative reality
assumed in the DCF with regard to two deals with Microsoft
and one deal with Millennial Media Inc.; (3) the proper
projection period and terminal growth rate; and (4) how much
of AOL's cash balance must be added back after the DCF. I
discuss each in turn.
B.
Disputed Addition and Inputs
1.
Cash Flow Projections
"The
most important input necessary for performing a proper DCF is
a projection of the subject company's cash flows. Without
a reliable estimate of cash flows, a DCF analysis is simply a
guess."[132] The parties point to three potential
sets of cash flow projections. The projections relied on by
Fischel in his analysis, which I use as a starting point, are
management's long-term plan for 2015 (the
"Management Projections" or the
"LTP").[133] Fischel selected these projections
because they were "described as the 'best currently
available estimates and judgements of [AOL]'s management
as to the future operating and financial performance of
[AOL], ' and were used by AOL's financial advisor
Allen in its May 11, 2015 fairness
opinion."[134] The Petitioners encourage me to use
either of two other projections relied on by Cornell. The
first is based on ten-year projections that AOL submitted to
Deloitte for a tax impairment analysis (the "Deloitte
Projections").[135] The second, (the "Disputed
Projections"), contained substantial differences,
compared to the Management Projections, in working capital
requirements and was sent by AOL to Verizon's advisors in
April 2015. I find that the best estimate of cash flow
projections is the Management Projections, made in the
regular course of business, for the reasons that follow.
The
Management Projections were completed in mid-February 2015
and presented to the AOL Board.[136] The AOL Board created
four-year long-term plans as a part of its annual internal
budgeting process.[137] AOL executives testified that the LTP
did not include costs or risks from specific acquisitions or
transactions;[138]however, the LTP assumed that AOL would
fill strategic gaps in areas such as mobile supply, shifting
demographics, and consumer data.[139] AOL financial advisor
Allen & Co. sent the Management Projections to Verizon,
albeit without AOL management's sign off.[140]
The
Deloitte Projections were created after AOL hired Deloitte to
perform a goodwill impairment valuation of the Company using
a set of ten-year projections developed by AOL for this
purpose.[141] AOL CFO Dykstra testified that she did
not create the Deloitte Projections for non-tax
purposes.[142] These projections were created through
inputs provided by AOL Senior Vice President of Financial
Planning and Analysis Michael Nolan, [143] after
which "[Deloitte] . . . r[a]n it through their standard
model."[144] According to Cornell, a DCF analysis
based on the Deloitte Projections―instead of the
Management Projections―values AOL stock at $55.36 per
share.[145]
The
Disputed Projections were created when Allen & Co.
expressed concern, in April 2015, that AOL's projected
working capital "appear[ed] to be materially different
from research estimates"[146] AOL prepared and sent
another version of the working capital projections-the
Disputed Projections-with different assumptions to
Verizon's advisors.[147] AOL CFO of Platforms Nick
Bellomo stated that he "reviewed the numbers that were
shared [with Verizon] to "mak[e] them more
optimistic" in order to "decrease[] the change in
working capital, which would have had an increase in cash
flow for the business, which would ultimately increase the
valuation of the business under certain valuation
methodologies."[148] Bellomo stated that it was his
"understanding that the valuation that was initially
floated to AOL for the purchase of AOL may [have] be[en]
taken down unless these numbers were
improved."[149] Allen & Co. director Isani
explained to AOL Senior Vice President Mark Roszkowski on
February 8, 2015 that:
I think we should be presenting a robust opportunity case to
[Verizon]―and as is typical for these processes, it
will vary from budget. For internal purposes and record
keeping, we should have the bridge btw that case and the
board budget as well as document the rationale for the gap.
However, for the dialogue with [Verizon], we present only the
robust case and completely own it as "the" plan.
Typically we would not show board minutes as this is not a
corporate deal (this case is tricky as the asset represents a
large portion of total value). They will ask is this budget
and we will have to rehearse the answer. But for a process
like this it is not typical for the financials to be revised
upward from the conservative board/budget ones
(Should probably also connect w/ legal to get their input
into the caveats for documenting the gap).[150]
AOL
management sometimes referred to the Disputed Projections as
"aspirational" in their internal
correspondence.[151] There is also contemporaneous
correspondence and trial testimony that the Disputed
Projections were created with the assumption that AOL would
become part of Verizon.[152]
I note
that other evidence challenges this narrative. The Disputed
Projections were created after a rigorous internal process
that involved input from a variety of departments within
AOL.[153] Certain of AOL's employees signed
off on the projections while they were unaware of a potential
or likely sale to Verizon.[154] The Disputed Projections
were submitted to Verizon and explained to AOL's Board,
apparently as though they were current
projections.[155] There are emails between AOL employees
that refer to the LRP as being "incorrect" and
outdated.[156] The Petitioners contend that AOL's
goal for more leverage to decrease day sales outstanding
(thus decreasing the required working capital and thereby
improving cash flow) could have occurred outside of an
anticipated deal with Verizon, although an exact method is
left unspecified.[157]
I find
that the Management Projections are in fact management's
best estimate as of the Valuation Date. While a close call,
the record indicates that the Disputed Projections were most
likely created as a marketing tool in AOL's attempted
sale of itself to Verizon. My purpose here is to determine
the fair value of AOL, and not AOL's value as-advertised.
I am not persuaded that the Disputed Projections represent
the most recent and valid projections used by AOL management
prior to the Valuation Date.
Finally,
I find that the goodwill impairment projections are not
pertinent to my DCF analysis here. The purpose behind any set
of projections matters because it determines the
appropriateness of various assumptions that must be made. The
Deloitte Projections were made for the goodwill impairment
analysis―a tax-driven assessment with a host of
required assumptions that should not, in these circumstances,
be used for a DCF analysis. While certain assumptions may be
appropriate for a tax analysis, those same assumptions may be
nonsensical for valuation purposes. Consequently, I use the
Management Projections in my DCF analysis.
2.
Pending Transactions as of the Merger
I start
with the following assumptions. "The determination of
fair value must be based on all relevant factors, including .
. . elements of future value, where
appropriate."[158] "[A]ny . . . facts which were
known or which could be ascertained as of the date of the
merger and which throw any light on [the] future prospects of
the merged corporation" must be considered in fixing
fair value.[159] A corporation "must be valued as
a going concern based upon the 'operative reality' of
the company as of the time of the merger."[160] I must
exclude speculative costs or revenues, however.[161] Mere
"actions in furtherance" of a potential
transaction, without a manifest ability to proceed, should
not be valued as part of a company's operative
reality.[162]
The
Petitioners argue that three potential deals were part of
AOL's operative reality, and that any fair value analysis
of AOL must include these transactions.[163]These
include: (i) AOL's acquisition of Millennial, a
programmatic mobile advertising platform;[164] (ii) a
deal for Microsoft's Bing search engine to replace Google
in powering search results on AOL properties (the
"Search Deal"), [165] and (iii) a ten-year
commercial partnership for AOL to run the sales of display,
mobile, and video ads on Microsoft properties in the United
States and eight international markets (the "Display
Deal") (the Display Deal and Search Deal are together
referred to as the "Microsoft
Deals").[166] Fischel did not ascribe value to these
transactions in his DCF analysis.[167] For each of these
transactions I ask: (i) if the transaction was part of the
"operative reality" of the Company as of the
Valuation Date, and (ii) if so, was the transaction
appropriately valued in the LTP. I will adjust my
Fischel-based DCF analysis to include the financial impact of
those transactions that were part of the Company's
operative reality on the Valuation Date but which were not
included in the LTP.
a.
Operative Reality
i.
Description of the Deals
As
mentioned, the Display Deal allowed AOL to run the sale of
display, mobile, and video ads on Microsoft properties such
as Xbox, Skype, Outlook, MSN, and others in the United States
and eight other markets.[168] After months of
negotiation, [169] Microsoft and AOL traded draft term
sheets at least through May 2015.[170] Armstrong testified
that the Display Deal "could have blown up at any
time" because of, among other things, uncertainty
surrounding the customers and the Microsoft employees AOL
would need to onboard.[171] Armstrong confirmed in a May 14,
2015 email that AOL expected to close the Display Deal on May
27, 2015.[172] Nevertheless, AOL pushed back the
Microsoft announcement until after the Verizon
announcement.[173] AOL signed an agreement for the
Display Deal with Microsoft on June 28, 2015 and announced
the transaction on June 30, 2015.[174] The Petitioners imply
that the Display Deal contributes $2.57 per share if included
under Fischel's DCF Model.[175]
The
Search Deal replaced a soon-to-expire contract with Google to
allow Microsoft's Bing search engine to power advertising
and results on AOL's properties.[176] Similar
to the Display Deal, AOL planned to close the Search Deal on
May 27, 2015 but delayed until after the Verizon
announcement.[177] An AOL presentation from June 10, 2015
included the key terms, financial projections, and other
business implications of the Search Deal.[178] The
Search Deal closed on June 26, 2015.[179] Microsoft
and AOL announced the Microsoft Deals on June 30,
2015.[180] The Petitioners do not quantify the
impact of the Search Deal but instead urge me to "select
a DCF value slightly above the median to account for the
value added by the Microsoft Search Deal, which was accretive
to free cash flow beginning in 2016."[181]
The
path of Millennial Media, Inc. ("Millennial") to an
acquisition by AOL (the "Millennial Deal") was more
circuitous than the Microsoft Deals. After conducting initial
diligence, AOL passed on buying Millennial in late 2014 but
resumed preliminary diligence in February 2015.[182] AOL
paused its diligence in April 2015 until Millennial announced
its quarterly earnings.[183] In May 2015, Armstrong told
the AOL Board that Millennial might "secure another
offer in the near term, but we are willing to take that
risk."[184] Armstrong made a non-binding offer to
Millennial for $2.10 per share on June 5, 2015,
"conditioned on exclusivity, " and stated that
"AOL was prepared to move expeditiously to negotiate and
sign a definitive agreement to effect the
transaction."[185] AOL sent a "written, non-binding
proposal . . . reflecting the terms of the June 5 Proposal,
and which also included an exclusivity period to negotiate a
transaction between the parties until July 17,
2015."[186] On June 10, 2015, Millennial opened a
data room to AOL and its advisors.[187] On June 15, 2015,
Millennial and AOL signed an agreement to negotiate
exclusively until July 17, 2015, and "which contained a
standstill provision that would terminate if the Company
entered into a definitive agreement with a third party to
effect a business combination."[188]
Representatives of AOL and Millennial met on June 17-19, 2015
to discuss Millennial's "financials, business
operations, product and technology, real estate and security
infrastructure."[189] On June 23, 2015, Verizon closed
the merger with AOL.[190]
On June
30, 2015, AOL's counsel "circulated a first draft of
the Merger Agreement, " followed by two weeks of
meetings, discussions, and negotiations.[191] The
parties discussed:
[T]he scope of the representations and warranties, the
benefits to be offered to the Company's employees
following the transaction, the conduct of the Company's
business between signing and closing of the transaction, the
parties' respective conditions to closing, AOL's
obligation to indemnify and maintain insurance for the
Company's directors and officers, the rights of the
parties to terminate the transaction, and the amount and
conditions of payment by the Company of the termination fee
and expense reimbursement described above.[192]
The SEC
sent Millennial a letter "notifying [Millennial] that
the SEC was conducting an information investigation" for
fraud starting in July 2015.[193] After the expiration of the
exclusivity agreement, Millennial attempted to auction itself
to six other buyers, but AOL was the only party to submit a
proposal.[194] AOL, by then under Verizon, agreed to
pay $1.75 per share to acquire Millennial on September 2,
2015.[195] AOL signed the Millennial Deal on
September 3, 2015.[196] The Millennial Deal closed on October
23, 2015.[197] The Petitioners argue that the
Millennial Deal contributes $4.14 per share if included under
Fischel's DCF model.[198]
ii.
Conclusions
I find
that the Display Deal was part of the operative reality of
AOL as of the Valuation Date. I am persuaded by the level of
certainty in that transaction, given AOL's internal
correspondence and the concrete plans for an announcement
date. I also find that the Search Deal was part of the
operative reality of AOL as of the Valuation Date. I am
persuaded by the apparent certainty of the transaction, based
on internal correspondence and presentations, that this
transaction was one that both sides fully expected to occur.
However, I find that the Millennial Deal was not part of
AOL's operative reality as of the Valuation Date. AOL had
taken a number of steps toward a transaction, such as sending
a non-binding offer subject to an exclusivity period,
beginning the due diligence process, and meeting with
executives. However, no merger agreement drafts had been
exchanged and weeks of negotiations, a robust due diligence
...