New Delaware ruling shows there’s real risk in ‘appraisal arbitrage’

February 2, 2015

The upstart business of appraisal arbitrage – a distant relation of M&A shareholder litigation – has attracted hundreds of millions of dollars of smart hedge-fund money in the past few years. As I described in more detail in a post last month, appraisal arbitrageurs acquire shares after a company has announced its acquisition, refuse to cash out their stake when the deal goes through and then bring claims in court that the sale price was too low. Essentially, they are betting that judges will set a higher value on shares of an acquired company than the company’s own board and the shareholders who voted to accept the offer.

On Friday, three appraisal arbitrageurs lost their bet. Vice Chancellor Sam Glasscock of Delaware Chancery Court ruled that the fair value of shares in Ancestry.com is $32 – the price at which the private equity fund Permira Advisors bought out the genealogical research site in 2012. Glasscock’s decision means that Merion Capital, Merlin Partners and the Ancora Merger Arbitrage Fund – whose expert had argued that Ancestry.com shares were worth at least $42.81 – will get no more for their 1.5 million shares than shareholders who liquidated their stake in the merger. And unlike those shareholders, the funds are out whatever money they spent on the appraisal litigation.

The Ancestry.com ruling underscores the difference between appraisal claims and ordinary pre-merger shareholder class actions. The risk in M&A class actions is typically carried by plaintiffs’ firms, which bring cases on a contingency basis. But in appraisal cases, according to what is by far the most comprehensive study of the business – a forthcoming article in the Washington University Law Review by law professors Minor Myers of Brooklyn Law School and Charles Korsmo of Case Western Reserve – arbitrageurs appear to pay their lawyers by the hour. The shareholders who bring appraisal actions, in other words, bear real risk when they spend the money to take a case all the way to trial.

The Ancestry.com decision should also give arbitrageurs second thoughts about challenging the fair value of shares when deal prices are set through legitimate sales processes. Myers and Korsmo found that arbitrageurs usually pick their challenges carefully, typically targeting going-private acquisitions by a controlling shareholder or deals that offer shareholders a low premium over the trading price. The Ancestry.com deal, as Glasscock described it, featured neither red flag. The company’s board hired qualified bankers and reached out to 14 potential bidders, both strategic and financial. Seven eventually made preliminary bids, though only Permira submitted a final offer. The Ancestry.com board then pushed the private equity fund to raise its bid by a dollar, from $31 to $32, a 41 percent premium over the trading price before the merger announcement. No higher bid emerged in the two months between the announcement and the deal closing.

An expert economist hired by the three funds that brought the post-merger appraisal action nevertheless argued that the company’s shares were worth as much as $47. Ancestry.com’s expert, meanwhile, said the fair value was actually $30.63, even though Permira ended up paying a bit more. Glasscock was politely exasperated by the divergent projections that led the experts to their valuations, both of which he called “less than fully persuasive” and “result-oriented riffs on the market price.” He also noted the “difficulties, if not outright incongruities, of a law-trained judge determining fair value of a company.”

Glasscock tinkered with the numbers and came up with a valuation of $31.79. But ultimately, he said, the fair value of Ancestry.com’s shares was best represented by the price Permira actually agreed to pay after a robust and untainted auction. This is the second decision, following a 2013 opinion in Huff Fund v. CKx Inc, in which Glasscock has decided that when neither side meets the burden of proving a more reasonable alternative, the most reliable indicator of value is the share price set at a well-run auction.

Wachtell Lipton Rosen & Katz, which represented Ancestry.com along with Potter Anderson & Corroon, said in a client alert about Glasscock’s ruling that it “confirms that the market still matters in appraisal proceedings, sometimes conclusively.” Hard to argue with that, though Wachtell did say that appraisal litigation will undoubtedly continue to surge, partly because of Glasscock’s previous holding in the Ancestry.com case on shareholder standing to assert an appraisal claim.

Merion Capital, which is by some measures the biggest appraisal arbitrageur, was represented by Abrams & Bayliss. Prickett Jones & Elliott represented Merlin and Ancora. I left messages for Kevin Abrams of Abrams & Bayliss and Ronald Brown of Prickett Jones but didn’t hear back.

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