Should Courts Care Who Wins in a Merger?

Also unicorns, behavior rules and some crypto.


We talked last week about appraisal arbitrage, the strategy in which hedge funds buy stock in companies that have announced mergers, vote against the mergers, and then sue in Delaware court to get a court to give them the fair value of their stock. Often, in the not-too-distant past, the court calculated a fair value that was a lot higher than the deal price, and so this strategy could be very profitable. But then Delaware Vice Chancellor Travis Laster issued a shocking shrug of an opinion in the appraisal litigation over Hewlett-Packard Co.'s acquisition of Aruba Networks Inc., figuring that the stock market knew how to value Aruba, and that it had valued Aruba at $17.13 per share, so he was going to use that value as the amount to award in the appraisal. That was the value that the stock market gave to Aruba before the deal, meaning that the appraisal arbitrage funds will get paid much less than the $24.67 deal price. The logic of the opinion is that any premium that HP paid beyond the stock's trading price must have had to do with something that HP brought to the table -- synergies, "reducing agency costs" -- and so wasn't part of Aruba's stand-alone value; that stand-alone value was best estimated by its trading price.

It is a shocking injection of efficient-markets-hypothesis fundamentalism into a process that is, after all, entirely about distrust of market efficiency: If markets were efficient then you'd never need appraisal. It's so strange that no one quite believes it, and several people who follow appraisal closely have suggested to me a sort of Straussian reading of Laster's opinion: Last year the Delaware Supreme Court reversed his decision awarding more money to appraisal plaintiffs in the Dell Inc. buyout, finding that he had relied too much on his own discounted-cash-flow math and not enough on the evidence of the market, and that the conflicts of interest he found in the Dell buyout were not enough to sway the price. His Aruba opinion is so extreme a swing the other way -- relying solely on the evidence, not even of the takeover market, but of the stock market, and finding conflicts of interest only to ignore them because they didn't affect Aruba's stand-alone value -- that it almost seems like his goal in this opinion might be to embarrass the Supreme Court into reversing him again and admitting that markets aren't that efficient.

I am not used to the idea of reading judicial decisions as sarcasm, but maybe that's how you should take this one. Still I ... think he is ... kind of right? When a public company buys another public company for cash in an arm's-length deal, with no disclosure or liquidity or conflict-of-interest problems, it does sort of seem like the unaffected stock price of the target is the best starting point for its appraised value. You'd expect at least a lot of the premium in the deal to come from synergies -- from the fact that the two companies can cut costs or cross-sell when they're combined into one -- which are not part of the appraised value. Of course some companies are worth more than their stock price and others are worth less, but in general the stock price is a better indicator of value than some after-the-fact discounted cash flow models built by a judge in Delaware, particularly if those DCF models always result in a higher valuation.

But if this really is the rule then of course there will be many fewer appraisal lawsuits: Hedge funds used to figure their worst likely case in appraisal litigation was to get the deal price (plus above-market interest), while their best case was to get some extra money, so it was a popular strategy. Now the worst case -- and maybe the most likely case! -- is to get much less than the deal price. At least in arm's-length public-company mergers, you'd expect fewer appraisal lawsuits.

If you think -- as many people do -- that appraisal lawsuits are an effective check on underpriced acquisitions, that they keep buyers honest and force them to pay fair premiums to avoid being hit with big appraisal awards, then you might think this is bad. Without the threat of appraisal litigation, buyers won't feel the need to pay up as much, and deal premiums will drop.

This will be bad for shareholders in merger targets: They want big premiums, and without the threat of appraisal litigation they will get smaller premiums. On the other hand, it will be good for shareholders of the acquiring companies, who won't have to pay as much to get deals done. 

Here is my speculative reading of Aruba: This is the decision you would expect in a world of diversified index and quasi-index investors. If everyone owns all the companies, then who cares what the deal premium is? Who cares how the value of synergies is allocated between buyer shareholders and target shareholders? If they are the same shareholders then the point is to create the synergies, to do the deals; the shareholders care about growing the size of the pie, not fighting over its allocation.

A lot of thinking, and law, in corporate America comes from a time when shareholders weren't expected to be all that diversified. You bought Amalgamated Widgets stock, and you wanted Amalgamated to do well. You didn't care about Consolidated Thingamajigs; if anything, you wanted them to fail so that Amalgamated could expand its market share. And if Consolidated mounted a takeover bid for Amalgamated, you'd want Amalgamated to demand the highest possible premium for your shares: If there are going to be synergies from combining the two companies, you wanted to get paid for them, rather than just letting them accrue to Consolidated shareholders.

But now everyone owns both stocks and much of that imperative has just gone away. We talk a lot around here about the notion that the rise of large diversified institutional investors might reduce competition, because if every company in an industry is owned by the same shareholders then they have less reason to try to take market share from each other. Nobody quite believes in the mechanism by which this would happen. But it's easier to picture in the mergers-and-acquisitions context. Consolidated mounts a bid for Amalgamated, Amalgamated's managers put up a big fight and make a lot of noise about how the bid undervalues their company, and their large overlapping shareholder base quietly says: Look, there is value to be had -- in synergies, in pure market-dominating bigness -- in combining these companies, so let's just have it. Don't worry about whether it accrues mostly to target shareholders or acquirer shareholders, because they are the same shareholders.

In that world you would expect the courts to eventually shrug and say, you know what, in arm's-length deals between public companies, we're just going to effectively get rid of appraisal rights. The way to protect the value of your shares in public-company mergers is not appraisal; it's diversification. (This does not work as well in private-equity deals, of course, but it's fine for public-to-public mergers.)

Obviously you don't have to like this! The people who think that common ownership reduces competition think that competition is good and that common ownership is suspect. They should also worry if common ownership makes mergers easier. And Matthew Schoenfeld wrote about appraisal litigation (before Aruba): 

In addition to lower deal premia and higher agency costs, the primary effects of Delaware’s post-2015 effort to dull shareholder defenses, culminating in Dell, will likely be: 1) faster CEO pay growth, and 2) more M&A and higher industry-specific measures of concentration, which research has shown to contribute to declining competition, lower levels of labor market mobility, wage stagnation, and increasing inequality in the United States.

But I think if you look narrowly at the purposes of corporate law, it makes a kind of sense. Corporate managers are supposed to serve the interests of their shareholders. The approaches, and thus the interests, of those shareholders have changed. You'd expect corporate behavior, and corporate law, to change with them.

People are worried about unicorns.

Here is a story about Masayoshi Son, the whimsically benevolent fairy king of the Enchanted Forest, who bops around bestowing lavish gifts on unicorns with no particular rhyme or reason:

Investors want to understand just how Mr. Son goes about deciding on his billions of dollars of bets, among the largest in the tech industry, which he does through SoftBank and affiliated investment funds. Current and former SoftBank directors, executives, investing partners and others who know Mr. Son give a glimpse into how he works. It appears sometimes methodical, sometimes haphazard.

They describe a man who sometimes makes gut-instinct decisions in businesses he knows little about—such as the time he spent about 30 minutes deciding he wanted to invest $200 million in a startup that grows vegetables indoors. Other times, he compiles an elaborate analysis, inundating his directors with hundreds of pages of documents to help explain an investment target.

It is a weirdly wonderful development for Silicon Valley that Son came along when he did. A lot of unicorns are getting pretty long in the tooth. Someday soon they would have been exiled from the Enchanted Forest and would have to make their way out into the cold unfeeling public capital markets, where investors have quarterly time frames and don't care about their mission to change the world. And then Son came along as a sort of mega-unicorn with a "300 year" time horizon, a focus on bold and splashy technology, and a more or less unsupervised ability to write enormous checks. And now the lucky unicorns can take his money and stay in the cozy confines of the Enchanted Forest a while longer.

Elsewhere: "Social Capital’s Chamath Palihap­itiya Wants To Fix Capitalism." And: "New York Will Never Be Silicon Valley. And It's Good With That." And: "Dropbox Pitches IPO With Promise of Workplace Enlightenment." "Imagine if we finished work every day knowing what we did really mattered," says Dropbox's letter to shareholders, and as someone who writes on the internet for a living I confess that I find that act of imagination challenging. And I use Dropbox! Perhaps if I just shared a few more files I would achieve enlightenment.

Rules vs. principles.

I am in general a proponent of the rule of law, and I tend to think that people should not be punished unless they have fair notice that their actions will be illegal, but one does not want to go overboard. In particular if you run a company you don't want to hold a training session where you give your employees an exhaustive list of everything that they're not allowed to do. For one thing, you will inevitably omit something; your imagination in coming up with what to prohibit cannot possibly compete with their imagination in coming up with dumb things to do. For another thing there is no way to tick through that list without it sounding terrible:

The incident led Fidelity executives to hold a mandatory training session at the firm that ran through a laundry list of activities Fidelity deemed improper, including the inappropriate touching of outside analysts, gambling using work email and using company smartphones to hire prostitutes, people familiar with the training session said.

"The incident" here is one in which a Fidelity Investments analyst was "arrested a block from the firm's headquarters" for allegedly trying to solicit a prostitute while at work. If the response there is to have a specific training on not soliciting prostitutes from company devices, then, one, that creates an impression that you have the sort of workplace where people would otherwise be soliciting prostitutes from company devices, and, two, it creates an impression that you have the sort of workplace where soliciting prostitutes from personal devices is A-OK. "Do your gambling and prostitution using Gmail": not a perfect workplace message! 

The crypto.

Oh sure:

Craig Wright, the self-proclaimed inventor of bitcoin, is accused of swindling more than $5 billion worth of the cryptocurrency and other assets from the estate of a computer-security expert.

Wright, who claimed in 2016 that he created the computer-based currency under the pseudonym Satoshi ‎Nakamoto, allegedly schemed to use phony contracts and signatures to lay claim to bitcoins mined by colleague Dave Kleiman, another cryptocurrency adherent, who died in 2013, according to a lawsuit filed by Kleiman’s brother.

I have no knowledge of or view on the truth of those allegations, but ... you know ... if only there was some sort of cryptographically secure decentralized immutable way to verify who owned those Bitcoins! Like you could have a ledger of who owned which Bitcoins, and to transfer Bitcoins out of anyone's account you'd need a private key that is known only to the owner of that account, and phony contracts and fake signatures wouldn't affect the integrity of that ledger. But here we are, in the world, where the pristine cryptographic integrity of Bitcoin is constantly being compromised by human foibles and scraping up against the messy complications of the legal system and interpersonal relations.

Elsewhere: Oh sure:

“I wanted to show that yes, you still can buy pizzas with Bitcoin,” Hanyecz said in a telephone interview from Jacksonville, Florida. “But if it’s a $50 pizza and a $100 transaction fee, that doesn’t work. The idea is that on Lightning Network we can get the security of Bitcoin and instant transfers. You don’t have to wait for a blockchain confirmation.”

That's Laszlo Hanyecz, who "bought two pizzas with 10,000 Bitcoin back in 2010 to prove the digital currency worked," and I guess if you once paid $100 million (well, in 2018 Bitcoins -- it was $30 in 2010) for two pizzas then you may develop a distorted sense of how much pizzas cost? Because where is he getting this $50 pizza? Actually "he ended up paying 0.00649 Bitcoin for two pizzas, or $67, and the transaction cost about 6 U.S. cents." But also:

The mechanism is far from frictionless at this stage as the technology is still in a beta, or a testing stage. Hanyecz opened a payment channel with another blockchain enthusiast, who ordered the pizza for him. The delivery person was instructed to only deliver the pizza if Hanyecz showed him the first and last four characters of the string of code that proved he had made the payment. He showed him the numbers he had written down on a notebook, the driver saw they matched with what Hanyecz’s friend had told him, and he delivered the pizza.

The security procedures for getting this pizza seem to have been a lot more rigorous than whatever Dave Kleiman was doing to keep his $5 billion of Bitcoins safe. But, yes, the point is, if you clear your calendar, recruit a support team, and commit to spending a whole day buying a pizza with Bitcoin, you can probably manage it.

Elsewhere: "50 Cent admits he ‘has never owned, and does not now own’ any bitcoin." Previously he supposedly owned a lot of Bitcoins, but I guess not. "It is good opsec to deny owning cryptocurrencies," tweeted Antony Lewis, and you know what, sure, let's go with that explanation. (It also might be a ... good? terrible? ... idea to hide your bitcoins when you're in bankruptcy?) And: If you were trading Bitcoins on Coinbase, and made a lot of money, and neglected to report that money to the Internal Revenue Service, you might be in trouble.

Things happen.

Comcast Sets Stage For Sky Takeover Fight With $31 Billion Bid. Qualcomm Warms to Broadcom Bid, but Price Is Sticking Point. Rothschild’s chairman to hand bank’s dynastic reins to son. A profile of hedge-fund public-relations guy Jonathan Gasthalter. Choppy Markets Grant Hedge Funds Their Wish. Trump’s SEC Makes Slow Progress on Trimming Rules. World's Biggest Sovereign Wealth Fund Delivers Record Return. GE Overhauls Board, Dumps Longest-Serving Directors, Names Outsiders. Anbang’s Rescue Is China’s Too-Big-to-Fail Moment. JPMorgan Buys Rights for HQ From Michael Dell Partnership. "One in 3 British children age 6 to 17 told pollsters last year that they wanted to become a full-time YouTuber." Buffett’s $11 Million Beach House Is Still on the Market. Commerce Secretary: Let’s Turn the Moon Into a ‘Gas Station for Outer Space.’ A library for fake books. "Maybe the worst thing is being conscious at all."

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