Blueblade Capital Opportunities LLC and Blueblade Capital Opportunities CI LLC v. Norcraft Companies, Inc. ( 2018 )

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
BLUEBLADE CAPITAL OPPORTUNITIES
LLC, a Delaware limited liability company,
and BLUEBLADE CAPITAL
OPPORTUNITIES CI LLC, a Delaware
limited liability company,
Petitioners,
v. : C.A. No. 11184-VCS
NORCRAFT COMPANIES, INC., a
Delaware corporation,
Respondent.
MEMORANDUM OPINION
Date Submitted: April 25, 2018
Date Decided: July 27, 2018
David A. Jenkins, Esquire and Robert K. Beste, Esquire of Smith, Katzenstein &
Jenkins LLP, Wilmington, Delaware and Michael E. Davidian, Esquire of Blueblade
Capital Opportunities LLC and Blueblade Capital Opportunities CI LLC, New York,
NeW York, Attorneys for Petitioners Blueblade Capital Opportunities LLC and
Blueblade Capital Opportunities CI LLC.
Raymond J. DiCarnillo, Esquire and Kevin M. Gallagher, Esquire Of Richards,
Layton & Finger, P.A., Wilrnington, Delaware, Attorneys for Respondent Norcraft
Companies, Inc.
SLIGHTS, Vice Chancellor
This statutory appraisal action arises out of a May 12, 2015, merger Whereby
Fortune Brands Home & Security, Inc. (“Fortune”) acquired Norcraft Companies,
Inc. (“Norcraft” or the “Company”) (the “Merger”) for $25.50 cash per share
(the “Merger Price”). Petitioners, Blueblade Capital Opportunities LLC and
Blueblade Capital Opportunities CI LLC (together, “Blueblade”), Were Norcraft
stockholders on thc Merger’s effective date and seek a judicial determination of the
fair value of their Norcraft shares as of that date.
In an appraisal action under the DelaWare General Corporation Law, the trial
court’s “fair value” determination must “take into account all relevant factors.”l The
relevance (or not) of certain factors “can vary from case to case depending on the
nature of the [acquired] company,” the nature of the process leading to the
company’s sale and, perhaps most importantly, the evidence adduced by the parties
at trial in support of their respective valuation positions.2 “In some cases, it may be
that a single valuation metric is the most reliable evidence of fair value and that
giving Weight to another factor Will do nothing but distort that best estimate. In other
cases, “it may be necessary to consider two or more factors.”3 In all cases, however,
1 8 Del. C. § 262(h).
2 Merion Capital L.P. v. Lena'er Processing Servs., Inc., 2016 WL 7324170, at *16
(Del. Ch. Dec. 16, 2016).
3 DFC Global Corp. v. Muizy‘ield Value P’rs, L.P., 172 A.3d 346, 388 (Del. 2017).
1
the trial court’s determination respecting the “relevant factors” must be grounded in
the evidentiary record and “accepted financial principles.”4
I am cognizant of the DelaWare Supreme Court’s embrace of “deal price” as
a strong indicator of fair value in Dell and DFC. Those decisions teach that deal
price often Will be a relevant factor in the trial court’s fair value calculus_
particularly Where the respondent company Was publicly traded and sold following
a meaningful market check.5 In both cases, however, despite having been urged to
do so, the Supreme Court declined to adopt a rule that the deal price is presumptively
reflective of fair value.6 Mindful of DFC and Dell, I have considered carefully
Whether the Merger Price (less synergies) reflects the fair value of Norcraft as of the
Merger date. For the reasons explained beloW, l am satisfied it does not.
4 Dell, Inc. v. Magnelar Global Evem‘ Driven Master Funa’Lta’, 177 A.3d 1, 22 (Del. 2017);
DFC, 172 A.3d at 388 (“What is necessary in any particular [appraisal] case though is for
the Court of Chancery to explain its [fair value calculus] in a manner that is grounded in
the record before it.”).
5 See Dell, 177 A.3d at 35; DFC, 172 A.3d at 349, 351, 372; cf DFC, 172 A.3d at 369
n.118 (eXplaining that a discounted cash flow analysis is “often used in appraisal
proceedings When the respondent company Was not public or Was not sold in an open
market check”).
6 DFC, 172 A.3d at 348 (rejecting the petitioner’s (and others’) argument that the Court
should adopt a presumption in favor of the deal price, stating “[W]e decline to engage in
that act of creation, Which in our view has no basis in the statutory text”); Dell, 177 A.3d
at 21-22 (noting “We doubt[] our ability to craft the precise preconditions for invoking such
a presumption”).
In this case, the evidence reveals significant flaws in the process leading to
the Merger that undermine the reliability of the Merger Price as an indicator of
Norcraft’s fair value. There was no pre-signing market check; Norcraft and its
advisors fixated on Fortune and never broadened their view to other potential merger
partners. As the parties worked to negotiate the Merger agreement, Norcraft’s lead
negotiator was at least as focused on securing benefits for himself as he was on
securing the best price available for Norcraft. And, while the Merger agreement
provided for a thirty-five-day post-signing go-shop, that process was rendered
ineffective as a price discovery tool by a clutch of deal-protection measures.
Dell reminded us that Delaware courts have “long endorsed” the “efficient
market hypothesis” and emphasized “that the price produced by an efficient market
is generally a more reliable assessment of fair value than the view of a single analyst,
especially an expert witness who caters her valuation to the litigation imperatives of
a well-heeled client.”7 l have heeded that guidance as well. Unfortunately, this case
was tried before the Supreme Court decided Dell, and the record evidence regarding
the efficiency of the market for Norcraft stock prior to the Merger is, in a word, thin.
With that said, the evidence that can be drawn from the record reveals that, at the
time of the Merger, Norcraft was fresh off an initial public offering of its stock, was
7 Dell, 177 A.3d at 24.
relatively thinly traded given the niche market in which it operated and was also
thinly covered by analysts. Under these circumstances, 1 can discern no evidence-
based rationale that would justify looking to the unaffected trading price of
Norcraft’s stock either as a standalone indicator of fair value or as a data point
underwriting the use of a deal-price-less-synergies metric.
Having concluded that flaws in the sales process leading to the Merger
undermine the reliability of the Merger Price as an indicator of fair value, and that
the evidence sub judice does not allow for principled reliance upon the efficient
capital markets hypothesis, l have turned to a “traditional valuation methodology,”
a discounted cash flow (“DCF”) analysis, to calculate the fair value of Norcraft as
of the Merger date.8 In my view, given the evidence in this record, a DCF-based
valuation provides the most reliable means by which to discharge the Court’s
statutorily mandated function to appraise Norcraft.
Not surprisingly, both parties proffered expert testimony regarding Norcraft’s
fair value on a DCF basis. And, as we have come to expect in appraisal litigation,
the experts’ DCF analyses yielded valuations that are miles apart. Neither expert
walked the high road from start to finish during their respective DCF journeys. That
is to say, both experts, at times, made choices in their analyses that were not
8 See Hz'ghfield Capital, Ltd. v. AXA Fin., Inc. 939 A.2d 34, 47 (Del. Ch. 2007) (describing
DCF as a “traditional valuation methodology”).
4
supported by the evidence or not supported by “accepted financial principles” in
order to support a desired outcome. l have, therefore, borrowed the most credible
components of each expert’s analysis to conduct my own DCF valuation, in my best
effort to obey our appraisal statute’s “command that the Court of Chancery
undertake an ‘z``na’epena'ent’ assessment of fair value” when performing its mandated
appraisal f``unction.9 As explained below, my DCF analysis reveals a valuation of
$26. 16 per share.
Insofar as Dell and DFC require that the trial court carefully consider deal
price before disregarding it altogether, I have returned to the Merger Price as a
“reality check” before locking in my DCF valuation as the last word on fair value.
Having done so, l am satisfied that the $0.66 per share delta between the Merger
Price and my DCF valuation of Norcraft is a product of the identified flaws in
Norcraft’s deal process. Accordingly, I conclude that the fair value of Norcraft as
of the Merger date was $26. 16 per share.
I. FACTUAL BACKGROUND
I recite the facts as l find them based on the evidence presented during a four-
day trial. That evidence comprises testimony from thirteen fact witnesses
9 Dell, 177 A.3d at 21 (quoting Golden Telecom, Inc. v. Global GTLP, ll A.3d 214, 218
(Del. 2010) (emphasis in original)); see also Gholl v. eMachz``nes, Inc., 2004 WL 2847865,
at *5 (Del. Ch. Nov. 24, 2004) (noting that both parties bear a burden of proof in a statutory
appraisal trial and holding that, “[i]f neither party satisfies its burden . . . the court must
then use its own independent business judgment to determine fair value”).
5
(some presented live and some by deposition) and three live expert witnesses, along
with over 500 exhibits. I accord the evidence the weight and credibility I find it
deserves. As noted, both parties carried a burden to prove their respective valuation
positions by a preponderance of the evidence. Thus, Petitioners were obliged to
prove that their proffered valuation of Norcraft, a DCF-based valuation of $34.78
per share, represented Norcraft’s fair value as of the Merger; Respondent’s burden
was to prove that its proffered valuation of $21.90 per share, the Merger Price less
synergies, was Norcraft’s fair value as of the Merger. With these competing burdens
in mind, 1 find that the following facts were proven by a preponderance of the
evidence.
A. Parties and Relevant Non-Parties
Respondent, Norcraft, is a Delaware corporation in the cabinetry
manufacturing business.10 Prior to the Merger, Norcraft’s stock traded on the New
York Stock Exchange.ll On May 12, 2015, Fortune acquired Norcraft for $25.50
cash per share in the Merger.12 ln connection with that transaction, Norcraft merged
10 JX 267 (“Norcraft FY2014 10-K”) at 1, 6; JX 221 (“Merger Agreement”), pmbl. & § 1.3.
11 JX 267 (Norcraft FY2014 10-K) at 1.
12 Joint Pre-Trial Stipulation and Order (“PTO”) 1111 2y, 2ff. 1 commend the parties, and
counsel in particular, for the substantial effort that was undertaken to prepare and submit
comprehensive pre-trial factual stipulations.
with an indirect, wholly-owned subsidiary of Fortune, Tahiti Acquisition Corp.
(“Tahiti”), with Norcraft surviving as a wholly-owned Fortune subsidiary.13
Petitioners were Norcraft stockholders as of the Merger date and collectively
held 557,631 shares of Norcraft common stock.14 It is undisputed that they properly
perfected their statutory appraisal right.
Non-party, Fortune, is a home and security products company with four
business segments: cabinets, plumbing, doors and security.15 Fortune sells its
products through several sales channels, “including kitchen and bath dealers,
wholesalers oriented to builders or professional remodelers, industrial and locksmith
distributors [and] ‘do-it-yourself remodeling-oriented home centers . . . . ”16
Non-parties, Mark Buller, Christopher Reilly, Michael Maselli, Harvey
Wagner, Ira Zecher and Edward Kennedy served on Norcraft’s board of directors
(the “Board”) at all relevant times.17 Buller also served as the Chief Executive
Officer of Norcraft (and its predecessors) from 2003 to the Merger’s consummation
13 JX 221 (Merger Agreement), pmbl. & § 1.3; see PTO jj 2y.
14 PTO 1111 2h, 2i. Blueblade acquired all of its Norcraft stock after the Merger was
announced. PTO 1111 2h, 2i.
15 PTO 11 2g; JX 270 (“Fortune FY2015 10-K”) at 6.
16 JX 270 (Fortune FY2015 lO-K) at 5.
17 See PTO 11 2f.
in May 2015.18 Non-party, Leigh Ginter, was the ChiefFinancial Officer of Norcraft
(and its predecessors) from 2003 through the Merger’s consummation.19 And non-
party, Eric Tanquist, was Norcraft’s Vice President of Finance Administration from
approximately 2007 through the Merger’s consummation.20
Non-party, Christopher Klein, is Fortune’s CEO and served in that capacity at
all times relevant to this action.21 Non-party, Robert Biggart, is Fortune’s general
counsel and served in that capacity at all relevant times.22 And non-party, Jason
Baab, served as Fortune’s Vice President of Corporate Development and M&A at
the time of the Merger.23
B. Pre-Merger Norcraft
As of the Merger date, “Norcraft was a leading manufacturer of kitchen and
bathroom cabinetry in the United States and Canada.”24 The Company sold its
products primarily to kitchen and bathroom cabinet dealers in the horne repair,
18 PTO 11 2f; JX 3 (Buller Dep.) at 19:9-21. Buller was also the Chairman of Norcraft’s
Board at all relevant times prior to the Merger. JX 3 (Buller Dep.) at 19:9-21.
19 PTO 11 2f; JX 1 (Ginter Dep.) at 18_19.
20 PTO 11 2f; JX 2 (Tanquist Dep.) at 21 :2_16.
21Projzg.
22 Ia'.
23 ]d_
24PTojza.
remodeling and new home construction markets through four business divisions:
Mid Continent Cabinetry, StarMark Cabinetry, UltraCraft Cabinetry and Urban
Effects (a.k.a. Norcraft Canada).25- Prior to the Merger, Norcraft regarded Fortune,
American Woodmark Corporation (“American Woodmark”) and Masco as its
principal competitors.26 lt also faced competition from “a large number of smaller
,,27
manufacturers
1. Buller and Two Private Equity Firms Acquire Norcraft’s Operating
Subsidiary in 2003
In October 2003, Buller, certain Buller family members and funds
affiliated with the private equity firms Saunders, Karp & Megrue (“SKM”) and
25 PTO 1111 2b, 2c; JX 267 (Norcraft FY2014 10-K) at 6_10. For FY2014, “kitchen and
bathroom cabinet dealers accounted for [86%] of Norcraft’s net sales, home builders
accounted for [9%], and wholesale retailers, or home centers, accounted for [5%].”
PTO 11 2b. “[A]pproximately 58% of [Norcraft’s FY2014] net sales were to the home
repair and remodeling market and the remaining net sales were to the new residential
construction market.” JX 267 (Norcraft FY2014 10-K) at 6. As of the Merger date,
Norcraft, Fortune and Masco Corporation (“Masco”) were the only three “dealer channel”
cabinet manufacturers in the United States with a market share of over 5%. See JX 112
(Gabelli & Co., T he Home Improvement Opportunily, published Jan. 29, 2015 [“Gabelli
Report”]) at CITI-00053582. In the cabinetry industry, the “dealer channel” comprises
third parties who purchase cabinets from manufacturers (or wholesalers) and sell them to
end users. See id.; JX 12 (Baab Dep.) at 36:8_20. In 2014, nearly half of U.S. cabinet
sales (representing approximately $6 billion) were made through the dealer channel, which
is generally considered the most profitable sales channel in the cabinetry industry.
See JX 112 (Gabelli Report) at CITI-00053582, CITI-00053595; JX 1 (Ginter Dep.)
at 153:17-154:1; JX 5 (Klein Dep.) at 293:25~294:3.
26 JX 267 (Norcraft FY2014 10-K) at 11.
27 Id.
Trimaran Capital Partners (“Trimaran”) acquired Norcraft Companies, L.L.C. for
approximately $315 million (the “2003 Acquisition”).28 At the same time, Norcraft
Companies, L.L.C. converted to a Delaware limited partnership, Norcraft
Companies, L.P. (“Norcraft LP”), and Buller became the CEO of that entity.29 For
the next ten years, Norcraft LP operated as a privately-held company.
2. Norcraft and the Cyclical Cabinetry Industry
The undisputed evidence reveals that Norcraft operated in a cyclical
industry.30 As one naturally might expect, the cabinetry industry is directly affected
by the home improvement industry, which, in turn, is affected by macro-economic
conditions, including employment levels, demographic trends, availability of
financing, interest rates and consumer confidence.31 The cabinetry industry is also
directly affected by housing starts, as a significant percentage of sales are connected
28 JX 3 (Buller Dep.) at 1613-24. As of 2003, Norcraft Companies, L.L.C. was the
operating entity in Norcraft’s organizational structure. JX 400 (Norcraft Amendment No. 5
to Form S-l, filed Oct. 30, 2013 [“Norcraft Amendment 5 to Form S-l”]) at 19. F or
purposes of this Memorandum Opinion, 1 have not distinguished SKM and Trimaran from
the SKM and Trimaran funds that owned Norcraft common stock prior to the Merger.
29 JX 27 (Mar. 29, 2004 Norcraft LP Press Release) at 2. Following the 2003 Acquisition,
Norcraft LP became the operating entity in Norcraft’s organizational structure. JX 400
(Norcraft Amendment 5 to Form S-l) at 19. Buller and his family collectively owned
approximately ll% of Norcraft LP’s equity. JX 3 (Buller Dep.) at 18:6_8.
30 TT 21:6_11, 21:20-21 (Eldridge), 96:22~97:7 (Biggart), 607:23~608:1 (Clarke).
31 Jx 267 woman FY2014 10-K).
10
to new home construction.32 When housing starts decrease, as they often do for
various reasons,33 cabinet sales decrease as well.34
Norcraft was no exception to this cyclicality. Norcraft LP enjoyed steady
growth of its earnings before interest, taxes, depreciation and amortization
(“EBITDA”) from 2003 through 2006_$47 million (2003) to $80 million (2006).35
This growth was fueled, in large part, by a significant acquisition in March 2002 and
a boom in the United States housing market.36 Growth stalled, however, beginning
in 2007, when Norcraft LP experienced the first of three consecutive years of
declining sales and adjusted EBITDA.37 As is typical in classically cyclical
businesses, Norcraft LP saw improved sales beginning in 2010, although its adjusted
EBITDA continued to decline until 2012 (with 2010 being the only exception). The
attached chart illustrates the trends38:
32 Id.; see also TT 607:23-608:1 (Clarke); JX 14 (Clarke Dep.) at 60 (“I do believe that the
home building industry is cyclical and at some point the housing starts would decrease.”).
33 JX 23 (Austin Smith Rebuttal Report) at 6.
34 Jx 267 (Norcraft FY2014 10-K).
33 JX 20 (Austin Smith Report) at 7.
36 JX 400 (Norcraft Amendment 5 to Form S-l) at 19.
37 JX 20 (Austin Smith Report) at 7.
38 Id_
ll
Net Sa|es Adjusted EB|TDA
{$Mil|ions] YoY%change ($ Mi||ions) YoY%change
[1] 2003 256 47
[2] 2004 330 29% 58 23%
[3] 2005 405 23% 70 21%
[4] 2006 441 9% 80 14°0
[5] 2007 394 ~11% 72 -10%
[6] 2008 332 -16% 51 -29%
[7] 2009 247 -26% 36 -29%
[8] 2010 263 6% 39 8%
[9] 2011 269 2% 37 -5%
[10] 2012 289 7% 34 -8%
[11] 2013 340 18% 43 26°0
[12] 2014 376 11% 52 21%
As reflected in the chart, Norcraft LP’s adjusted EBITDA trended up in 2013,
suggesting that its six-year period of decline had come to an end, at least for the time
being.39
3. Norcraft’s IPO and Reorganization
On November 13, 2013, Norcraft completed an initial public offering
(“IPO”)40 whereby the Norcraft enterprise was reorganized into the following
holding company structure41:
39 ld. 1 note that between 2006 and 2013, Norcraft LP’s management struggled accurately
to project the company’s future performance JX 3 (Buller Dep.) at 183-84.
40 JX 267 (Norcraft FY2014 10-K) at 12; PTO 11 2j.
41 JX 267 (Norcraft FY2014 lO-K) at 12, 15, 65; PTO 11 2d.
12
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The newly-formed parent company, Norcraft_a publicly-traded company_was a
holding company; Norcraft Companies LLC (“Norcraft LLC”)42 and its subsidiaries
42 Norcraft LLC is not to be confused with Norcraft Companies, L.L.C. As noted, Norcraft
Companies, L.L.C. was converted into Norcraft LP in connection with the 2003
Acquisition, and it continues to exist as such in the Norcraft enterprise structure. JX 400
(Norcraft Amendment 5 to Form S-l) at 19; JX 267 (Norcraft FY2014 10-K) at 12;
Pro 11 2d.
13
were the operating entities.43 Following the reorganization, Norcraft was
Norcraft LLC’s sole managing member and owned (directly and indirectly)
approximately 87.7% of Norcraft LLC, with Buller, his family members and certain
members of Norcraft management holding the remainder.44
As part of the IPO, Norcraft sold 7,356,634 shares of Norcraft common stock,
or 39.1% of Norcraft’s equity, to the public at $l6.00 per share.45 SKM and
Trimaran together retained a 60.9% equity interest in Norcraft, while Buller, his
family members and certain members of Norcraft management, through their
convertible Norcraft LLC units, collectively held a prospective 12.3% equity
interest.46
In conjunction with the IPO, Norcraft entered into Tax Receivable
Agreements (“TRAS”) with SKM, Trimaran and the Norcraft LLC unitholders
(collectively, the “TRA Beneficiaries”).47 Under the TRAS, Norcraft was required
43 JX 267 (Norcraft FY2014 10-K) at 12.
44 Ia’. PTO ‘|l 2d. Buller et al.’s LLC units were convertible “at the option of the
[unitholders]” into restricted shares of Norcraft common stock “on a one-for-one basis” or
into cash (pursuant to a stated conversion formula), with the form of consideration to be
determined at Norcraft’s option. JX 267 (Norcraft FY2014 10-K) at 72; see also JX 35
(Norcraft Form 424B4, filed Nov. 6, 2013 [“Norcraft IPO Prospectus”]) at 101-02.
43 JX 35 (Norcraft IPO Prospectus) at 1; PTO 11 2d.
46 JX 35 (Norcraft IPO Prospectus) at 102-03; JX 267 (Norcraft FY2014 10-K) at 73;
PTO 11 2d.
47 JX 36 (LLC Unitholder TRA), pmbl.; JX 267 (Norcraft FY2014 10-K) at 79.
14
to pay the TRA Beneficiaries 85% of the applicable annual tax savings, if any, that
Norcraft realized as a result of certain tax benefits contributed to Norcraft by the
TRA Beneficiaries, including net operating losses and asset basis step-ups.48 The
TRAs also provided that Norcraft’s payment obligations to the TRA Beneficiaries
would be accelerated in the event of a “Change of Control.”49 The TRAs later came
to feature prominently in the Norcraft-Fortune negotiations leading up to the Merger.
C. Fortune Approaches Norcraft
On October 20, 2014, representatives of Fortune’s financial advisor, RBC
Capital Markets, LLC (“RBC”), contacted Buller to inform him of Fortune’s interest
in a potential acquisition of Norcraft.50 Three days later, Buller met with Fortune’s
CEO, Christopher Klein, at Fortune’s headquarters in Deerfield, Illinois to discuss a
potential Norcraft-Fortune transaction.51 During that meeting, Buller informed
Klein that Norcraft was not for sale, but also indicated that he (Buller) would convey
43 JX 36 (LLC Unitholder TRA) §§ 1.1, 3.1 (defining “Realized Tax Benefit” and
“Cumulative Net Realized Tax Benefit”).
49 Ia’. §§ 4.1_4.3. The TRAs defined “Change of Control” to include “the acquisition,
directly or indirectly, by any [unaffiliated third-party acquiror] . . . of beneficial ownership
. . . of more than 50.1% of the aggregate voting power” of Norcraft’s outstanding voting
stock. ]a’. § 1.1.
50 PTo 11 2k.
51 PTo 11 21.
15
any acquisition proposal to Norcraft’s Board.32 Perhaps sensing that his Board might
be inclined to pursue a deal with Fortune, Buller advised Klein that he would like to
have a role in the post-Merger company in the event the parties reached an
agreement53 Klein was noncommittal but, internally, Fortune was disinclined to
bring Buller on board post-Merger.54 At the meeting’s close, Klein provided Buller
with a written, non-binding proposal under which Fortune would (1) acquire “100%
of [Norcraft’s] equity ownership interests” for $22.00 cash per share via a tender
offer (followed by a merger); and (2) satisfy Norcraft’s obligations under the
TRAs.55
32 JX 238 (Norcraft Schedule 14D-9, filed Apr. 14, 2015 [“Norcraft Schedule 14D-9”])
at 10.
33 Transcript of Trial (“TT”) at 205:1_10 (Biggart) (“Q. You suspect that Mr. Buller first
raised the desire to be employed by Fortune following any merger during a meeting on
October 23, 2014. Correct? A. 1 believe that’s when he expressed an interest to
[Klein].”).
34 JX 13 (Biggart Dep.) at 86:16-87:18 (“Q. Were there any internal discussions within
Fortune about hiring [Buller] post-merger? A. Yes, 1 talked to [Klein] directly a number
of times about it. Q. What did he say? A. [Klein] said I don’t know that there is a place
for him. . . .”).
33 PTO 11 21; JX 69 (Fortune’s Oct. 23, 2014 Proposal) at FB0049476. Fortune viewed the
TRA payments as part of the Merger consideration. See JX 13 (Biggart Dep.) at 34:10-
21, 166:10-167:8. Thus, for every dollar spent to satisfy the TRA Beneficiaries, that dollar
would not be included in the consideration paid to Norcraft’s public stockholders. See
JX 249 (Funds Flow Memorandum), Ex. E.
16
Buller promptly informed Norcraft’s Board of Fortune’s proposal, and the
Board convened on November 4, 2014 to discuss it.36 Following that meeting,
Norcraft engaged legal and financial advisors to assist the Board in its consideration
of Fortune’s proposal.57 The Company retained Ropes & Gray LLP (“Ropes &
Gray”) as its legal advisor and Citigroup Global Markets Inc. (“Citi”) as its financial
advisor.58 The Board promptly tasked Citi with “review[ing] strategic alternatives
of the [C]ompany, including a potential sale to Fortune.”39 Norcraft also engaged
Pricewaterhouse Coopers (“PwC”) to provide an assessment of the Company’s
contractual obligations under the TRAs.60
D. Norcraft’s Management Prepares Long-Term Projections
Norcraft’s Board met again on November 8, 2014.61 During this meeting,
“[t]he [B]oard . . . discussed next steps in formulating a potential response to
[Fortune], and after discussion, agreed that [Buller, Ginter and Reilly] would map
out a proposed strategy and response with Citi[] and report their recommendations
36 JX 238 (Norcraft Schedule 14D-9) at 10.
37 PTO 11 2m; JX 238 (Norcraft Schedule 14D-9) at 10.
38 PTO 11 2m; JX 238 (Norcraft Schedule 14D-9) at 10.
39 TT 12:1_3 (Eldridge). Nathan Eldridge was Citi’s lead banker in connection with the
Norcraft engagement Ia'. at 12:1-15.
60 PTO 11 2m; JX 238 (Norcraft Schedule 14D-9) at 10.
61 JX 71(Norcraft Board Minutes, Nov. 8, 2014) at NCFT0165019.
17
back to the [B]oard.”62 The Board also instructed Buller and Ginter to prepare five-
year financial projections to facilitate the Board’s evaluation of strategic alternatives
(including a potential Norcraft-Fortune transaction).63
Buller and Ginter both had experience preparing long-term projections,
having previously prepared five-year projections in connection with Norcraft’s IPO
and four debt financing transactions between 2003 and 2010.64 Norcraft, however,
did not prepare long-term projections in the ordinary course of its business; it only
did so in connection with “extraordinary event[s]” such as financing transactions
and ultimately the Merger.65 Ordinarily, Norcraft management prepared an annual
one-year budget, which forecasted Norcraft’s quarterly (and monthly) performance
for the upcoming year.66 The Company’s annual budgeting process began each fall
and involved several steps67:
62 ]d. at NCFT0165020.
63 JX 1 (Ginter Dep.) at 35-36; see JX 3 (Buller Dep.) at 112-16.
64 JX 1 (Ginter Dep.) at 27-28; JX 3 (Buller Dep.) at 28:21-29:3, 102.
63 JX 1 (Ginter Dep.) at 27:8-12.
66 JX 1 (Ginter Dep.) at 22:4~24, 25:3-25; see JX 150 (Feb. 27, 2015 e-mail from Tanquist
to RBC, attaching Norcraft’s FY2015 budget) at NCFTOl38021-24.
67 JX 2 (Tanquist Dep.) at 25_27; JX 3 (Buller Dep.) at 24:8~26:1.
18
l First, the corporate controller for each of Norcraft’s four business divisions
would prepare a detailed “bottoms-up” budget for his or her division.68 As
part of that process, the division controllers “would work with
[their respective] division presidents to come up with what they expected for
sales growth in the [upcoming] year and . . . would build that into the budget[,]
[along with] .. . other assumptions like labor efficiencies [and] material
cost.”69 In this way, the division controllers “would get a picture of what
[profit and loss] would look like for [their respective divisions for] the
[upcoming] year.”70
l Next, each division controller would present his or her division-level budget
to Buller and Ginter “for review and approval.”71
l Finally, “[a]f``ter several rounds of . . . back-and-forth,” Ginter would compile
the division-level budgets “into a consolidated format,” which was then
presented to the Board for review and approval in January of the budgeted
year.72 After review, the Board typically would approve the consolidated
annual budget that same month.73
Following the Board’s November 8, 2014 meeting, Buller and Ginter created
two sets of five-year projections: a base-case projection (the “Base Case”) and an
upside-case projection (the “Upside Case”), both of which are summarized below.74
63 JX 1 (Ginter Dep.) at 22:9-12; JX 2 (Tanquist Dep.) at 25:12-24.
69 JX 2 (Tanquist Dep.) at 25:25-26:5.
70 ld. 312615-7.
71 JX 1 (Ginter Dep.) at 22:11_14; JX 3 (Buller Dep.) at 24:8-25:1.
72 JX 1 (Ginter Dep.) at 22:15-18; JX 2 (Tanquist Dep.) at 26:8~10; JX 3 (Buller Dep.)
at 24:12_18.
73 JX 2 (Tanquist Dep.) at 26:8-10; JX 3 (Buller Dep.) at 24:15_18.
74 JX l (Ginter Dep.) at 74-80; JX 99 (Jan. 9, 2015 e-mail from Reilly to other Norcraft
Board members, attaching Norcraft management presentation [“Norcraft Jan. 2015
Management Presentation”]) at NCFTOl46344-47. The record also contains a set of three-
19
Base Case Projections (FY2014-2019)73
($ in milliOrlS) 2014E 2015E 2016E 2017E 2018E 2019E
Net Sal€S 8371 $4()9 $448 $483 8523 $568
EBITDA $51 859 870 879 $89 $100
EBIT 836 842 851 858 868 881
CapEX $10 818 812 815 816 817
Upside Case Projections (FY2014-2019)76
($ in milliOnS) 2014E ZOISE 2016E 2017E 2018E 2019E
Net Sales 8373 8415 $460 $507 $558 $613
EBITDA $51 861 $75 $89 $105 8120
EBIT 836 845 856 867 882 $100
CapEX 810 $18 812 815 817 818
year projections for Norcraft, apparently created by Ginter prior to October 2014 (the
“Ginter 2014 Projections”). Ginter, however, did not recall creating these projections or
the purpose for which they were prepared. See JX 1 (Ginter Dep.) at 35:23-36:4, 53:22_
54:18.
73 JX 99 (“Norcraft Jan. 2015 Management Presentation”) at NCF10146344-47.
76 Ial. The Base Case and Upside Case projections also included free cash flow forecasts.
Ia’. at NCFTOl46347. Those free cash flow forecasts, however, did not deduct for income
taxes and, therefore, significantly overstated Norcraft’s future free cash flows. JX 1 (Ginter
Dep.) at 44~45. Accordingly, the tables depicted here do not include the free cash flow
component of the Base Case and Upside Case projections.
20
In preparing the Base Case and Upside Case projections, Buller and Ginter
took a “top-down” approach-independently projecting Norcraft’s net sales,
operating expenses and capital expenditures (for all business divisions) in the first
instance, and then consulting with division-level management as and where
needed_rather than the “bottoms-up” approach they used to prepare Norcraft’s
annual budgets.77 They created the Upside Case first.78 After preparing the Upside
79
Case, Buller and Ginter presented it to Reilly for his review. “Upon review,
[Reilly opined] that the [Upside Case] . . . was too aggressive . . . and asked
[Buller and Ginter] to go back and . . . do a more conservative model, which became
known as the [B]ase [C]ase.”30 Buller and Ginter both believed that Norcraft could
achieve the results forecasted in the Base Case and Upside Case projections,
although “the [U]pside [C]ase was more of a stretch and everything would have had
to go right.”81
77 JX 1 (Ginter Dep.) at 22-23, 75-76, 87-88; JX 3 (Buller Dep.) at 34_36.
73 JX 1 (Ginter Dep.) at 75-76.
79 Ia'.
80 Ia'. at 75:23-76:8.
31 Ia'. at 97:12-13; JX 3 (Buller Dep.) at 115:8_18 (“The [B]ase 1C]ase is something that
we felt very, very comfortable in doing, and then [in the Upside Case] we showed the
upside that if everything, everything went our way, there was a possibility that we could
hit the [U]pside [Case].”).
21
Buller and Ginter presented the Base Case and Upside Case projections to
Norcraft’s Board at a meeting on November 25, 2014.82 After discussion, the Board
approved both sets of projections for use in connection with the Board’s
consideration of Fortune’s proposal.83
E. Norcraft Pushes Fortune to Increase its Offer
Norcraft’s Board next met on December 3, 2014.84 During this meeting, Citi
presented the Board with an analysis of Norcraft’s standalone prospects and possible
strategic alternatives.85 Citi’s presentation included an overview of preliminary
valuation perspectives and selected strategic alternatives,86 “including maintaining
the status quo, a possible sale of the Company to [Fortune] or another buyer, as well
as some other potential acquisition targets.”87 Following Citi’s presentation, the
Board determined that (1) “[Fortune’s] proposed price of 822.00 per share was
inadequate”; and (2) “[Fortune’s] offer would need to be significantly and
82 JX 71 (Norcraft Board Minutes, Nov. 25, 2014) at NCF1``0165023.
83 Ia'.; PTO 11 2o.
84 JX 71 (Norcraft Board Minutes, Dec. 3, 2014) at NCFT0165024.
83 Ia’. at NCFTOl65025; JX 95 (Dec. 2, 2014 email from Reilly to other Norcraft Board
members attaching Citi presentation deck).
86 JX 95 (Dec. 2, 2014 email from Reilly to other Norcraft Board members attaching Citi
presentation deck).
87 JX 71 (Norcraft Board Minutes, Dec. 3, 2014) at NCFTOl65025.
22
substantially higher in order for the Board to consider a potential sale of the
Company at this time.”88 The Board, however, did not task Citi with pursuing
alternative buyers or canvassing the market.
Two days later, Buller called Klein and conveyed to him the Board’s
determination.89 Buller also explained that “if [Fortune] were interested in
significantly increasing [its proposed price] . . . , [Norcraft] would be prepared to
share certain [non-public] information [with Fortune], under a confidentiality
agreement with an appropriate standstill, in order to assist [Fortune] in understanding
>>90
[Norcraft’s] prospects, upside potential and intrinsic value. Soon thereafter, on
December 11, 2014, Norcraft and Fortune entered into a confidentiality agreement
with a standstill.91
On January 7, 2015, Buller, Ginter and Citi representatives met with Fortune’s
management at Buller’s home in Winnipeg, Canada to discuss the proposed
Norcraft-Fortune transaction.92 The discussion focused on the structure and timing
of the proposed transaction, Norcraft’s business and financial projections and the
88 Ia'.
89 JX 238 (Norcraft Schedule 14D-9) at 11.
901d_
91 PTO 11 2p; JX 97 (Confidentiality Agreement).
92 PTo 11 2q.
23
integration of Norcraft into Fortune.93 Norcraft provided Fortune with the Base Case
and Upside Case projections as well as certain preliminary information regarding
the TRAs.94 During this meeting, Buller reiterated his interest in post-closing
employment with Fortune and discussed the possibility with Klein.93 Again, Klein
“ke[pt] the door open” but stopped short of making a commitment.96
The following week, on January 14, Norcraft’s tax advisor, PwC, presented
its analysis regarding the TRAs to Fortune’s management and RBC.97 PwC
explained that termination of the TRAs in connection with Fortune’s acquisition of
Norcraft would require significant payments to the TRA Beneficiaries (including
Buller).98 PwC also identified certain tax benefits that Fortune could realize from
the acquisition, including a stepped-up basis in Norcraft’s assets.99 The next day,
Klein advised Buller that Fortune’s tax advisor was performing its own analysis of
93 [d_
94 Ia'.
93 JX 238 (Norcraft Schedule 14D-9) at 12.
96 JX 13 (Biggart Dep.) at 88:2-3.
97PToj[zr.
98 Id.; JX 238 (Norcraft Schedule 14D-9) at 12. All parties agreed that Fortune’s
acquisition, directly or indirectly, of 100% of Norcraft’s equity would constitute a “Change
of Control” within the meaning of the TRAs. JX 36 (LLC Unitholder TRA) § 1.1 (defining
“Change of Control”); see PTO 11 2z.
99PToj]zr.
24
Norcraft’s obligations under the TRAS following the proposed transaction.100 Klein
also noted that Fortune would require more information about the TRAs to calculate
Fortune’s full payment obligations to the TRA Beneficiaries.101
On January 27, 2015, Klein delivered to Buller a revised written indication of
interest with a proposed price of $25.00 per share.102 Buller promptly informed
Norcraft’s Board of Fortune’s revised proposal, and the Board met on February 2 to
discuss it.103 During this meeting, Citi provided the Board with its revised valuation
analysis, which incorporated Norcraft’s net sales and EBITDA results for Q4
FY2014 (both of which were higher than expected) and Fortune’s latest proposal of
$25.00 per share.104 Reilly then reviewed with the Board the tax benefits that
Fortune would realize in connection with its proposed acquisition of Norcraft,
including a stepped-up basis in Norcraft’s assets.105 After receiving Reilly’s report,
1110 PTo 11 23.
101 Id
102 JX 238 (Norcraft Schedule 14D-9) at 12.
103 See JX 238 (Norcraft Schedule 14D-9) at 12; JX 71 (Norcraft Board Minutes, Feb. 2,
2015) at NCFT()165026-27.
104 JX 238 (Norcraft Schedule 14D-9) at 12; see JX 71 (Norcraft Board Minutes, Feb. 2,
2015) at NCFT0165026-27; PTO 11 2t. Citi’s valuation employed several methodologies,
including a DCF and comparable company analysis, and yielded values of $16.75 to $27
per share (based on the Base Case projections). JX 115 (Feb. 2, 2015 email from Citi,
attaching Board Discussion Materials) at CITI-00063489.
103 JX 71 (Norcraft Board Minutes, Feb. 2, 2015) at NCFTOl65027.
25
“the Board concluded that [Fortune] would benefit from th[at] step-up in basis going
forward and should therefore value th[at] benefit in its offer price.”106
With Citi’s and Reilly’s input in hand, the Board determined that Fortune’s
proposed purchase price of $25.00 per share was inadequate, in part because it did
not value the tax benefits that Fortune would realize in connection with the proposed
transaction.107 The Board also believed, however, “that a transaction with [Fortune]
could potentially create more value for [Norcraft] stockholders if at an appropriate
valuation than if [Norcraft] continued independently to execute on its strategic plan.
Accordingly, the Board authorized [Buller and Reilly] to continue to engage in
discussions with [Fortune] to confirm if [Fortune] was willing to further increase its
propos[ed] [price].”108 Even at this stage, however, the Board did not reach out to
other potentially interested parties in hopes of securing a better offer or, at least, a
source of leverage in its discussions with Fortune.
The next day, Buller called Klein to convey Norcraft’s position regarding
Fortune’s revised proposal.109 During that call, Buller advised Klein that Fortune’s
1061d
107 JX 238 (Norcraft Schedule 14D-9) at 12.
103 Id_
109 ld
26
proposed price remained inadequate and encouraged Fortune to increase its bid.110
Unable to invoke the threat of an alternative transaction, Buller highlighted
Norcraft’s better than expected preliminary FY2014 results and FY2015 outlook as
support for his pitch that Fortune pay a higher price.lll Apparently not feeling the
heat, Klein advised Buller that Fortune would consider increasing its bid but that it
was unlikely that Fortune’s proposed price would move significantly higher than
$25.00 per share.112
Following Buller and Klein’s February 3 call, Fortune increased its offer to
$25.50 per share, indicating that this was its “best and final offer.”113 The Norcraft
team was less than thrilled with Fortune’s $25.50 per share proposal; indeed, Reilly
and Ginter both believed that Fortune’s proposal significantly undervalued
Norcraft.114 Nevertheless, the Board remained focused exclusively on Fortune. ln
a last- ditch effort to get Fortune to increase its “best and final offer,” the Board
110 Id_
1111d.;PTo 11 2u.
112 JX 238 (Norcraft Schedule 14D-9) at 12.
113 JX 412 (Feb. 10, 2015 email from Klein to Buller, attaching Fortune’s re-revised
proposal) at 2.
114 JX 1 (Ginter Dep.) at 231:21-24 (“Q: [Y]ou testified that you thought that Norcraft was
undervalued in the transaction [with Fortune], right? A: Yes.”); JX 140 (Feb. 20, 2015
email from Reilly to Buller, Maselli and Citi representatives in which Reilly opines that
“[Norcraft was] leaving $ on the table” by moving forward with Fortune’s $25 .5 0 per share
proposal).
27
responded with a counterproposal of $27.50 per share.113 When Fortune rejected
that counterproposal, the Board bid against itself with a second counterproposal of
$26.25 per share.116 Once again, Fortune held firm and reiterated that $25.50 per
share was its best and final offerl 17_well aware that it was getting the Company for
a “good price.”l 18 With no alternative transaction on the horizon, Norcraft’s Board
capitulated on February 21 at $25 .50 per share, hoping to extract further value during
a post-sign go-shop.119
113 JX 412 (Feb. 10, 2015 email from Fortune to Buller attaching letter rejecting
counterproposal).
116 JX 413 (email chain Klein to RBC and Fortune deal team describing counterproposal,
Feb. 13, 2015)31FB0089263.
117 TT 100:4~17 (Biggart); JX 238 (Norcraft Schedule 14D-9) at 13.
118 JX 185 (Mar. 20, 2015 email from Klein to Fortune director Mackay) (“You are spot
on - its [sic] a good price, and there is a risk someone comes along and tries to top the
offer.”). 1ndeed, prior to signing the Merger Agreement, Fortune had RBC render a
fairness opinion. In that regard, RBC conducted a standalone DCF analysis of Norcraft
that valued Norcraft at $30.26 per share. JX 216 (Mar. 29, 2015 RBC presentation slides)
at FB0047801. Fortune’s management valued Norcraft even higher. Its discounted cash
flow and internal rate of return (“IRR”) analysis (the “DCF/IRR Analysis”) of Norcraft as
a standalone entity valued Norcraft at approximately double the Merger Price and
estimated a 16% annualized IRR before accounting for synergies. JX 191 (slides from
Mar. 29, 2015 Fortune board meeting regarding Norcraft acquisition) at FB0076961;
JX 301 (Apr. 28, 2015 email between Fortune deal team members, attaching Fortune
valuation of Norcraft dated Mar. 19, 2015).
119 JX 238 (Norcraft Schedule 14D-9) at 14; see TT 13~15 (Eldridge); JX 3 (Buller Dep.)
at 86:13_20.
28
F. The Parties Negotiate the Merger Agreement
1n late February 2015, Citi informed Fortune that Norcraft was prepared to
move forward with Fortune’s $25.50 per share proposal, subject to the negotiation
of a merger agreement that included a forty-five-day post-signing go-shop right for
Norcraft.120 Fortune responded with a counterproposal that provided for a twenty-
five-day post-signing go-shop “that would be limited to certain identified potential
purchasers.”121 The counterproposal also called for a $15 million termination fee if
Norcraft accepted a superior proposal received during the go-shop period and a
2
$25 million termination fee otherwise.12 By proposing this structure, Fortune
sought to give Norcraft’s Board “the minimum amount [of time it] needed to satisfy
”123 while also “discourag[ing] potential
[its] fiduciary responsibility . . . and no more,
bidders.”124
On February 27, following negotiations, the parties eventually settled on a
thirty-five day post-signing go-shop period (the “Go-Shop Period”) With no
120 JX 238 (Norcraft Schedule 14D-9) at 13_14. Norcraft also sought Fortune’s
confirmation that (1) it would allow enhanced severance for Norcraft’s outgoing senior
management; and (2) the TRA payment obligations would be satisfied in full at closing.
la'. at 14.
121 Id_
1221a1
123 JX 5 (Klein Dep.) at 164:20-165:4.
124 JX 12 (Baab Dep.) at 99:23-100:4.
29
restrictions on the parties Norcraft or its advisors could contact, a $lO million
termination fee if Norcraft accepted a superior proposal during the Go-Shop Period
and a 820 million termination fee otherwise.125 Importantly, however, Fortune also
secured information rights with respect to competing proposals and unlimited
matching rights with respect to superior proposals.126 In a final stroke of masterful
bargaining, Fortune also secured the right to launch Tahiti’s tender offer for all of
Norcraft’s outstanding common stock (at $25.50 per share) fifteen days after the
start of the Go-Shop Period.127
In early March 2015, Fortune was given access to Norcraft’s electronic data
room, and on March 4, Fortune and Norcraft entered into a thirty-day exclusivity
123 JX 238 (Norcraft Schedule 14D-9) at 13-14; JX 221 (Merger Agreement) §§ 5.4,
7.3(a)(ii), 8.2. The Merger Agreement defined a “superior proposal” as “a bona fide written
Competing Proposal (with all percentages in the definition of Competing Proposal
increased to fifty percent (50%)) that did not arise out of a breach of Section 5.4 made by
a Third Party on terms that the board of directors of the Company determines in good faith,
after consultation with the Company’s financial and legal advisors, and considering all
factors as the board of directors of the Company (in consultation with its financial and legal
advisors) considers to be appropriate (including financing risk, regulatory approval risk,
the conditionality, timing and likelihood of consummation of such proposal and the
experience and reputation of the proposed buyer) to be more favorable to the stockholders
of the Company from a financial point of view than the Offer and the other Transactions
(after giving effect to all adjustments to the terms thereof which may be offered by
[Fortune] in writing, including pursuant to Section 5.4(g)).” JX 221 (Merger Agreement)
§ 8.2 (defining “Superior Proposal”).
126 JX 221 (Merger Agreement) § 5.4(c), (g). Under the Merger Agreement, Fortune had
four business days to match a superior proposal by a third-party bidder and two business
days to match any subsequent proposal by the same bidder. Ia’. § 5.4(g).
127 Ia'., pmbl. & § 1.1
30
agreement.128 Thereafter, on March 13, Buller, Ginter and Tanquist met with
Fortune management to provide additional non-public information about Norcraft,
and, on March 18, Fortune met with the senior management of each Norcraft
business division. 129
With the Merger Price set, and negotiations between Norcraft and Fortune
proceeding apace, Buller again approached Klein about post-Merger employment
with Fortune. At a Fortune-initiated meeting with Norcraft management on
March 6, Buller advised Klein that he wanted to head Norcraft and Fortune’s
combined cabinetry business post-acquisition.130 With the price locked in, and the
inevitably uncomfortable confrontation now unavoidable, Klein finally informed
Buller that Fortune would have no place for him after the Merger.131 This came as
a shock to Buller, who thereafter became increasingly “disruptive.”132
128 JX 238 (Norcraft Schedule 14D-9) at 14; PTO 11 2w.
129 JX 238 (Norcraft Schedule 14D-9) at 15.
130 JX 163 (e-mail chain between Klein and RBC, Mar. 11, 2015) (Klein: “At one point
[Buller] said in a hopeful way - ‘Do you want to hire me to run your whole cabinet
business?’ 1 gently said no . . . . ”); JX 13 (Biggart Dep.) at 86:16-87:11 (explaining that
Buller “was hoping that [Fortune would] hire him”).
131 JX 163 (e-mail chain between Klein and RBC, Mar. 11, 2015); TT 205:7-14 (Biggart)
(On March 6, 2015, Fortune “definitively told [Buller] he didn’t have the job.”); see also
id. 83:1~3 (Biggart).
132 TT 205: 19 (Biggart); see JX 163 (e-mail chain between Klein and RBC, Mar. 11, 2015)
(Klein: “From that point forward [Buller] was rather short with me . . . . So 1 need some
help here - in a very careful way, so as not to turn this into WWIII. [Buller] and his ego
need to [be] managed.”); TT 127:11~17 (Biggart) (“Buller, at this point, is not supporting
31
Unable to abandon the enterprise completely, Buller soon returned to Fortune
with a new proposal: if he would not be a part of the combined company, then, upon
Fortune’s acquisition of Norcraft, Buller would acquire Urban Effects
O\Iorcraft Canada) from Fortune.133 After Buller announced his interest in acquiring
Norcraft Canada, the Board determined, for the first time, that Buller was conflicted
and, therefore, should be excluded from Board deliberations regarding the potential
Norcraft-Fortune transaction. 134
Buller, for his part, was determined to acquire Urban Effects and continued to
press Fortune for a commitment to sell him the business, while also continuing to
the transaction, and [Fortune was] getting the sense that he’s not going to sign the merger
agreement And I’m concerned.”).
133 JX 13 (Biggart Dep.) at 95:12_17 (“Q. Was it your understanding that Mr. Buller first
raised his desire to purchase Norcraft Canada . . . after he was told there’s no place for you
post-closing? A. 1 believe so, that was the first 1 heard about it.”); JX 168 (e-mail chain
between Klein and Fortune deal team, Mar. 14, 2015) (Klein: “So, 1 spoke to [Buller] this
morning, and he would like to buy Urban Effects.”); JX 11 (Reilly Dep.) at 156:3_9.
134 JX 71 (Norcraft Board Minutes Mar. 19, 2015) at NCF'1``0165034~35. According to
Buller, since he never engaged in pre-close negotiations with Fortune to acquire Norcraft
Canada, he did not recuse himself from Norcraft-Fortune negotiations JX 3 (Buller Dep.)
at 235:12_240:20. 1n contrast, Reilly testified that Buller did recuse himself from certain
Norcraft Board meetings JX 11 (Reilly Dep.) at 158:11_24. Remarkably, the Norcraft
Canada conflict was the first Buller conflict that seemed to percolate up to the Board’s
attention. As discussed below, the Board apparently was content to have Buller negotiate
TRA payments and Merger consideration at the same time (even though the TRA payments
were to be made only to select TRA Beneficiaries who were competing with Norcraft
stockholders for consideration), and also content to have Buller negotiate for his own post-
Merger employment with Fortune while simultaneously taking the lead for Norcraft in
Merger negotiations See JX 13 (Biggart Dep.) at 89:7-11; JX 5 (Klein Dep.) at 139:3~
140:14.
32
lead Norcraft’s negotiations with Fortune.135 Fortune, however, was unwilling to
give such a commitment while negotiations with Norcraft were ongoing_much to
Buller’s frustration.136 Yet it soon became clear to Fortune that Buller’s ire now
risked derailing the deal.137 To keep the peace, on March 25, Reilly emailed Buller
to advise him that “[Klein] is going to offer to provide you some meaningful comfort
on 1C]anada. . . .”138 Klein’s overture to Buller accomplished its intended purpose;
Buller felt he had “[g]ot[ten] good comfort on UE.”139 This “comfort” included:
133 See JX 13 (Biggart Dep.) at 97_100; icl. at 121:4_10 (“[Q.] As of Thursday, March
19th, was [it] your understanding that Mr. Buller was insisting on some understanding pre-
signing with respect to the sale to him of the Canada business? A. That’s my
understanding 1 believe [Buller] continued this up right until we signed the [Merger
Agreement].”); TT 125:3-21 (Biggart) (explaining that Buller was upset because Fortune
would not commit to sell him Norcraft Canada).
136 See JX 168 (e-mail chain between Klein and Fortune deal team, Mar. 14, 2015) (Klein:
“1 told [Buller that his proposed acquisition of Urban Effects] would likely be a subsequent
transaction - a week later or something like that, post close.”); JX 195 (e-mail chain
between Klein and Fortune deal team, Mar. 25, 2015) (Klein: “[Eldridge] said 1 need to
call [Buller] and calm him down and make him feel good”); TT 114-15 (Biggart)
(explaining that Fortune did not feel comfortable negotiating a Norcraft Canada transaction
with Buller pre-closing).
137 JX 195 (e-mail chain between Klein and Fortune deal team, Mar. 25, 2015)
(Klein: “[Eldridge] said 1 need to call [Buller] and calm him down and make him feel
good.”).
138 JX 197 (e-mail chain between Buller and Reilly, Mar. 26, 2015).
139 JX 202 (e-mail from Buller to PwC, Mar. 27, 2015).
33
l Fortune’s waiver of a two-year, Canada-specific non-compete covenant
otherwise applicable to Buller140; and
l Fortune’s agreement to modify Buller’s employment agreement with
Norcraft’s operating subsidiary to provide that Buller would receive a
severance payment if his employment was terminated without cause
(including by Buller himself) within twelve months of Fortune’s acquisition
of Norcraft. 141
Thereafter, it appears that Buller was content to “live with a trust me 1 will sell
Canada to you” status quo, and ostensibly was willing to support the Norcraft-
Fortune transaction again_to Fortune’s great relief.142
With the Norcraft Canada fire contained, Fortune was soon on to the next
Buller-related fire. 1n late March 2015, having finalized most of the merger
agreement’s material terms, Norcraft and Fortune found themselves unable to reach
agreement on the termination payments that would be due to the TRA Beneficiaries
holding Norcraft LLC units (including Buller and his family members).143
140 JX 198 (e-mail chain between Norcraft and Fortune deal teams, Mar. 26, 2015) at
NCF1``0168392; TT 126:6-16 (Biggart) (“1 got Chris Klein to agree . . . that [Fortune]
would waive [Buller’s] noncompete in Canada, as a showing of good faith to . . . Buller
that we were serious when we say we’re going to . . . have a negotiation after the
closing . . . . ”).
141 JX 219 (Amendment to Buller’s Employment Agreement).
142 JX 204 (e-mail from Reilly to Maselli, Mar. 27, 2015).
143 TT 123-26 (Biggart) (explaining the TRA-related difficulties); ia'. at 126:2-5 (Biggart)
(“1 called [Ropes & Gray] and said . . . [w]e better do something quick or this whole deal
is going to fall apart.”).
34
Norcraft’s and Fortune’s tax advisors disagreed as to the value of certain tax
attributes associated with the Norcraft LLC units, resulting in a $3 million difference
in their respective calculations of the termination payments.144
On March 26, Fortune tried to “cut a deal with Buller” on the TRA termination
payments by offering to pay $2 million of the $3 million difference.143 Buller
insisted, however, that Fortune pay the entire $3 million, much to Fortune’s
exasperation.146 At this point, Fortune seemingly had reached its limit with Buller
and advised Citi that “if there [was] no signed [merger] agreement by [the morning
of March 30, Fortune was] done.”147 Negotiations followed. Ultimately, to appease
Buller and keep the deal on track, SKM and Trimaran offered to transfer $1 million
of the TRA termination payments they stood to receive to the Norcraft LLC
unitholders, such that the unitholders would receive the full $3 million demanded by
144 TT 123-24 (Biggart).
143 JX 13 (Biggart Dep.) at 168:2_3; JX 198 (e-mail chain between Norcraft and Fortune
deal teams, Mar. 26, 2015); JX 207 (e-mail from Klein to Fortune deal team, Mar. 27,
2015); TT 126:8 (Biggart) (“[Fortune was] willing to pay 2 out of the $3 million.”).
146 JX 207 (e-mail from Klein to Fortune deal team, Mar. 27, 2015) (Klein: “We[] heard
through [Buller’s] personal lawyer that he rejects our offer of 2 of 3 million [of the]
disputed TRA amount, needs all 3. . . . 1’ve been very reasonable here in all of this, but
really cannot go any farther. 1 do not wish to call [Buller] and go through all of this again
with him - it could do more harm than good.”) (formatting altered); TT 128:12_23 (Biggart)
(“Q. What was [Buller’s] response to that proposal? A. He said no. And he said,
1want . . . everything that my accountant says I’m entitled to. He said, [my accountant]
has calculated my TRA payment at 19.7 [million], 1 want 19.7.”).
147 JX 207 (e-mail from Klein to Fortune deal team, Mar. 27, 2015).
35
Buller.148 With that, the TRA fire was extinguished and Fortune had no more Buller-
related fires to fight.
G.Norcraft’s Board Approves the Merger and Norcraft Executes the
Merger Agreement
On March 29, 2015, Norcraft’s Board received Citi’s fairness opinion and
approved the Merger Agreement.149 The following day, Norcraft and Fortune
executed the Merger Agreement and issued a press release announcing the
Merger.130 Immediately following the execution of the Merger Agreement, Norcraft
entered into TRA termination agreements with the TRA Beneficiaries-SKM,
Trimaran and the Norcraft LLC unitholders-providing that the TRAs would be
terminated (if the Merger was consummated) in exchange for $43.5 million in total
payments to the TRA Beneficiaries.131
148 JX 212 (Mar. 27, 2015 e-mail from Buller to Maselli, Reilly et al., thanking Maselli and
Reilly for agreeing that Trimaran and SKM, respectively, would transfer the $l million
sum to the Norcraft LLC unitholders); TT 129:6-24 (Biggart).
149 JX 238 (Norcraft Schedule 14D-9) at 16~17.
130 PTO 11 2y; JX 238 (Norcraft Schedule 14D-9) at 17.
131 PTO 11 2z. Under the TRA termination agreements the Norcraft LLC unitholders would
receive approximately $19.7 million, SKM would receive approximately $15.9 million and
Trimaran would receive approximately $7.9 million. Ia’.
36
SKM, Trimaran and the Norcraft LLC unitholders also entered into Tender
and Support Agreements (“TSAS”) with Fortune and Tahiti,132 whereby SKM,
Trimaran and the Norcraft LLC unitholders agreed that:
l they would “promptly” tender their Norcraft shares into Tahiti’s tender offer
and, in any event, would do so at least two days before the offer’s initial
expiration date133; and
l the shares so tendered could not be withdrawn unless and until the tender offer
expired or was “terminated in accordance with the terms of Merger
Agreement.”134
H. The Go-Shop
The Go-Shop Period commenced with the Merger’s announcement on
March 30, 2015.155 Given that Norcraft and Citi had focused exclusively on Fortune
during the pre-sign “process,” it was especially important that the Company run an
effective go-shop to provide a meaningful market check. Yet Citi’s lead banker,
Eldridge, had never run a sell-side go-shop.136 Because Norcraft’s Board was unsure
152 PTo 11 2bb.
133 JX 229 (Buller Tender and Support Agreement [“Buller TSA”]) § 3; JX 230
(SKM Tender and Support Agreement [“SKM TSA”]) § 3; JX 231 (Trimaran Tender and
Support Agreement [“Trimaran TSA”]) § 3. Fortune initiated Tahiti’s tender offer on
April 14, 2015, PTO 11 2ee, and the offer’s initial expiration date was May 1 1, 2015. JX 239
(Norcraft Schedule TO, filed Apr. 14, 2015, attaching Tahiti’s tender offer) at 9.
154 Jx 229 (Buller TsA) § 3(b); Jx 230 (sKM TsA) § 3(1>); Jx 231 (Trimaran TsA) § 3(b).
133 PTO 11 2cc.
136 TT 45:14-46:8 (Eldridge); JX 8 (Eldridge Dep.) at 49:8~12, 89:17-90:22.
37
of the go-shop’s core components, it relied completely on Citi to oversee the
process157 Fortune, on the other hand, knew full well what was at stake. 1ts Vice
President of M&A, Robert Baab, pushed hard for an unlimited match right and for
Fortune’s right to launch Tahiti’s tender offer during the Go-Shop Period,
understanding that both measures would make it less likely that a topping bidder
would emerge.138
During the Go-Shop Period, Citi contacted fifty-four potential bidders: twelve
potential “strategic” bidders and forty-two private equity firms.139 Of the fifty-four
parties contacted, seven entered into nondisclosure agreements_six private equity
firms and American Woodmark, one of Norcraft’s industry peers.160 Only one of
137 JX 3 (Buller Dep.) at 199_200; JX 9 (Maselli Dep.) at 76:5-16; JX 11 (Reilly Dep.) at
122-29.
138 JX 12 (Baab Dep.) at 100-02; see also JX 149 (Feb. 27, 2015 email from Klein to
Fortune deal team outlining Fortune’s conditions for the go-shop, explaining their intended
effect of avoiding an auction); JX 232 (e-mail chain between RBC, Klein and other
members of Fortune’s deal team, Apr. 7, 2015, explaining RBC should emphasize to other
potential buyers that Fortune has matching rights).
139 TT 26:22-27:1 (Eldridge). Citi’s contact list was developed with input from Buller and
Reilly, who “suggested [certain] companies to put on the list, including companies that had
reached out to [Norcraft] historically.” TT 2727-12 (Eldridge).
160 TT 27 (Eldridge); JX 243 (“Buyers Log” dated May 4, 2015, prepared by Citi [“Citi
Go-Shop Log”]). The six private equity firms were The Carlyle Group (“Carlyle”), TPG
Capital, Wind Point Partners, Olympus Partners, American Industrial Partners and another
unidentified private equity firm. TT 27 (Eldridge); JX 243 (Citi Go-Shop Log).
38
those seven parties, Carlyle, went on to meet with Norcraft management.161 Carlyle
ultimately did not submit a bid.162
Most of the parties Citi contacted indicated either that they were “not
interested in competing with Fortune”163 or that “[t]he price [was] too high.”164
At least two non-bidding parties, however, advised Citi that they could not “move
fast enough [to submit a bid] in 35 days.”163
1n an effort to ensure that Fortune would reap the benefits of its hard-fought
bargain, RBC and Klein devised a strategy to dissuade potentially interested parties
from engaging with Norcraft. 1n that connection, early in the go-shop process, RBC
emailed Klein advising that RBC had “a call scheduled for [April 9, 2015] with
161 JX 240 (“Go-Shop Process Update” dated Apr. 20, 2015, prepared by Citi); TT 157
(Biggart).
162 PTO 11 2cc.
163 JX 243 (Citi Go-Shop Log) at 5 (“no interest in going head-to-head with Fortune on
this”), 7 (“Fortune is a logical buyer here, so hard for us to compete”), 8 (“[n]ot that
interested in competing against Fortune”), 10 (“[c]an’t compete with Fortune”), 11
(“[c]an’t compete with Fortune”).
164 Id. at 6, 14 (“[v]alue too high”).
163 Id. at 15; see id. at 2 (“investment is too big [] to consider in a short period”); TT 46:9-
19 (Eldridge) (“Q. And, sir, you testified at your deposition that there were go-shop
participants in this process who indicated that they would like to have more time. Correct?
A. Yes. Q. And what parties were those? A. 1 don’t recall specifically. 1 recall it being
a general comment from a couple of people that we spoke with. They may not have been
people that signed NDAs. 1t was just a general comment from various people that we
contacted.”).
39
Masco”_one of the go-shop participants_“to discuss the [Merger].”166 1n this
email, RBC explained that it would “emphasize [to Masco] that [Norcraft] is an asset
that [Fortune has] been monitoring/targeting for a long time . . . and [that Fortune]
view[ed] the [Merger] as highly strategic.”167 RBC also indicated that it hoped to
“get some sense from Masco as to whether or not [Masco was] likely to engage
[with Norcraft].”168 Eager to close the deal, Klein advised RBC that “[t]he trick
[with Masco] . . . is not to make Norcraft sound very interesting for them.”169 Klein
also emphasized that he was “more interested in [RBC] shutting the door on [Masco]
and [its] willingness to look at [acquiring Norcraft], versus learning a lot from
[Masco] . . . . ”170
When Fortune’s general counsel, Biggart, learned of this correspondence, he
nearly had “a heart attack in [his] office.”171 He immediately “went over to see
[Klein]”_before RBC’s call with Masco_and “explained to him that [Fortune and
166 JX 233 (e-mail chain between Klein, RBC and other members of Fortune’s deal team,
Apr. 7, 2015)3115130089016.
161 1a
168 lai
169 Id
170 Id
111 TT 144;3_4 (Biggart).
40
its deal team] can’t be doing this.”172 Biggart then warned RBC that Klein’s
proposed approach was “the wrong way to deal with a go-shop” and that “[RBC]
can’t be interfering like this.”173 Klein apparently heeded Biggart’s admonition, as
did RBC.174
As permitted by the Merger Agreement, Fortune launched Tahiti’s tender
offer for Norcraft’s stock fifteen days into the Go-Shop Period, on April 14, 2015,
securing the support of a majority of Norcraft’s outstanding common stock (per the
TSAs). 173 The Go-Shop Period expired as scheduled on May 4, with Norcraft having
received no competing acquisition proposals.176 Tahiti successfully completed its
tender offer on May 11, and the Merger closed the following day.177
I. The Parties’ Experts
Both parties presented valuation experts at trial to opine on Norcraft’s fair
value as of the Merger date.178 Petitioners’ valuation expert was David A. Clarke;
172 TT 144:5_6 (Biggart).
173 TT 144:16_18 (Biggart).
174 JX 5 (Klein Dep.) at 275:6-276:14.
173 JX 221 (Merger Agreement), pmbl. & § 1.1; PTO 1111 2cc, 2ee.
176 PTO 11 2cc.
177 JX 250 (May 12, 2015 Fortune press release); PTO 11 2ff.
178 TT 455-56 (Clarke); TT 698 (Austin Smith).
41
Respondent presented Yvette R. Austin Smith.179 Petitioners also presented a deal
process expert, Guhan Subramanian (“Subramanian”), to opine on the soundness (or
not) of Norcraft’s deal process.180 1 summarize each expert’s opinion below.
1. Clarke’s Opinion Regarding Norcraft’s Fair Value
Clarke opined that the Merger Price of $25.50 per share “does not reflect
Norcraft’s fair value [as of the Merger date] . . . [b]ecause there was no competitive
process to acquire Norcraft prior to the signing of the Merger Agreement and the
179 TT 455_56 (Clarke); TT 698 (Austin Smith). By any measure, both experts are well
qualified. See JX 18 (Report of David G. Clarke, ASA [“Clarke Report”]) at 8 (describing
qualifications); JX 20 (Austin Smith Report) at 3 (describing qualifications). And both
did what they were engaged to do here - advocate their side’s position on fair value - quite
effectively. lt is accepted in DelaWare appraisal litigation that paid valuation experts have
assumed more of an advocacy role, and less of a traditional expert witness role (as
illustrated by the wide deltas we regularly see in their valuation conclusions). See Dell,
177 A.3d at 24 (“the price produced by an efficient market is generally a more reliable
assessment of fair value than the view of a single analyst, especially an expert witness who
caters her valuation to the litigation imperatives of a well-heeled client”); Global GTLP v.
Golden Telecom, 993 A.2d 497, 498_99 (Del. Ch. 2010) (“Both these men of valuation
science purported to apply the same primary method of valuation_the discounted cash
flow (‘DCF ’) method-_but the expert for the petitioners came up with a value of $139 per
share and the expert for Golden came up with a value of only $88 per share_a modest $51
per share value gap.” (emphasis supplied)). Despite the repeated expressions of frustration
by our courts, the practice continues When a rushing river flows against a resisting rock,
eventually the river wins out. Perhaps that is the hope among appraisal advocates and the
valuation experts they engage to sponsor their positions
180 TT 243-44 (Subramanian). Subramanian is “the H. Douglas Weaver Professor of
Business Law at the Harvard Business School (HBS) and the Joseph Flom Professor of
Law and Business at the Harvard Law School (HLS).” JX 19 (Expert Report of Guhan
Subramanian [“Subramanian Report”]) at 2; see id. (describing qualifications).
42
post-signing go-shop process was not an effective tool for price discovery . . . . ”181
According to Clarke, a DCF analysis premised on the Base Case projections
provides the most reliable evidence of Norcraft’s fair value as of the Merger date.182
Based on his DCF analysis, Clarke concluded that Norcraft’s fair value as of the
Merger was $34.78 per share.183
For his DCF analysis, Clarke chose to extend the Base Case projections for an
additional five years (through 2024), before applying a perpetuity growth rate
(“PGR”) of 3.5% at the end of the projection period.184 He also adjusted the Base
Case projections to deduct for income tax expense in each projected year, which the
Base Case projections presented in Norcraft’s Schedule 14D-9 failed to do.185
181 JX 18 (Clarke Report) at 17 (quoting JX 19 (Subramanian Report) at 25) (intemal
quotation marks omitted). Clarke did not offer any independent analysis as to why the
Merger Price is not a reliable indicator of Norcraft’s fair value as of the Merger date;
instead, he adopted in full Subramanian’s conclusion on that point. See JX 18 (Clarke
Report) at 6, 17.
182 See id. at 2.
1831a1
184 Id. at 2-3. The extension of the proj ections, according to Clarke, was required to reduce
Norcraft’s growth rates gradually to a “steady state.” 1n this regard, Clarke notes that
“if 1he] had to use 2019 as the final year of [his] projections, [he] would then need to use a
higher [PGR of 4.4%] to account for the tapering of [Norcraft’s] growth to a steady state.”
JX 21 (Rebuttal Report of David G. Clarke, ASA [“Clarke Rebuttal Report”]) at 27 n.62.
183 JX 18 (Clarke Report) at 24; JX 1 (Ginter Dep.) at 44-45.
43
After determining Norcraft’s projected unlevered free cash flows through
Norcraft’s FY2024, Clarke then discounted each year’s projected free cash flow
amount to present value using a 9.6% discount rate based on an estimate of
Norcraft’s weighted average cost of capital (“WACC”).186 With these inputs, Clarke
concluded that the present value of Norcraft’s projected unlevered free cash flows
through FY2024 was $297.3 million.187
Clarke then calculated Norcraft’s terminal value by (1) dividing Norcraft’s
terminal year unlevered free cash flow by a capitalization rate of 6.1% and
(2) discounting the quotient of that calculation to present value using Norcraft’s
186 JX 18 (Clarke Report) at 3, 42. To derive Norcraft’s WACC, Clarke first “calculated
[1] Norcraft’s cost of equity based on the capital asset pricing model (‘CAPM’) and
[2] Norcraft’s long-term[,] [after-tax] cost of debt.” ld. at 3, 33. Clarke next multiplied
(1) Norcraft’s estimated cost of equity (11.4%) by the proportion of equity in Norcraft’s
capital structure (approximately 75%), as measured by Norcraft’s (undiluted) market
capitalization immediately before the Merger’s announcement ($396 million); and
(2) Norcraft’s estimated after-tax cost of debt (4.31%) by the proportion of debt in
Norcraft’s capital structure (approximately 25%), as measured by the book value of
Norcraft’s long-term debt on March 29, 2015 ($147.5 million). Id. at 33, 42 & sched. 5-B.
Finally, Clarke summed the product of each calculation to obtain a WACC of 9.6%.
Id. at 33.
187 Id., sched. 2-A (DCF analysis).
44
estimated 9.6% WACC.188 This yielded a terminal value of $509.5 million.189
Clarke then added Norcraft’s terminal value to the present value of Norcraft’s
projected unlevered free cash flows through FY2024 to obtain an $806.8 million
operating value.190
Clarke next made the following adjustments to Norcraft’s operating value to
derive Norcraft’s total equity value: (1) adding Norcraft’s excess cash, estimated at
$44.3 million; (2) adding the value (to Norcraft) of TRA-related tax benefits,
estimated at $4.4 million; (3) adding cash received by Norcraft from the (presumed)
exercise of all outstanding options on Norcraft stock, estimated at $18.3 million; and
(4) deducting the book value of Norcraft’s long-term debt_$147.5 million, per
Norcraft’s Form 10-Q for Ql FY2015.191 After making these adjustments, Clarke
188 Id., sched. 2-A (DCF analysis). Terminal year free cash flow is the future value implied
by (1) the subject company’s projected revenue and expense items in the final year of the
discrete projection period; and (2) the subject company’s estimated PGR. See id. Clarke
calculated Norcraft’s capitalization rate as the positive difference of Norcraft’s estimated
WACC (9.6%) and estimated PGR (3.5%). Id. at 43.
189 Id_, sched. 2-A (DCF analysis).
190 Id_
191 Id. Operating value, as stated here, represents the present value of Norcraft’s future
unlevered free cash flows Id. A DCF analysis, however, attempts to derive the value of
the subject company’s equity. Id. at 45. Thus, adjustments to the operating value are
generally necessary to add in equity in the form of excess cash (or cash equivalents) and to
remove debt. Id. at 45-47. Clarke based his excess cash and “cash from option exercise”
estimates on the information disclosed in the Base Case projections and Norcraft’s
Form 10-Q for Ql FY2015. Id. at 45. He based his estimation of the TRA-related tax
45
concluded that Norcraft’s total equity value was $726.3 million.192 Finally, Clarke
divided this aggregate value by Norcraft’s “fully diluted” shares outstanding
(20,880,123) to obtain an aliquot value of $34.78 per share.193
Clarke also performed a comparable company analysis to confirm the results
of his DCF analysis.194 For this analysis, he selected four companies for his peer
group: (1) American Woodmark, (2) Masonite 1nternational Corp. (“Masonite”),
(3) PGT Innovations, Inc. (“PGT”) and (4) Ply Gem Holdings, Inc. (“Ply Gem”).193
The analysis yielded a $33.92 per share valuation.196 Clarke “determined not to
weight this analysis in determining a specific per share value [for Norcraft],
however, due to the difficulties in finding any companies that were fully comparable
to Norcraft.”197
benefits on the “[I.R.C. §] 743(b) and [net operating loss] utilization” projections included
in Citi’s March 28, 2015 presentation to the Norcraft Board. Id. at 46.
192 Id. at 48.
193 Id. Clarke calculated Norcraft’s “fully diluted shares outstanding” as the sum of (1) the
total number of Norcraft shares and stock options outstanding as of the Merger date; and
(2) the total number of convertible Norcraft LLC units (convertible into Norcraft stock)
outstanding on that date. Id.
194 Id. at 2-4.
193 Id. at 51.
196 Id. 314.
197 Id. at 2.
46
2. Austin Smith’s Opinion Regarding Norcraft’s Fair Value
Austin Smith determined that the most reliable indicator of Norcraft’s fair
value as of the Merger date was the Merger Price, “less . . . contemporaneously
estimated synergies [of $3.60 per share]”198_a metric that yields a valuation of
$21.60 per share. Austin Smith also conducted an independent valuation using three
different valuation methodologies: DCF, comparable company and precedent
transaction analyses.199 Based on those approaches, Austin Smith determined that
Norcraft’s fair value as of the Merger date “ranged from 817.48 to no more than
$23.74.”200
Austin Smith’s primary DCF analysis, like Clarke’s, relied on the Base Case
projections (adjusted to deduct for income tax expense in each of the projected years)
and applied a 3.5% PGR at the end of the projection period.201 Unlike Clarke,
however, Austin Smith did not extend the Base Case projections.202
198 JX 20 (Austin Smith Report) at 29 (emphasis in original). Austin Smith based her $3.60
per share “synergies” figure on “the presentations of Citi and the work done by RBC.” TT
704:24_705:1 (Austin Smith).
199 JX 20 (Austin Smith Report) at l.
200 ld_
201Id. at 20-21, 23 & Ex. 6 (DCF Analysis). Austin Smith performed two additional DCF
analyses, one relying on the Ginter 2014 Proj ections, which valued Norcraft at $15.59 per
share, and another relying on a Capitalization of Cash Flow methodology, which valued
Norcraft at $12.65 per share. Id. at 23-24.
202 Id. at 23 & Ex. 6 (DCF Analysis).
47
After determining Norcraft’s projected unlevered free cash flows through
Norcraft’s FY2019, Austin Smith discounted each year’s projected free cash flow
amount to present value using a 11.2% discount rate based on her estimate of
Norcraft’s WACC.203 From this, Austin Smith concluded that the present value of
Norcraft’s projected unlevered free cash flows through FY2019 was $151 million.204
Austin Smith then calculated Norcraft’s terminal value by (1) dividing
Norcraft’s terminal year unlevered free cash flow by a capitalization rate of 7.69%
and (2) discounting the quotient of that calculation to present value using Norcraft’s
estimated 11.2% WACC.203 Austin Smith concluded that Norcraft’s terminal value
was $435 million.206 She then added Norcraft’s terminal value to the present value
203 Id. at 20.
204 Id., Ex. 6 (DCF Analysis). To derive Norcraft’s WACC, Austin Smith first calculated
(1) Norcraft’ s cost of equity based on CAPM and (2) Norcraft’ s after-tax cost of debt (using
a 37.69% tax rate). Id., Ex. 5 (Calculation of WACC). She next multiplied (1) Norcraft’s
estimated cost of equity (12.4%) by a target proportion of equity in Norcraft’s capital
structure (86%), based on the capital structure of selected comparable companies; and
(2) Norcraft’s estimated after-tax cost of debt (3.6%) by a target proportion of debt in
Norcraft’s capital structure (14%), again based on a “comparable capital structure”
approach. Id., Exs. 4 (Calculation of Beta) and 5 (Calculation of WACC). Finally, Austin
Smith summed the product of each calculation to obtain a WACC of 11.2%. Id., Ex. 5
(Calculation of WACC).
203 See id., Ex. 5 (Calculation of WACC). This is the same approach Clarke followed to
determine terminal value (with different inputs). JX 18 (Clarke Report), sched. 2-A (DCF
analysis).
206 JX 20 (Austin Smith Report), Ex. 6 (DCF Analysis).
48
of Norcraft’s projected unlevered free cash flows through FY2019 to obtain a
$5 86 million operating value.207
Austin Smith made two adjustments to Norcraft’s operating value to
determine Norcraft’s total equity value: (1) adding Norcraft’s excess cash, estimated
at $52.7 million208; and (2) deducting the book value of Norcraft’s long-term debt-
$147.5 million, per Norcraft’s Form 10-Q for Ql FY2015.209 Having made these
adjustments, Austin Smith concluded that Norcraft’s total equity value was
$491 million.210 She then divided this total equity value by Norcraft’s “fully diluted”
shares outstanding (20,880,123) to obtain an aliquot value of $23.54 per share.211
207 Id
208 JX 537 (native Excel version of Austin Smith’s DCF model). Austin Smith calculated
Norcraft’s excess cash on the Merger date based on the “Cash from Norcraft” figure in the
“Funds Flow Memorandum” prepared in connection with the Merger ($54,396,335.01),
JX 249 at 2, less a $20 million cash balance (cash for operations, per the Base Case
projections) plus the product of (1) Norcraft’s total options outstanding as of the Merger
date (1,142,383) and (2) the weighted average exercise price of those options ($16.01).
JX 20 (Austin Smith Report), Ex. 6 (DCF Analysis) (drawing option-related information
from Norcraft’s Ql FY 2015 10-Q, JX 248 at 14).
209 JX 20 (Austin Smith Report), Ex. 6 (DCF Analysis).
210 ]d_
211 Id. Austin Smith calculated Norcraft’s fully diluted shares outstanding as 20,869,976.
JX20 (Austin Smith Report) at 13 & n.25. lt is unclear how Austin Smith derived this
figure, and the figure conflicts with the information set forth in Norcraft’s Form 10-a for
Ql FY2015 and the “Funds Flow Memorandum” prepared in connection with the Merger.
See JX 248 (Norcraft’s Ql FY2015 Form 10-Q) at 4, 11 (17,311,573 shares of Norcraft
common stock outstanding, 2,426,167 convertible Norcraft LLC units outstanding and
1,142,383 options on Norcraft stock outstanding as of March 31, 2015); JX 249 (Funds
F low Memorandum) at 3, 11 (18,947,886 shares of Norcraft common stock outstanding,
49
Finally, upon “summing th[is] . . . component[] of [Norcraft’s] value” with the value
of the TRA-related tax benefits that Norcraft would realize in each projected year
(estimated at $0.20 per share), Austin Smith determined that “the per share value of
Norcraft was $23.74” as of the Merger date.212
As noted, Austin Smith also undertook to value Norcraft using two “market-
based” valuation methodologies Her comparable company analysis yielded a
valuation of $23.46 per share and her precedent transaction analysis yielded a
valuation of $17.48 per share.213
According to Austin Smith, “[t]he high level of consistency between [her]
three separately determined estimates of fair value and the [Merger Price] (less
synergies) provides strong analytical support that $21.90 accurately represents the
per share fair value of Norcraft.”214 1n addition, Austin Smith submits, “the fact that
the [Merger Price] derived from a robust deal process” lends “additional support” to
her fair value determination.213
789,854 convertible Norcraft LLC units outstanding and 1,142,3 83 options on Norcraft
stock outstanding as of May 11, 2015). Both documents indicate a figure of 20,880,123
fully diluted shares outstanding as of the Merger date.
212 JX 20 (Austin Smith Report) at 23.
213 Id. 3125-28.
214 Id. at 29.
213 Id. 1n her reports and trial testimony, Austin Smith provided only a cursory_and
mostly conclusory_discussion of Norcraft’s deal process See id. at 19_20; TT 701-703
50
3. Subramanian’s Opinion Regarding Norcraft’s Deal Process
Professor Subramanian served as Petitioner’s deal process expert.216
According to Subramanian, Norcraft’s deal process was flawed in several respects
that rendered the process “unlikely to have yielded fair value for the Norcraft
shareholders.”217 The principal flaws Subramanian identifies are (1) the lack of any
“competitive process to acquire Norcraft prior to the signing of the Merger
Agreement”218; (2) information asymmetries between Fortune and potential third-
party bidders219; and (3) the presence of certain deal protection mechanisms that
curbed the efficacy of the go-shop and effectively truncated the Go-Shop Period by
at least five days.220
a. Absence of Pre-Signing Competition
Subramanian posits that Norcraft’s “decision to negotiate exclusively with
Fortune” prior to signing the Merger Agreement “eliminated a standard source of
bargaining leverage for Norcraft”_namely, “invok[ing] the threat of an alternative
(Austin Smith). She also acknowledged that she had never before been called upon to offer
expert testimony on the efficacy of a sales process TT 791 :20_24 (Austin Smith).
216 JX 19 (Subramanian Report) at 24_25.
217 Id. 3126.
218 ]d_
219 Id. 3125, 33-36.
220 Id. at 25, 45_52.
51
deal” to extract a higher price.221 Consequently, Norcraft was unable to move
Fortune above its proposed purchase price of $25.50.222 Moreover, Subramanian
submits, it does not appear “that Norcraft extracted something else [from Fortune]
in exchange for exclusivity.”223
As a practical matter, the absence of pre-signing competition “meant that the
Norcraft Board was relying on [the] go-shop process to ensure that Norcraft
shareholders received fair value.”224 According to Subramanian, this reliance was
misplaced because Norcraft’s go-shop process was so poorly structured that it was
rendered entirely ineffective as a price discovery tool.225
b. Information Asymmetries
Subramanian next posits that certain information asymmetries between
Fortune and prospective acquirors vitiated the effectiveness of Norcraft’s go-shop
process.226 As noted, Fortune first approached Norcraft regarding a potential
acquisition on October 20, 2014, and the parties signed a confidentiality agreement
221 Id. at 30 (intemal quotation and footnote omitted).
222 Id. at 31; see TT 100:4_17 (Biggart); JX 238 (Norcraft Schedule 14D-9) at 13.
223 JX 19 (Subramanian Report) at 31.
224 Id. at 32.
225 Id. 21132-33.
226 Id. at 25, 33-36.
52
on December 11, 2014.227 Exclusivity soon followed.228 This dynamic gave Fortune
a substantial head start relative to other potential suitors in evaluating the benefits
and challenges of a Norcraft transaction, including the complex issues relating to the
TRAs.229 And, per Subramanian, “[t]his discrepancy . . . created a severe
information asymmetry problem, because it would be virtually impossible for
prospective third-party bidders to [leam] as much about Norcraft as Fortune
[already knew]” in the thirty-five days allotted for Norcraft’s go-shop process.230
Moreover, Subramanian submits, regardless of whether Fortune’s “first
mover” status provided it with an actual benefit, potential competing bidders would
have perceived Fortune to enjoy an informational advantage.231 That perceived
advantage, in tum, discouraged others from bidding for Norcraft to avoid the
“winner’s curse”_a phenomenon that occurs in common value auction settings
221 PTo 1111 2k, 2p.
221 PTo 11 2w.
229 JX 19 (Subramanian Report) at 29-30, 34 (“Fortune . . . signed a confidentiality
agreement on December 11th, 2014, and then had 110 days of exclusive access to
confidential information and management time at Norcraft before the deal was announced
on March 30th, 2015.”). During the course of those 110 days, both Norcraft and Fortune
had to deal not only with valuation issues relating to the Norcraft business, but also
complex tax and valuation issues (with the help of separate independent experts) relating
to the TRAs JX 5 (Klein Dep.) at 137-38.
230 JX 19 (Subramanian Report) at 34.
231 See id. at 35.
53
where the winning bidder has “buyer’ s remorse” because it has overpaid for the asset
in question.232 That remorse is a product, in part, of the winner’s perception that it
lacked an adequate understanding of the asset before it made its bid.233 Here,
Subramanian submits, because potential competing bidders for Norcraft perceived
that Fortune knew more about the Company than they could hope to learn in thirty-
five days, they may well have feared that they would end up overpaying to acquire
Norcraft if they outbid Fortune.234
c. Deal Structure Minimizes Eff"lcacy of the Go-Shop
According to Subramanian, the interaction between certain deal protection
provisions in the Merger Agreement and the TSAs effectively truncated the Go-Shop
Period “from 35 days to 30 days or even shorter.”233 As noted, the Merger
Agreement entitled Fortune to launch Tahiti’s tender offer for Norcraft’s stock
fifteen days into the Go-Shop Period.236 ln addition, under the TSAs, Buller, SKM
and Trimaran were obligated to tender 53 .6% of Norcraft’s outstanding voting stock
232 Id. at 35-36 (citing Guhan Subramanian, Deal Makz'ng: T he New Strategy of
Negotiauctions 87-88 (2011)).
233 Id. at 40-41.
234 Id. Per Subramanian, Fortune’s unlimited match right compounded the “winner’s
curse” problem, and so operated as a “‘powerful disincentive’ to prospective third-party
bidders.” Id. at 43 (footnote and citation omitted).
233 Id. at 52.
236 JX 221 (Merger Agreement), pmbl. & § 1.1.
54
into Tahiti’s tender offer “promptly following” the initiation of the offer and, in any
event, no later than two days before the offer’s initial expiration date.237 And that
tender could not be rescinded absent a “full-blown superior proposal.”238
Thus, if Fortune launched Tahiti’ s tender offer halfway through Norcraft’ s go-
shop process (as it did),239 53.6% of Norcraft’s voting shares would “promptly” be
tendered to Tahiti_and that tender would be irrevocable absent a superior proposal.
Moreover, even if Norcraft received a superior proposal during the Go-Shop Period,
Fortune would still have at least four days to match that proposal.240
According to Subramanian, the confluence of the deal protections, the limited
duration of the Go-Shop Period, Fortune’s unlimited match right, the definition of
“superior proposal” and Fortune’s ability to launch Tahiti’s tender offer during the
go-shop, resulted in a systematic “tightening and shortening” of the go-shop process.
The “tightening” occurred because “a third party would have to make a full-blown
»241
superior proposal, not just get to excluded party status, by the end of the 35 days.
The full-blown superior proposal was required for Norcraft to terminate the Merger
237 JX 229 (Buller TSA) § 3; JX 230 (SKM TSA) § 3; JX 231 (Trimaran TSA) § 3.
233 TT 254:21~255:7 (Subramanian); JX 221 (Merger Agreement) § 1.1.
239 PTO 1[ 2ee.
240 JX 221 (Merger Agreement) § 5.4(g).
241 TT 255:4_7 (Subramanian).
55
Agreement and prevent Tahiti from accepting the shares tendered pursuant to the
TSAS (a majority of the shares outstanding). Subramanian explained:
Ordinarily, if this was a normal go-shop, you’d have excluded party
status by the end of the go-shop period. But . . . [here] you’ve got to
get to a superior proposal. Got to get the whole shebang done, as
Chancellor Strine said it in Lear, by the end of the go-shop period. And
in my observation and in my experience looking at these go-shops, that
is a big deal. Having to get to an entire superior proposal by the end of
the go-shop period is a very different task than getting to simply
excluded party status.242
The ”shortening” occurred because any potential bidder contemplating
whether to participate in the go-shop could wait no longer than April 30_what
Subramanian terms the “last clear chance” date_to make its superior proposal if it
wanted to ensure that (i) the Norcraft Board had the two business days it was allowed
under the Merger Agreement to assess the proposal and declare it superior;
(ii) Fortune’s four-business-day period to match expired; and (iii) Norcraft
terminated the Merger Agreement before Fortune (via Tahiti) could close on the
tendered Covered Shares. The following graphic from Subramanian’s report
illustrates the “tightening and shortening” phenomenon:
242 TT 299:18-300:4 (Subramanian).
56
“Last C|ear Chance” For a Third-Party Was On April 30th
Mon Tue wad Thu Fri Mon Tue Wed 'Thu"\ Frl Ml:m Tue Wed Thu Frl Mr.\n Tue
4{20 4/21 rlle d,!?..’, 4!24 4}27 MZB 4/29 (\4{30!,- 5!1 5/4 515 516 517 513 5]11 5;1;!
Go-Shop Period (began on 3/30] _->
Coh"ci_l.ls``_i``on'; N_of*.":_``¢?aftitan '
Exc|uded Party _t¢'rmiq;:_;_t¢ ghe_Me_;_-Bgr_
identified .Agre_ernerj:'t'_hefqne ramp cruise .
the TO§-§'t!.)i'=h allows Ifhpus?§§
Superior Proposa! 1 does not§§§§euimj Cove``r'ed 3§§
Made Shares tb§:§§§l;§d 'f'l"oi'n' TO``
Norcraft board T one day befd;r§:'§§§°uid close
convenes, declares
Excluded Party & ¢Day
Superior Proposei 4- Match _»
Right
Tender Offer (began on 4/14} _"'__'P
Covered Shares
Must Be Tendered
Jx19 at 45_52 13
Subramanian also observes that, even without the “tightening and shortening”
of the go-shop, Fortune’s unlimited match right stands alone as a disabling feature
of this go-shop.243 According to Subramanian, from the perspective of a potential
bidder, unlimited match rights are typically perceived as limiting any “pathway to
success.”244 Indeed, Subramanian submits, “[e]verybody agrees that match rights
deter bids. lt [is] not even a debated question.”245
243 JX 19 (Subramanian Report) at 41~44; JX 221 (Merger Agreement) at § 5.4(g).
244 JX 19 (Subramanian Report) at 50.
245 TT 254;4_7 (Subramanian).
57
Here again, Fortune was acutely aware of the advantage it secured, while
Norcraft’s Board apparently did not understand what an unlimited match right was
6In
much less how that deal protection might work to hinder the go-shop.24
describing the disparity in the sophistication of the two parties negotiating this
Merger, Subramanian observed: “it seems like . . . the Fortune side was playing chess
and the Norcraft side was playing checkers.”247
J. ProceduralPosture
Petitioners filed a petition with this Court on June 22, 2015, seeking appraisal
of their 557,631 shares of Norcraft common stock.248 The Court held a four-day trial
in June 2017, and the parties thereafter submitted post-trial briefing
On December 20, 2017, the Court requested supplemental submissions from the
parties to address certain questions following the Delaware Supreme Court’s
December 14, 2017, decision in Dell.249 The Court heard post-trial argument on
Apri125, 2018.
246 Compare JX 232 (e-mail chain between RBC, Klein and other members of Fortune’s
deal team, Apr. 7, 2015) with JX 11 (Reilly Dep.) at 125:3-22 and JX 3 (Buller Dep.)
at 206:16-207:24.
247 TT 269:8-11 (Subramanian).
243 JX 260 (Petition for Appraisal).
249177 A.3d1;D.I.91.
58
II. ANALYSIS
Our appraisal statute, 8 Del. C. § 262, provides, “[t]hrough [the appraisal]
proceeding, 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 or
consolidation, together with interest, if any, to be paid upon the amount determined
to be the fair value. In determining such fair value, the Court shall take into account
all relevant factors.”250 “Easy enough,” one might say on a first read, but the judicial
appraisal process, through the years, has proven to be anything but “easy.”231
“Section 262(h) unambiguously calls upon the Court of Chancery to perform
an independent evaluation of ‘fair value’ at the time of a transaction . . . [and] vests
250 8 Del. C. § 262(h).
251See, e.g., In re Orchara'Enters., Inc., 2012 WL 2923305, at * 18 (Del. Ch. July 18, 2012)
(“As a law-trained judge who has to come up with a valuation deploying the learning of
the field of corporate finance, I choose to deploy one accepted method as well as I am able,
given the record before me and my own abilities.”); Global GTLP, 993 A.2d at 517 n.126
(explaining that “academics and professionals throw around . . . ranges of value [that] are
used by a law-trained judge to come to a single point estimate of value” and that “[t]he
law-trained judges who must perform such analyses are more conscious than anyone of the
inherent risk of error in such an endeavor, and indeed of the reality that no one can really
tell if an error was made”), ajj"d, 11 A.3d 214; Finkelstein, 2005 WL 1074364, at *12
(“The judges of this court are unremittingly mindful of the fact that a judicially selected
determination of fair value is just that, a law-trained judge’s estimate that bears little
resemblance to a scientific measurement of a physical reality.”). Indeed, “the judges of
this Court” have lamented the challenges posed by the appraisal statute for many years.
While perhaps repetitive, these expressions serve a valuable function; they serve as a
longhand way of saying to the parties and the community of interest: “I’ve done the best l
can here.”
59
the Chancellor and Vice Chancellors with significant discretion to consider
‘all relevant factors’ and determine the going concern value of the underlying
company.”252 “By instructing the court to ‘take into account all relevant factors’ in
determining fair value, the statute requires the Court of Chancery to give fair
consideration to ‘proof of value by any techniques or methods which are generally
considered acceptable in the financial community and otherwise admissible in
court.’ Given that ‘[e]very company is different; [and] every merger is different,’
the appraisal endeavor is ‘by design, a flexible process.”’233
Taking to heart the mandate of Section 262(h), as reiterated by our Supreme
Court, I have carefully considered all relevant factors. And 1 have assigned those
factors the weight (or not) 1 determined they deserve based on my evaluation of the
credible evidence, and my application of “accepted financial principles” as derived
from that evidence.254
A. The Merger Price is Not a Reliable Indicator of Norcraft’s F air Value
As our Supreme Court has recognized, “corporate finance theory reflects a
belief that if an asset_such as the value of a company as reflected in the trading
252 DFC, 172 A.3d at 364 (quoting 8 Del. C. § 262(h)).
233 Dell, 177 A.3d at 21 (quoting Weinberger v. UOP, 457 A.2d 701, 713 (Del. 1983);
Golden Telecom, 11 A.3d at 218; and In re PetSmart, Inc., 2017 WL 2303599, at *26 (Del.
Ch. May 26, 2017)) (alteration in original).
254 Dell, 177 A.3d at 22.
60
value of its stock-can be subject to close examination and bidding by many humans
with an incentive to estimate its future cash flows[’] value, the resulting collective
judgment as to value is likely to be highly informative[.]”233 So long as “all
estimators hav[e] equal access to information, the likelihood of outguessing the
market over time and building a portfolio of stocks beating it is slight.”256 Thus, the
Supreme Court has emphasized that our courts must appreciate “the economic reality
that the sale value resulting from a robust market check will often be the most
reliable evidence of fair value, and that second-guessing the value arrived upon by
the collective views of many sophisticated parties with a real stake in the matter is
hazardous.”237
Nevertheless, our Supreme Court has declined on several occasions to
pronounce a presumption in favor of deal price in determining fair value.238 Instead,
it has reiterated the “flexible” nature of the trial court’s fair value calculus, while
also noting its lack of “confidence in [its] ability to craft, on a general basis, the
255 DFC, 172 A.3d at 370.
2561d
257 Id. at 366.
233 See, e.g., id.; Golden Telecom, 11 A.3d at 217-18.
61
precise pre-conditions that would be necessary to invoke a presumption” in favor of
the deal price.239
Here, Norcraft’s deal process did not include a meaningful market check and,
consequently, the Merger Price was not “arrived upon by the collective views of
many sophisticated parties with a real stake in the matter.”260 Prior to the execution
of the Merger Agreement, the Company chose to negotiate with Fortune and Fortune
alone.261 That decision, if made as a strategic choice, does not alone render
Norcraft’s deal process unsound.262 Nor does it preclude a finding that Norcraft’s
deal process resulted in a reliable indication of fair value (reflected by the Merger
Price). lndeed, even Petitioners’ expert has acknowledged that negotiating with a
239 DFC, 172 A.3d at 366.
2601d.
261 TT 13_15 (Eldridge).
262 See In re Fort Howara' Corp. S’hola'ers Litig., 1988 WL 83147, at *13~14 (Del. Ch.
Aug. 8, 1988) (finding board-chosen single-bidder process satisfied Revlon duties); In re
Pennaco Energy, Inc., 787 A.2d 691, 706 (Del. Ch. 2001) (“[T]he mere fact that the
Pennaco board decided to focus on negotiating a favorable price with Marathon and not to
seek out other bidders is not one that alone supports a breach of fiduciary duty claim.”);
In re MONY Gp. Inc. S’holder Litig., 852 A.2d 9, 21 (Del. Ch. 2004) (same) (quoting
Pennaco, 787 A.2d at 706).
62
single potential buyer pre-signing can, in certain instances, lead to significant
value.263
But the single bidder focus here, while perhaps not amounting to a breach of
fiduciary duty,264 did not provide a meaningful market check as would yield a
reliable indication of fair value. First, there is no evidence that the Board or Citi
employed a single bidder approach for the sake of achieving a strategic advantage
or maximizing value. Second, and more troubling, the Board’s focus on only one
bidder was tainted by the fact that Buller (who was conflicted) served as Norcraft’s
lead negotiator from start to finish.
The shambolic pre-signing process left Norcraft’s post-signing go-shop as the
only meaningful opportunity to check the market.265 Unfortunately, Fortune
263 JX 31 (Guhan Subramanian, Go-Shops vs. No-Shops in Private Equity Deals: Evia’ence
and lmplicalions, 63 Bus. Law. 729 (2008)) at 755 (“[A] pure go-shop can be a valuable
tool for extracting the highest possible price in the sale of [a] company.”).
264 M.P.M Enters., Inc. v. Gilbert, 731 A.2d 790, 797 (Del. 1999) (“A fair merger price in
the context of a breach of fiduciary duty claim will not always be a fair value in the context
of determining going concern value.”); In re Traa'os Inc. S’holder Litig., 73 A.3d 17, 78
(Del. Ch. 2013) (“A court could conclude that a price fell within the range of fairness and
would not support fiduciary liability, yet still find that the point calculation demanded by
the appraisal statute yields an award in excess of the merger price.”); Reis v. Hazelett Strip-
Castz``ng Corp., 28 A.3d 442, 466 (Del. Ch. 2011) (same).
263 Petitioners urge the Court to conclude that “a go-shop only process” is, per se,
inadequate to generate fair value. Pet’rs’ Post Trial Opening Br. 3 (citing IQ Hldgs. v. Am.
Commercial Ll``nes, 2013 WL 4056207 (Del. Ch. Mar. 18, 2013) and Hujj’FundInv. P ’ship
v. CKx, Inc., 2013 WL 5878807, at *13 (Del. Ch. Nov. 1, 2013)). Having reviewed the
cited authority, I do not see where IQ Holdings addressed the issue at all. As for CKx, Inc.,
while the court acknowledges that a scenario where the only market check is an
63
extracted concessions from Norcraft that rendered the go-shop process equally
ineffective as a price discovery tool.
1. The Board’s Singular Focus on Fortune, Failure to Manage Buller’s
Conflicts and Misplaced Reliance on the Go-Shop
There is no dispute that neither Norcraft nor Citi contacted other bidders
before Norcraft signed the Merger Agreement This resulted in lost opportunities
Not only did Norcraft miss the opportunity to test the market before committing to
Fortune, it also missed the opportunity to leverage the interest of another suitor to
extract a higher price from Fortune. Given these missed opportunities, it is not
surprising that, by the time the parties settled on the Merger Price, Norcraft’s
management still believed that the merger consideration was too low.266 The plan,
therefore, was to put all eggs in the go-shop basket as a means to achieve fair value
for Norcraft stockholders.267
unsuccessful go-shop might undermine the reliability of the deal price as an indicator of
fair value, the court says nothing of adopting a rule that a go-shop alone will never produce
fair value for the target. Id. at *13. I see no basis in law or fact to adopt such a rule.
266 JX 140 (e-mail from Reilly to Buller, Maselli and Citi representatives, Feb. 20, 2015)
(Reilly: “I do believe we are leaving $ on the table”); TT 29:19_22 (Eldridge) (Buller
“eager to try and find a buyer at a higher valuation”); JX 13 8 (e-mail from Ginter to Buller,
Feb. 19, 2015) (“Current offer will be 10.9x or less by the time we close in April at $25.50.
so we weren’t happy with the deal in [O]ct[ober] but now we are?”).
267 See JX 3 (Buller Dep.) at 85-86.
64
Of course, on the other side of the table, Fortune perceived the Merger Price
as very favorable (to Fortune).263 lt was protective of that price and sought to avoid
or limit the go-shop to preclude a topping bid.269 And that is precisely what it did.
Norcraft’s Board left the negotiations principally to Buller. Yet Buller was
just as (if not more) fixated on extracting commitments from Fortune regarding the
TRAS and his future role with the combined company as he was on securing the best
price possible for Norcraft. Fortune, for its part, was “stringing Buller along” as it
negotiated with him over the Merger Price, leading him to believe he might continue
268 JX 185 (e-mail chain between Fortune director David Mackay and Klein, Mar. 20, 2015)
(Mackay: “Looks very positive[.] A good strategic fit at a reasonable price . . . I fully
support the deal and hope no one comes along and offers more.”); id. (Klein:“You are spot
on _ its [sic] a good price, and there is a risk someone comes along and tries to top the
offer.”); JX 300 (Mar. 31, 2015 e-mail from Fortune director Mackay to Fortune’S other
directors and deal team members) (“Let’s hope no one bids!”).
269 TT 146:18-147:9 (Biggart) (explaining a Fortune presentation analyzing potential go-
shop competitors “[b]ecause at this point in time, we’re about to agree to a go-shop, and
our CEO is very upset about the idea of doing this”); see also JX 5 (Klein Dep.) at 164:1 1-
22 (“Q. And Norcraft insisted on some type of go-shop process, right? A. Yes. Q. And
in the context of negotiating that, your goal was to minimize the chances that the go-shop
process would result in a higher bidder, -- A. l wanted to -- Q. -- correct? A. -- give them
what they needed _ the minimum amount they needed to satisfy their fiduciary
responsibility which I know they had.”). Of course, it is not unusual_or inherently
problematic-for a prospective acquiror to want to avoid being outbid after having
expended considerable time, effort and funds. Fortune’s attitude, however, suggests that it
appreciated the pre-sign process did not yield fair value for Norcraft stockholders and that
it wanted to protect that advantage throughout the go-shop process. Again, this is precisely
what the Board reasonably should have expected from the party sitting on the other side of
the table.
65
his employment with Fortune post-close.270 When Fortune finally informed Buller
(after settling on the Merger Price) that he would have no place at Fortune post-
close, Fortune secured Buller’s continued commitment to the Merger by stringing
him along again, this time by dangling the possibility that Fortune would be willing
to sell Norcraft Canada to Buller after the closing.271
The Board either did not appreciate Buller’s conflict, or chose not to manage
it, until Buller announced that he would pursue the acquisition of Norcraft Canada
after closing.272 By then, Buller had been spurring with Fortune in an attempt to
extract every dollar he demanded for the TRAs (diverting consideration from the
stockholders) and had pushed hard for post-closing employment with Fortune. Yet
all along, the Board did nothing to manage the conflict_it did not form a special
committee of its members to negotiate with Fortune or take any other steps to
neutralize Buller’s influence. Even its half-hearted effort to recuse Buller from
276 JX 166 (e-mail from Klein to Fortune deal team, Mar. 12, 2015); TT 205 (Biggart)
(On March 6, 2015, Fortune “definitively told [Buller] he didn’t have the job.”).
271 See JX 189 (e-mail chain between Dave Randich, head of Fortune’s cabinet division,
Klein and members of F ortune’s deal team, Mar. 23, 2015); JX 199 (Mar. 26, 2015 e-mail
from RBC to Klein and other members of Fortune’s deal team); JX 202 (Mar. 27, 2015 e-
mail from Buller to PwC); JX 194 (e-mail chain between members of Norcraft and Fortune
deal teams, Mar. 25, 2015).
272 JX 11 (Reilly Dep.) at 158-160.
66
further Board deliberations regarding the Merger following his demonstrated interest
in Norcraft Canada proved ineffective.273
Given that the single-bidder pre-signing process led by a conflicted negotiator
yielded what at least some within Norcraft deemed unsatisfactory consideration, it
was imperative that the Norcraft Board run an effective post-signing go-shop. It did
not.
2. The Post-Sign Go-Shop Provides No Basis to Rely on the Deal Price
Although it is hardly clear that Norcraft’s Board appreciated this fact, the
ineffective pre-signing process should have made clear that the post-signing go-shop
would offer the only real opportunity for a meaningful market check.274
Unfortunately, that process fell far short on many levels, as the following evidence
illustrates:
l Prior to the Go-Shop Period, it was not widely known that Norcraft was “up
for sale”273; thus, potentially interested parties did not know that Norcraft was
273 JX 13 (Biggart Dep.) at 107_109, 111:6_112:3; JX 194 (e-mail chain between members
of Norcraft and Fortune deal teams, Mar. 25, 2015).
274 In re AOL, Inc., 2018 WL 1037450, at *9 (Del. Ch. Feb. 23, 2018) (observing “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”).
273 The Merger Agreement was publicly announced on March 30, 2015. See JX 227
(Norcraft Mar. 30, 2015 Proxy Statement) at 3. That same day, the Go-Shop Period began.
PTO 11 200.
67
“in play” before the Merger was announced, putting them Several steps behind
Fortune in pursuing an acquisition of Norcraft276;
l Norcraft’s Board appeared to lack even a basic understanding of the terms and
function of the go-shop277;
276 JX 19 (Subramanian Report) at 34; JX 243 (Citi Buyers Log) at 2 (“investment is too
big [] to consider in a short period”); ia'. at 12 (“can’t move fast enough in 35 days”);
ia’. at 2, 5, 7~9 (prospective bidders explaining they had no interest in competing against
Fortune).
277 See, e.g. , JX 3 (Buller Dep.) at 207:5-24 (“Q. Do you know what Norcraft’s rights were
if another proposal came in during the go-shop period? A. Don’t recall. Q. Do you have
any knowledge of what Norcraft could have done if one of the go-shop parties was
interested and made a bid? A. We could have pursued the offer. Q. Were there any
restrictions on Norcraft’s ability to pursue an offer? A. Some, but 1 don’t recall what they
were. . . . Q. Do you recall anything about Fortune’s rights if another offer came in?
A. I don’t recall.”); JX 8 (Eldridge Dep.) at 85:17-19 (“Q. What kind of matching rights
did Fortune have in this transaction? A. I don’t recall.”); JX 9 (Maselli Dep.) at 75:5-
78:5 (“Q. Under the terms of the merger agreement, what needed to occur for a go-shop
participant to continue to negotiate with Norcraft regarding a possible sale after the go-
shop period ended? . . . A. I don’t know what the threshold was, but . . . if it was a
sufficiently robust offer, they would have an opportunity to complete the transaction.”);
JX 11 (Reilly Dep.) at 121:3-130:20 (“Q. Did you personally ever consider what effect
the tender and support agreements would have on the go-shop process? A. I can’t recall.
. . . To be honest with you, l’m not an expert in going private transactions, though I’ve
been around for a while; and, in my estimation, the retention of both Ropes and Citibank
and to rely on their advice and counsel with respect to the process was, you know, doing
my duty. So that’s kind of what we really looked to the experts to help us. . . . Q. What
are matching rights? A. I have no idea. . . . Q. Okay. Well, do you know what type of
matching rights Fortune had in Norcraft’s go-shop process? . . . A. I don’t recall. . . .
Q. Do you recall any discussions among Norcraft’s directors or officers with respect to
Fortune’s matching rights in this go-shop process? A. I do not. Q. Under the merger
agreement that Norcraft signed with Fortune Brands, what needed to happen for a go-shop
participant to continue to negotiate with Norcraft regarding a possible sale after the go-
shop period ended? A. Idon’t recall.”); cf. JX 1 (Ginter [CFO] Dep.) at 140:9_14 (“A.
My knowledge of a go-shop is limited in that regard. I know the banks ran it for us and
prepared a list of potential investors that may be interested in looking at Norcraft. But my
knowledge of a go-shop is limited to that and what I learned during the process.”).
68
l Any potential bidder had to value the TRAs_and provide for the satisfaction
of Norcraft’s payment obligations thereunder_within the Go-Shop Period, a
task that Fortune had several months to complete (and struggled to navigate
successfully, even with the assistance of expert tax advisors)273;
l Fortune had an unlimited match right under the Merger Agreement, which
gave Fortune four business days to match a superior proposal by a third-party
bidder and two business days to match any subsequent proposal by the same
bidder279;
l In order to proceed with an alternate transaction, Norcraft had to receive a
“Superior Proposal” by the end of the Go-Shop Period, “essentially
requir[ing] the bidder to get the whole shebang done within the [Go-Shop
Period].”230 This requirement was made more onerous by the TRAS’
interaction with the Merger Agreement’s go-shop provisions, allowing
“Fortune [to] close its tender offer for the 54 percent [of Norcraft common
stock] before Norcraft [could] terminate the merger agreement, because
Norcraft [couldn’t] terminate on the possibility of a superior proposal.
[Rather, Norcraft could] only terminate after [it had] given Fortune four days
to match. And the four days [could] go beyond the tender offer expiration.”231
273 JX 5 (Klein Dep.) at 137-139; JX' 11 (Reilly Dep.) at 164_165; JX 130 (Feb. 9, 2015
RBC presentation regarding TRA value); JX 162 (Mar. 10, 2015 RBC email attaching
questions regarding TRAs).
279 JX 221 (Merger Agreement) § 5.4(g); see Lena'er Processing, 2016 WL 7324170, at
*25 (“In this case, the most persuasive explanation is that the existence of an incumbent
trade bidder holding an unlimited match right was a sufficient deterrent to prevent other
parties from perceiving a realistic path to success. . . . Without a realistic path to success,
it made no sense to get involved.”). Fortune’s Vice President of M&A confirmed that “the
team at Fortune understood that unlimit[ed] matching rights would discourage potential
bidders in a go-shop process.” JX 12 (Baab Dep.) 99-100. And, Fortune’s CEO touted
Fortune’s match right when instructing RBC how to dissuade potential go-shop
participants from bidding. JX 232 (e-mail chain between RBC, Klein and other members
of Fortune’s deal team, Apr. 7, 2015).
230 In re Lear Corp. S ’hola’er Ll``tig., 926 A.2d 94, 119-20 (Del. Ch. 2007).
281 TT 289;1_7 (Subramanian).
69
l On April 14, 2015, about two weeks into the thirty-five-day Go-Shop Period,
Fortune launched Tahiti’s tender offer,232 triggering the TSAS and causing
53.6% of Norcraft’s outstanding shares to be committed to supporting the
Norcraft-Fortune transaction absent a superior proposal233; ana’
l In a fit of bad judgment, RBC attempted to contact and dissuade possible
bidders from topping Fortune’s bid during the go-shop.234
Presented with this factual record, I am not persuaded that Norcraft’s go-shop
process provided a meaningful market check that resulted in a transaction price
derived from the “collective views of many sophisticated parties with a real stake in
the matter.”235 Accordingly, I do not accord any weight to the deal price in my fair
value calculus.236
232 PTO 11 2ee. As noted, the Go-Shop Period began on March 30, 2015. PTO 11 2cc.
233 JX 229 (Buller TSA); JX 230 (SKM TSA); JX 231 (Tl'imararl TSA).
234 JX 232 (e-mail chain between RBC, Klein and other members of Fortune’s deal team,
Apr. 7, 2015) (RBC describing its planned efforts to dissuade potential buyers); id. (Klein
expressing his interest in RBC “shutting the door on [potential buyers] and their willingness
to look at [Norcraft]”).
233 DFC, 172 A.3d at 366. Respondent advanced deal price less synergies as reflecting
Norcraft’s fair value. Accordingly, it was Respondent’s burden to prove the reliability of
Norcraft’s deal process. Respondent, however, failed to meet that burden_its witnesses
struggled to recall basic aspects of the deal process and its valuation expert presented only
a cursory, mostly conclusory, analysis of that process. Petitioners, on the other hand,
presented credible evidence demonstrating that deal price less synergies is not a reliable
indicator of Norcraft’s fair value.
236 This, of course, means that l give no weight to Austin Smith’s deal price less synergies
valuation,
70
3. Insuff``icient Evidence to Consider the Efficient Market Hypothesis
Following our Supreme Court’s renewed endorsement of the efficient capital
market hypothesis in Dell, 1 requested that the parties submit supplemental post-trial
briefing addressing whether Norcraft’s unaffected trading price was probative of
Norcraft’s fair value on the Merger date.237 Because this case was tried before the
Supreme Court’s decision in Dell, the parties presented limited evidence at trial
respecting Norcraft’s trading history and the market for its stock. Consequently, the
parties had a rather limited record to draw upon when addressing this issue in their
supplemental submissions.233
To the extent the trial evidence is informative at all on this issue, it does not
support assigning any weight to Norcraft’s unaffected trading price for purposes of
determining Norcraft’s fair value on the Merger date. Norcraft had a limited public
trading history given that it had just completed an IPO eighteen months before the
Merger.239 What trading did occur following the IPO was relatively limited, an
237 D.1. 91.
233 See AOL, 2018 WL 1037450, at *10, n.118 (declining to engage in an extensive analysis
of the efficient market hypothesis when the parties did not present either an argument to
that effect or sufficient evidence to allow the court to undertake the analysis on its own).
239 JX 216 (e-mail from RBC to Biggart, Mar. 29, 2015, attaching RBC presentation on
Norcraft) at FB0047792, FB0047795.
71
unsurprising phenomenon given the niche market in which Norcraft operated.290
The analyst coverage of Norcraft’s stock was relatively sparse.291 Based on this
record, 1 am unable to conclude that the market for Norcraft’s common stock was
efficient or semi-strong efficient.292 Absent that finding, 1 do not assign any weight
to Norcraft’s unaffected trading price as an indicator of Norcraft’s fair value on the
Merger date.293
B. Norcraft’s Fair Value under “Traditional Methods” of Valuation
Having determined that neither the Merger Price nor Norcraft’s unaffected
stock price provide a reliable indicator of the Company’s fair value, 1 must now
consider the remaining valuation analyses presented by the parties’ experts. 1n this
regard, our law is clear that:
290 See JX 68 (Sept. 18, 2014 Fortune Presentation) at FB0089499; JX 215 (Citi Board
Discussion Materials) at FB0049833.
291 See JX 215 (Citi Board Discussion Materials) at FB0049845.
292 See Dell, 177 A.3d at 25 (“A market [for a company’s stock] is more likely efficient, or
semi-strong efficient, if [the company] has many stockholders; no controlling stockholder;
‘highly active trading’; and if information about the company is widely available and easily
disseminated to the market.” (quoting DFC, 172 A.3d at 373-74)).
293 See Verition P’rs Master Funa’ Lta’. v. Aruba Nelworks, Inc., 2018 WL 922139, at *24
(Del. Ch. Feb. 15, 2018) (“DFC and Dell teach that if a company’s shares trade in a market
having attributes consistent with the assumptions underlying a traditional version of the
semi-strong form of the efficient capital markets hypothesis, then the unaffected trading
price provides evidence of the fair value of a proportionate interest in the company as a
going concern.” (footnote omitted)).
72
1n discharging its statutory mandate, the Court of Chancery has the
discretion to select one of the parties’ valuation models as its general
framework or to fashion its own. The Court of Chancery’s role as an
independent appraiser does not necessitate a judicial determination that
is completely separate and apart from the valuations performed by the
parties’ expert witnesses who testify at trial. It must, however, carefully
consider whether the evidence supports the valuation conclusions
advanced by the parties’ respective experts.294
1 have followed this guidance as 1 have worked through the experts’ competing
analyses here.
1. Comparable Companies and Precedent Transaction Analyses Are N ot
Reliable
As previously mentioned, both experts performed a comparable company
analysis. Austin Smith also performed a precedent transaction analysis. “The utility
of a comparable company [or precedent transaction] approach is dependent on the
similarity between the company the court is valuing and the companies [or precedent
transactions] used for comparison.”295 When there are no sufficiently comparable
companies or precedent transactions, such analyses are unavailing in the search for
fair value.296
294 MG. Bancorp., Inc. v. Le Beau, 737 A.2d 513, 525-26 (Del. 1999).
293 IQ Hla’gs., Inc., 2013 WL 4056207, at ’1‘1 (quoting Doft & Co. v. Travelocily.com Inc.,
2004 WL 1152338, at *8 (Del. Ch. May 20, 2004)) (internal quotation omitted); see also
Merz``on Capital, 2013 WL 3793896, at ’1‘5; James R. Hitchner, Financz``al Valuation.'
Applicatz``ons ana’ Moa’els 291-93, 297 (4th ed. 2017) (cited in JX 21 (Clarke Rebuttal
Report)).
296 In re Orchara’Enters., Inc., 2012 WL 2923305, at *9 (Del. Ch. July 18, 2012) (“Reliance
on a comparable companies or comparable transactions approach is improper where the
73
After carefully reviewing the evidence, 1 see no factual basis to rely on a
precedent transaction or comparable company analysis as an indicator of Norcraft’s
fair value as of the Merger date. The parties agree that there had not been an
acquisition of any publicly-traded, “dealer channel” cabinet manufacturer-or a
satisfactorily comparable business297-in any temporal proximity to the Merger.293
Nor were the parties (or their experts) able to identify any truly comparable
companies that could support a reliable comparable company analysis.299 1t is,
purported ‘comparables’ involve significantly different products or services than the
company whose appraisal is at issue, or vastly different multiples.”); see also Hitchner,
supra, at 292-93.
297 See JX 13 (Biggart Dep.) at 75:1-76:23, 152:22-153:1 (explaining he could not recall
any precedent transaction in the dealer channel since 2010). Many of the precedent
transactions identified by Austin Smith preceded the Norcraft-Fortune Merger by three or
more years during a time in which the housing market was still recovering from the Great
Recession. See JX 20 (Austin Smith Report), Ex. 14 (Precedent Transaction Method)
(showing that 11 out of the 16 transactions predated 2012). The remaining transactions
involved very small, non-public companies, making them unfit for comparison. See ia’.
Under these circumstances, 1 see no reason to dwell on a precedent transaction analysis in
determining Norcraft’s fair value on the Merger date. See Merion Capital, 2013
WL 3793896, at *5 (“The utility of a market-based method depends on actually having
companies that are sufficiently comparable that their trading multiples provide a relevant
insight into the subject company’s own growth prospects.”); see also Hitchner, supra,
at 304_06.
293 See JX 20 (Austin Smith Report), Ex. 14 (Precedent Transaction Method) (showing that
11 out of the 16 transactions predated 2012); JX 18 (Clarke Report) at 4 n.8; JX 21 (Clarke
Rebuttal Report) at 6.
299 Cf JX 20 (Austin Smith Report) at 25~28 (explaining, “of the guideline public
companies, [Norcraft] is most similar to (though smaller than) American Woodmark, the
only other pure-play cabinet manufacturer,” “Norcraft is significantly smaller than most of
the guideline public companies based on revenue, EBITDA, or assets”); TT 510:10-13
74
therefore, unsurprising that neither expert relied on market-based approaches
(comparable company or precedent transaction analyses) as the principal metric by
which to value Norcraft.300 1nstead, they offered these valuations to corroborate the
results they reached utilizing their preferred valuation methodologies301 Because 1
disagree that market-based valuation metrics provide any guidance here, 1 do not
consider those metrics further.
2. The DCF Analysis
“[A] DCF analysis can provide the court with a helpful data point about the
price a sale process would have produced had there been a robust sale process
involving willing buyers with thorough information and the time to make a bid.”302
The basic premise underlying the DCF methodology is that the value
of a company is equal to the value of its projected future cash flows,
discounted to the present value at the opportunity cost of capital.
Calculating a DCF involves three steps: (1) one estimates the values of
future cash flows for a discrete period, where possible, based on
contemporaneous management projections; (2) the value of the entity
attributable to cash flows expected after the end of the discrete period
must be estimated to produce a so-called terminal value, preferably
using a perpetual growth model; and (3) the value of the cash flows for
(Clarke) (“1 view Norcraft being somewhat unique in that regard. So these are not -- you
know, these are not perfect comps.”).
300 JX 18 (Clarke Report) at 32, 55; TT 636:17-637:6 (Clarke); JX 20 (Austin Smith
Report) at 29.
301 JX 18 (Clarke Report) at 32, 55; TT 636:17~637:6 (Clarke); JX 20 (Austin Smith
Report) at 29.
302 Dell, 177 A.3d at 35.
75
the discrete period and the terminal value must be discounted back
using the capital asset pricing model or “CAPM.” 1n simpler terms, the
DCF method involves three basic components: (1) cash flow
projections; (2) a discount rate; and (3) a terminal value.303
a. The Disputed Inputs
As is typically the case, the substantial delta between the experts’ DCF
valuations can be traced to their disagreements regarding the DCF inputs. Their most
significant disagreements are: (1) whether to extend the Base Case projections by an
additional five years; and (2) how to calculate Norcraft’s beta in connection with
estimating Norcraft’s WACC. On the latter point, the experts disagree regarding
(i) the selection of appropriate guideline public companies (“GPCS”) for a proxy beta
calculation and whether net debt or gross debt should be used to unlever the GPC
betas and relever the resulting proxy beta304; and (ii) whether Norcraft’s observed
capital structure or a target capital structure should be used to relever the concluded
303 Merion Capital, 2013 WL 3793896, at * 10 (internal citation omitted).
304 See Shannon P. Pratt & Roger J. Grabowski, Cost of Capital.' Applz'cations and
Examples 223 (5th ed. 2014) (cited in JX 18 (Clarke Report)) (“Using betas of guideline
public companies for estimating a proxy beta has been found to provide reasonably
accurate estimates of the subject company”); Duff & Phelps, 2015 Valuation Handbook,
Guide to Cost of Capital 5-3 (2015) (cited in JX 18 (Clarke Report)); Andaloro v. PFPC
Worldwide, Inc., 2005 WL 2045640, at * 15 (Del. Ch. Aug. 19, 2005). “A company’s debt
capital can be measured by [gross] debt or net debt, where net debt is equal to total debt
less excess cash.” JX 23 (Austin Smith Rebuttal Report) at 23 (emphasis in original).
76
beta when calculating Norcraft’s cost of equity.305 The experts generally agree on
the remaining DCF inputs.
i. Management 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.”306 While Norcraft’s management
(Buller and Ginter) prepared several sets of projections, the experts agree that the
most reliable projections are the Base Case projections_and both experts relied on
those projections in their primary DCF analyses.307
The record reflects that Norcraft management did not prepare long-term
projections in the ordinary course of Norcraft’s business.303 Nevertheless, Buller and
Ginter knew how to prepare long-term projections and they approached the Base
303 The capital structure used to relever the subject company’s unlevered beta should also
be used when calculating its WACC (for weighting purposes). TT 854: 17~857: 10 (Austin
Smith).
306 AOL, 2018 WL 1037450, at *11 (quoting Del. Open MRI Radiology Assocs., P.A. v.
Kessler, 898 A.2d 290, 332 (Del. Ch. 2006)). See also Shannon P. Pratt, Robert F. Reilly
& Robert P. Schweihs, Valuing a Business: T he Analysis and Appraisal of Closely Held
Companies 156 (4th ed. 2000) (cited in JX 18 (Clarke Report)) (hereinafter “Valuing a
Business”).
307 As noted, Austin Smith performed two additional DCF analyses, one relying on the
Ginter 2014 Projections and another relying on a Capitalization of Cash Flow
methodology. See JX 20 (Austin Smith Report) at 23-24. Neither analysis, however,
formed the basis for her final conclusion regarding fair value. See id. at 1.
303 JX 1 (Ginter Dep.) at 27:2-28:14, 34:5_10; JX 3 (Buller Dep.) at 101:20-24.
77
Case projections with a view to providing the Board with a reliable estimate of
Norcraft’s future financial performance.309 When all was said and done, Buller and
Ginter were confident they had prepared a set of realistic, reasonable projections
upon which Citi and the Board could rely in assessing Norcraft’s value during the
course of negotiations.310 While not perfect, 1 am satisfied that the Base Case
projections provide a reliable foundation for a valid DCF.31l
The experts’ dispute regarding the Base Case projections does not turn on their
reliability (or lack thereof), but rather on whether the projections should be extended
309 JX 3 (Buller Dep.) at 115:8-18 (explaining that the Base Case projections were
“something [management] felt very, very comfortable in doing”); id. at 114:11_22; JX 1
(Ginter Dep.) at 93:23-25 (stating the Board approved the Base Case projections); JX 11
(Reilly Dep.) at 55:9-19.
310 JX 3 (Buller Dep.) at 115:8_18. Cf Petsmart, 2017 WL 230359, at * 12 (noting that the
respondent company’s management characterized their projections as “bordering on being
too aggressive”_even “approaching ‘insan[ity]”’) (alteration in original) (internal
quotation marks, footnote and record citation omitted).
311 TT 473-75 (Clarke) (explaining why the Base Case projections are reasonable). Austin
Smith found several “significant limitations” to the Base Case projections: (1) they were
not created in the ordinary course; (2) they were not created using the same procedure as
Norcraft’s annual budgets (i.e. , bottoms-up); (3) they projected an additional five years of
growth after two years of already achieved growth in a cyclical industry; and (4) Ginter
and Buller, who prepared the Base Case projections, allegedly knew they were going to
lose their jobs if the transaction was completed_introducing the possibility of bias. TT
734: 10-736: 14 (Austin Smith). Despite all of her concerns, however, Austin Smith relied
on the Base Case projections for her primary DCF analysis. TT 737:13-23 (Austin Smith).
See In re Appraisal ofAncestry.com, Inc., 2005 WL 399726, at ’1‘ 18 (Del. Ch. Jan. 30, 2015)
(noting that “in a number of cases Delaware Courts have relied on projections that were
prepared by management outside of the ordinary course of business and with the possibility
of litigation”) (collecting cases).
78
by an additional five years. Clarke opined that the extension was necessary, while
Austin Smith opined that a PGR should be applied at the end of the five-year Base
Case projection period.
According to Clarke, extending the Base Case projections is necessary to
capture Norcraft’s future cash flows because “the Base Case [p]rojections had
not reached [a] steady state at the end of the [five-year] projection period” and,
therefore, “it would be inappropriate to apply a standard [PGR] at th[e] last year
[of that period:|.”312 To account for Norcraft’s growth potential as of 2019, Clarke
extended the Base Case projections by an additional five years_through 2024_“to
gradually reduce growth rates over time until reaching [a 3.5%] PGR.”313
Austin Smith, on the other hand, maintains that extending the Base Case
projections is inappropriate because doing so forecasts growth that Norcraft almost
certainly could not achieve. 1n this regard, she points out that the cabinetry industry
is cyclical, as demonstrated by trends in (1) the industry’s historical performance
(growth and decline); and (2) the historical growth (and decline) of the residential
312 JX 18 (Clarke Report) at 2.
313 Id. 2_3. Clarke “gradually reduce[d] growth rates over time until reaching the PGR,”
id., by applying a “straight line reduction in growth” from the end of the Base Case
projections to the end of his additional five-year projection period. TT 606-607.
According to Clarke, “if [he] had to use 2019 as the final year of [his] projections, [he]
would need to use a higher [PGR of 4.4%] to account for the tapering of [Norcraft’s]
growth to a steady state.” JX 21 (Clarke Rebuttal Report) at 27 n.62.
79
construction market.314 Extending the Base Case projections by an additional five
years implies a ten-year period of consistent growth following two years of already
achieved growth. According to Austin Smith, projecting twelve years of steady
growth for a business in the cabinetry industry is patently unreasonable.315
On this point, 1 find Austin Smith most credible. The evidence adduced at
trial supports her view that the cabinetry industry is cyclical and follows the cycle of
the residential construction market.316 The evidentiary record also reflects that the
residential construction market is projected to reach a “steady state” at or slightly
before the last year of the Base Case projection period (2019).317 Moreover, insofar
314 JX 23 (Rebuttal Report of Yvette R. Austin Smith [“Austin Smith Rebuttal Report”])
at 5-6.
313 See id. at 4-6.
316 See JX 20 (Austin Smith Report) at 21-22 & Ex. 3 (Indexed Growth of Norcraft
Adjusted EBITDA versus Key Economic 1ndicators 2013_2015); TT 21:8-9 (Eldridge)
(“[B]uilding products companies are cyclical . . . . ”); JX 23 (Austin Smith Rebuttal
Report), Fig. 1 (Comparison of Normalized Growth Patterns); id. at Fig. 2 (Historical and
Forecasted EBITDA Margins); TT 607:23-608:1 (Clarke) (“Q: Mr. Clarke, the cabinet
business is cyclical, isn’t it? A. Yes.”); see also JX 23 (Austin Smith Rebuttal Report),
Fig. 1 (Comparison of Normalized Growth Patterns); id. at Fig. 2 (Historical and
Forecasted EBITDA Margins); JX 5 (Klein Dep.) at 312:4-10. 1n light of this
determination, 1 decline to apply Petitioners’ suggested 4.4% PGR since that PGR is based
on an unrealistic assessment of Norcraft’s iiiture financial performance See JX 21
(Clarke Rebuttal Report) at 27 n.62.
317 See JX 112 (Gabelli Report) (stating, as of January 2015, “[w]e see a gradual recovery
in housing that will materialize over the next several years”); JX 535 (Fortune 1nvestor
Presentation, “Maximum Long-Term Value,” May 1, 2015) (“Expectation is for the
housing market to return to steady state (1.5 million [new construction] starts and 5-6%
[average] annual [repair and remodeling] growth) by 2017 or 2018.”). According to
“accepted financial principles,” Dell, 177 A.3d at 22, “terminal value must reflect an
80
as Norcraft’S own management was not inclined to project Norcraft’s financial
results beyond FY2019, 1 see no basis to do so post hoc for the sake of reaching a
litigation result.
ii. Norcraft’s Estimated WACC
The parties also dispute how to calculate the applicable discount rate based on
Norcraft’s estimated WACC. More specifically, they dispute how to calculate
Norcraft’s beta in connection with estimating Norcraft’s cost of equity capital (a key
component of WACC).
The application of a discount rate to financial projections attempts to “convert
the [subject company’s] expected economic income stream to present value.”313
appropriate estimate of sustainable growth.” Pratt, supra, at 49. “[F]or cyclical
businesses[] the discrete [projection] period commonly corresponds to the number of years
or periods until the point is reached where the net cash flow represents an average base net
cash flow expected over an entire business cycle,” i.e., until the midpoint of the cycle.
Id. at 47 (emphasis supplied); see also Robert W. Holthavsen & Mark E. Zmijewski,
Corporate Valuation.' Theory, Evidence & Practice 216 (2014) (“[T]he steady state for a
company in a cyclical industry should be at the midpoint of the cycle.”). Clarke’s extension
of the Base Case projections posits a ten-year growth trend but does not account for
cyclicality in the cabinetry industry and the impact of such cyclicality on Norcraft’s free
cash flows. See JX 14 (Clarke Dep.) at 60-61 (explaining his extension does not reflect
cyclicality prior to 2025); JX 23 (Austin Smith Rebuttal Report), Fig. 1 (Comparison of
Normalized Growth Patterns); JX 18 (Austin Smith Report), Fig. 1 (Norcraft Net Sales and
EBITDA (Historical 2003-2014) (citing JX 99 (Norcraft Jan. 2015 Management
Presentation))). See also AOL, 2018 WL 1037450, at * 19 (“In a fast-paced industry with
significant fluctuations, where management is hesitant to project beyond four years, using
a three-stage DCF model or a ten year projection period seems particularly brazen.”).
313 Pratt, supra, at 8; see also Duff & Phelps, supra, at 10-15.
81
Where the discount rate is based on the subject company’s WACC, the projected
future cash flows and terminal value are discounted by the WACC to bring them
back to present value.319 A company’s WACC represents the cost (to the company)
of financing its business operations; it comprises the weighted average of the
company’s cost of debt and equity320:
E D
WACC : (requny X I_/) + ('“deb¢ X _``} >< (1 - t))
where.'
reqw~,y = cost of equity capital
E = market value of the company’s equity
mem = cost of debt capital
D = value of the company’s debt
V = E + D = total value of the company’s equity and debt
t = applicable tax rate
Here, both experts calculated Norcraft’s cost of equity capital pursuant to CAPM.321
Following CAPM, a company’s cost of equity is calculated as follows322:
319 Pratt, supra, at 546 (“WACC generally works as a substitute for the enterprise-cash-
flow discount rate.”). See also Valuing a Business, supra, at 184.
320 Valuing a Business, supra, at 184; Duff & Phelps, supra, at 10-16.
321 JX 18 (Clarke Report) at 33; JX 20 (Austin Smith Report), Ex. 5 (WACC Calculation).
322 Duff & Phelps, supra, at 2-13.
82
requity : rrw~risk '1' (B X ERP) + SS
where.'
r,w_,,'sk = risk-free rate of return
13 = beta coefficient of the subject company
ERP = equity risk premium
SS = size premium
The experts generally agree on many of the relevant inputs to calculate
Norcraft’s WACC; both experts used the same risk-free rate of return (2.75%),
equity risk premium (6.21%) and size premium (2.69%).323 The experts differed,
however, in their respective estimates of Norcraft’s pre-tax cost of debt. Clarke
estimated Norcraft’s pre-tax cost of debt as 6.95%_based on “the average of the
15-year yield-to-maturity of B and BB rated bonds” as of the Merger date.324 Austin
Smith, by contrast, estimated Norcraft’s pre-tax cost of debt as 5.85%_based on the
“[a]verage of (a) BofA Merrill Lynch US High Yield B Effective Yield as of 5/12/1 5
[the Merger date] and (b) total return on Norcraft[’s] [then-outstanding] term loan
(including [the] effect of issuance discount).”323
323 JX 21 (Clarke Rebuttal Report) at 27.
324 JX 18 (Clarke Report) at 41.
323 JX 20 (Austin Smith Report), Ex. 5 (WACC Calculation). The BofA Merrill Lynch US
High Yield B Effective Yield “represents the effective yield of the ICE BofA[]
[Merrill Lynch] US Corporate B Ind'ex, a subset of the ICE BofA[] [Merrill Lynch] US
High Yield Master 11 Index tracking the performance of US dollar denominated below
investment grade rated corporate debt publically issued in the US domestic market This
subset includes all securities with a given investment grade rating B.” ICE BofAl\/IL US
High Yield B Effective Yield, retrieved from FRED, Fed. Reserve Bank of St. Louis;
83
The experts’ respective estimates of Norcraft’s pre-tax cost of debt are both
reasonable. As of the Merger date, Norcraft’s long-term debt was rated “B2” by
Moody’s Global Credit Research and “B+” by Standard & Poor’s, and the yield to
maturity on high-yield U.S. corporate bonds with 10+ year maturity on that date was
approximately 6.34%.326 Accordingly, 1 use the average of the experts’ respective
estimates of Norcraft’s pre-tax cost of debt (_6.40%) for my DCF analysis.327
As to the estimation of Norcraft’s cost of equity, the experts’ principal point
of disagreement concerns Norcraft’s beta coefficient. “Beta is a measure of the
https://fred.stlouisfed.org/series/BAMLHOA2HYBEY (last visited July 24, 2018). By way
of reference, Citi used a pre-tax cost of debt of 5.3% in its calculation of Norcraft’s WACC
and RBC used 4.5%. See JX 18 (Clarke Report) at 41 n.91.
326 JX 267 (Norcraft FY2014 10-K) at 21; ICE BofAML US High Yield B Effective Yield,
retrieved from FRED, Fed. Reserve Bank of St. Louis;
https://fred.stlouisfed.org/series/BAMLHOA2HYBEY (last visited July 24, 2018); S&P
U.S. High Yield Corporate Bond 10+ Year Index, available online at
https://us.spindices.com/indices/fixed-income/sp-us-high-yield-corporate-bond-10-year-
index (last visted on July 24, 2018). The experts do not challenge each other’s estimates
of Norcraft’s pre-tax cost of debt. See JX 21 (Clarke Rebuttal Report) at 31 (“Austin
Smith’s conclusion [regarding Norcraft’s pre-tax cost of debt] is in the range of
reasonableness given Norcraft’s improving performance and generally positive industry
outlook as well being consistent with the financial advisors’ cost of debt estimate.”).
327 This average figure tracks the ICE BofA Merrill Lynch US High Yield B Effective
Yield as of the Merger date (6.39%) and the S&P U.S. High Yield Corporate Bond 10+
Year Yield to Maturity as of that date (6.34%). ICE BofAML US High Yield B Effective
Yield, retrieved from FRED, Federal Reserve Bank of St. Louis;
https://fred.stlouisfed.org/series/BAMLHOA2HYBEY (last visited July 24, 2018); S&P
Dow J ones Indices LLC, S&P U.S. High Yield Corporate Bond 10+ Year Index, available
online at https://us.spindices.com/indices/fixed-income/sp-us-high-yield-corporate-bond-
10-year-index (last visited on July 24, 2018).
84
systematic risk of a stock; the tendency of a stock’s price to correlate with changes
in the market. . . . [B]etas for equity capital are used as a modifier to the equity risk
premium [] in the context of [calculating a company’s cost of equity].”323
A company’s beta is measured by tracking relative change in the trading price
of its stock over a discrete time period (the “lookback period”), with a set frequency
(e.g., daily, weekly, monthly).329 When there is insufficient data on the trading
history of a company’s stock, the company’s “beta must be an estimate based on the
[observed] betas of comparable, publicly traded companies” (i. e. , a “proxy beta”).330
Observed betas are levered betas; they reflect a company’s operating risk and its
financial risk.331 Thus, when calculating a proxy beta, one must “unlever” each
GPC’s observed (levered) beta to remove the debt-related risk(s) of that particular
GPC.332 Once the GPC betas are unlevered, and the mean or median of those betas
is calculated, the unlevered summary measure beta (i.e., the unlevered proxy beta)
323 Duff & Phelps, supra, at 5-1.
329 lCl. 211 5-3.
330 Id.; Pratt, supra, at 223. When calculating a company’s beta, change in the trading price
of the company’s stock is measured relative to change in the returns of the overall market
(or a proxy therefor) over the relevant observation period. JX 18 (Clarke Report) at 34.
331 JX 18 (Clarke Report) at 34-35.
332 See Duff & Phelps, supra, at 5-25 and 10-17.
85
must be relevered to add back financial risk.333 The relevant financial risk, however,
is the subject company’s not the GPCs’.334
The experts generally agree that there is insufficient information regarding
Norcraft’s own beta to allow a reliable beta calculation based solely on that
information_a function of Norcraft’s limited trading history.333 Accordingly, they
agree that the use of a proxy beta is appropriate. They disagree, however, as to
(1) which GPCs should be used to derive the proxy beta; (2) whether gross debt or
net debt should be used to unlever the GPC betas and relever the resulting unlevered
proxy beta; and (3) whether Norcraft’s observed capital structure or a target capital
structure should be used to relever the proxy beta.
1 begin with the first point of disagreement_appropriate GPCs. Clarke used
four GPCS for his proxy beta calculation_American Woodmark, Masonite, PGT
and Ply Gem336_which he selected by applying a set of comparability-related
333 See JX 18 (Clarke Report) at 34_35.
334 See Duff & Phelps, supra, at 10-21; Pratt, supra, at 244.
333 See JX 18 (Clarke Report) at 37_39; JX 23 (Austin Smith Rebuttal Report) at 18-20.
While Clarke found Norcraft’s observed beta “statistically relevant,” he did not rely upon
that beta beyond using it to define the lower end of a range of betas. He ultimately selected
the higher end for his DCF. See JX 18 (Clarke Report) at 37-39.
336 JX 18 (Clarke Report) at 51. Clarke notes in his report that RBC used all four of his
chosen companies and Citi used three of the four in their respective analyses of Norcraft.
Id.
86
screening criteria.337 After selecting these four GPCS, Clarke then calculated each
GPC’s beta over a two-year lookback period (measured weekly) and a one-year
lookback period (measured daily)_-both periods relative to the Merger date_and
unlevered each observed GPC beta using the gross debt of the corresponding GPC.333
This led Clarke to derive an (unlevered) proxy beta for Norcraft of 0.80 based on the
mean and median of the unlevered GPC betas.339
Austin Smith, by contrast, identified sixteen GPCs for her proxy beta
calculation; the four companies selected by Clarke and twelve additional companies,
337 Id. at 48~49. Clarke’s screening criteria were: (1) public company; (2) industry
classification of “Building Products”; (3) 2014 Calendar Year Revenue between
$40 million and $4 billion; (4) primary geographic location in the U.S. or Canada; and
(5) no recent maj or divestures or pending significant acquisitions Id. Clarke’s application
of these criteria yielded a set of sixty-five companies, which Clarke then screened “for
companies with a minimum expected EBITDA margin of 7.5% for fiscal year 2016
(approximately half of Norcraft’s EBITDA margins) and a maximum expected EBITDA
margin of 22.5% for fiscal year 2016 (approximately 50% above Norcraft’s margins).
In addition, [he] screened for companies that had forecasted 2016 revenue growth between
5% (approximately half of Norcraft’s expected growth) and 15% (approximately 50%
above Norcraft’s expected growth). Based on those two criteria, the 65 companies were
reduced to 28.” Id. at 50. Clarke then determined that four of those companies_his four
chosen GPCs_“had a primary business in manufacturing products for the [repair and
remodeling] and/or new construction residential home construction [markets].” Id.
333 Id. at 38 & sched. 5-C; JX 517 (native Excel version of Clarke’s DCF model).
339 JX 18 (Clarke Report) at 39 (“An unlevered beta of 0.80 is slightly above the median
and average of the one-year daily betas of the [GPCs] (0.75 to 0.79) while slightly below
the median and average two-year weekly betas of the [GPCS] (0.81 to 0.87).”). Clarke
relevered his concluded unlevered beta for Norcraft based on Norcraft’s actual (observed)
capital structure as of the Merger date (75% equity, 25% debt, per Clarke). Id., sched. 5-
B. This resulted in a relevered beta for Norcraft of 0.97. Id.
87
including Fortune and Masco.340 Having selected these sixteen GPCS, Austin Smith
derived a proxy beta for Norcraft based on the median of the unlevered GPC betas,
measured weekly over a two-year lookback period_relative to the Merger date_
and unlevered using each GPC’s net debt.34l This resulted in an unlevered proxy
beta for Norcraft of 1.02.342
Each expert disputes the suitability of the other’s selected GPCs. According
to Clarke, Austin Smith’s selected GPCs “were either not comparable [to Norcraft]
and/or were going through significant restructuring events that impacted their
historical betas.”343 Austin Smith, for her part, maintains that Clarke’s methodology
for selecting GPCs is “fundamental[ly]” flawed, principally because: (i) it “results
340 JX 20 (Austin Smith Report) at 26 & Ex. 4 (Beta Calculation). The other ten GPCs
were: Armstrong World 1ndustries, Inc., Beacon Roofing Supply, Inc., Builders
FirstSource, Inc., Caesarstone Ltd., Continental Building Products, 1nc., Mohawk
1ndustries, Inc., Patrick Industries, 1nc., Quanex Building Products Corporation, Trex
Company, Inc. and Universal Forest Products, Inc. Id., Ex. 4 (Beta Calculation). Austin
Smith divided her sixteen GPCs into two groups: Group 1 (comprising American
Woodmark, Masco and Fortune), “which consists of companies operating specifically
(though not exclusively) in the cabinet market, and Group 11 [comprising the rest of the
GPCs], which consists of companies operating in the general residential building products
sector.” Id. at 26.
341 Id., Exs. 4 (Beta Calculation) and 5 (WACC Calculation).
342 Id., Exs. 4 (Beta Calculation) and 5 (WACC Calculation). Austin Smith relevered her
concluded unlevered beta for Norcraft based on a target capital structure comprising 86%
equity and 14% debt. Id., Ex. 5 (Calculation of WACC). This yielded a relevered beta for
Norcraft of 1.12. Id.
343 JX 21 (Clarke Rebuttal Report) at 28.
88
in the exclusion of two of the three publicly-traded cabinet manufacturers:
Fortune . . . and Masco”; and (ii)-'it yields a relatively small set of companies, all but
one of which manufacture products other than cabinets_meaning they are less
comparable to Norcraft than Fortune and Masco.344
Both experts present valid arguments After considering the evidentiary
record, 1 have determined to derive a proxy beta for Norcraft based on the weekly
observed betas of Fortune, Masco, American Woodmark, Masonite, PGT and Ply
Gem, measured over a two-year lookback period (relative to the Merger date).
1 acknowledge the size difference between Norcraft, on one hand, and Fortune and
Masco, on the other, but there are few publicly-traded, “dealer channel” cabinet
manufacturing businesses operating in the United States from which to draw.345
To account for this dynamic, 1 have selected a set of GPCs that includes publicly-
traded companies directly competing with Norcraft (Fortune, Masco and American
Woodmark), and also public companies operating in the same general industry that
are more comparable in size to Norcraft (Masonite, PGT and Ply Gem).346 Since
344 JX 23 (Austin Smith Rebuttal Report) at 17.
345 See .lX 112 (Gab€lli R€pOl‘t) at C111-00053582.
346 See Pratt, supra, at 223 (“The more guideline companies used in the sample size, the
better the accuracy.”); id. (“The accuracy is also enhanced if the guideline public
companies are reasonably close in size to the subject company. When the guideline public
companies are larger than the subject company, the beta estimate for the subject company
is likely biased low because of the propensity of betas of larger companies to be smaller
than the betas of smaller companies.”). My selection of GPCs is further supported by RBC
89
neither party has provided me with a principled way to assign different weights to
the betas of individual GPCs, 1 have determined to derive the proxy beta by taking
the median of the unlevered GPC betas.347
As to the question whether to use gross or net debt for unlevering and
relevering purposes, 1 have determined that Clarke’s approach (gross debt) is most
appropriate 1 consulted the finance literature cited by both experts with regard to
this issue and have come to the conclusion that using gross debt is the more generally
accepted approach when applying the Hamada unlevering and relevering formulas
and Citi’s choices of GPCs RBC included all six of the selected companies JX 216
(Mar. 29, 2015 e-mail from RBC to Biggart, attaching RBC presentation) at FB0047799,
and Citi included five out of the six (it did not include Masonite). JX 505 (Citi Discussion
Materials for the Fairness Opinion Committee) at C1T1-00075076.
347 See Pratt, supra, at 204 (explaining that to derive a proxy beta, one will take the median
or an average of the unlevered betas). This approach also avoids additional risk for error
that might flow from assigning different weights See JX 530 (Bradford Cornell, Corporate
Valuation, Toolsfor Etective Appraisal and Decision Making (1993)) at 68. As previously
explained, Austin Smith derived a proxy beta for Norcraft based on the median of the
unlevered betas of her selected GPCs. JX 20 (Austin Smith Report), Exs. 4 (Beta
Calculation) and 5 (WACC Calculation). Clarke’s proxy beta calculation, by contrast, took
into account both the median and the mean of the unlevered betas of his selected GPCs
JX 18 (Clarke Report) at 39. My proxy beta calculation utilizes the median rather than the
mean of the unlevered GPC betas 1 took that approach to account for Masonite. Austin
Smith and Clarke included Masonite in their respective analyses but both acknowledged
that its business was less comparable to Norcraft than some of the other companies
considered lndeed, Masonite exhibited a significantly lower unlevered beta that risked
distorting the Court’s measurement of Norcraft’s relative operating risk (if the Court were
to use the mean for summary measure purposes).
90
(as both experts did),343 which utilize “total debt” as an input.349 1 also find that
considering net debt, while it might eliminate some of the drawbacks of the Hamada
approach if done properly,330 complicates the analysis and adds a significant risk of
error to an already abstract process
1n her deposition, Austin Smith explained that using net debt requires
“a judgment call” because “public companies don’t report excess cash.”331
1n essence, to derive net debt, one “look[s] at how the cash balances for th[e chosen]
companies changed over time, and [then] look[s] at the relationship between cash
and debt, and come[s] to an assessment.”332 1f insufficient data about excess cash is
343 JX 18 (Clarke Report), sched. 5-B (Cost of Equity Calculation per CAPM); JX 20
(Austin Smith Report), Exs. 4 (Calculation of Beta) and 5 (Calculation of WACC).
349 Pratt, supra, at 243. The Hamada unlevering formula is as follows:
13lezi)ered
1 + ((1 - tax rate) X (Total Debt/Equity)))
13unlevered : (
Id. at 247.
By corollary, the Hamada relevering formula is:
_ "l‘otal Debt
15levered _ Bunlevered X [1 +(1 5 tax rate) X ']_‘gta] Equity]
Id.
350 See ia'. at 262-63.
331 JX 16 (Austin Smith Dep.) at 192:5-12.
332 Id. at 192:13-16.
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”333 Considering the many
available, “total cash is assumed to equal excess cash.
variables already at play in a DCF analysis (especially when deriving a proxy beta),
1 find that figures based on a “judgment call” are unreliable in the absence of a
principled way to evaluate the soundness of the underlying “judgment.” For all these
reasons, 1 have utilized gross debt rather than net debt for unlevering and relevering
purposes
That takes me to the final beta-related dispute: the appropriate capital structure
to relever the unlevered proxy beta. Austin Smith submits that a target capital
structure based on the capital structure of comparable companies provides the most
reliable input, while Clarke advocates the use of Norcraft’s actual (observed) capital
structure as of the Merger date. Austin Smith explains her choice by noting that
Norcraft only went public in 2013 and its management had not indicated as of the
Merger that it intended to maintain the Company’s then-existing capital structure.334
According to Austin Smith, it is likely that, over time, Norcraft’s capital structure
would come to resemble that of its peers.333 Clarke counters that Norcraft’ s observed
capital structure as of the Merger date was the “operative reality” of the Company at
353 Id. at 192118-21.
334 See JX 23 (Austin Smith Rebuttal Report) at 22; TT 764:1-19 (Austin Smith).
333 See TT 764:1-19; JX 23 (Austin Smith Rebuttal Report) at 22.
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that time and, as such, is the appropriate capital structure to apply when relevering
the unlevered proxy beta.336
Clarke has the better of this debate. While there are instances where using a
target capital structure for relevering purposes would be appropriate,337 especially
where the target’s capital structure is in flux, that is not the case here. 1t is true that,
as of the Merger, Norcraft had operated for only eighteen months after its 1P0. There
is no evidence, however, that management intended to change Norcraft’s capital
structure, and any suggestion that it would do so is nothing more than sheer
[Remainder of Page 1ntentionally Left Blank]
336 TT 506:11-17 (Clarke).
337 See Duff & Phelps, supra, at 1-15, 1-16.
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speculation.333 Accordingly, 1 refer to Norcraft’s observed capital structure as of the
Merger (75% equity, 25% debt) to relever Norcraft’s concluded unlevered beta.339
333 TT 859:4-16 (Austin Smith) (“-Q. And you testified earlier that you found no evidence
in the record which would guide you in selecting what that target capital structure would
be for Norcraft. Correct? A. That’s right. Q. And so you had to use the data from
comparable companies Correct? A. Right. Q. And just to be explicit, there’s no evidence
in the record that Norcraft had any expectation of changing its capital structure after the
transaction Correct? A. That’s correct.”). Austin Smith herself recognizes that use of a
target capital structure is only appropriate when “the company’s existing capital structure
is not equal to the company’s target capital structure.” JX 23 (Austin Smith Report) at 21-
22. According to Austin Smith, Clarke’s estimation of Norcraft’s actual capital structure
as of the Merger date is erroneous because it fails to account for Buller et al.’s ownership
of Norcraft LLC units convertible into a 12.3% equity ownership interest in Norcraft (in the
form of shares of Norcraft common stock). Id. at 21. Austin Smith’s criticism in this
regard is based on her (apparent) assumption that the conversion of the Norcraft LLC units
into Norcraft common stock would not affect the per share trading price of that stock. See
id. (calculating Norcraft’s fully diluted market capitalization on the Merger date without
adjusting for the potential dilutive effect of a Norcraft-LLC-unit-to-Norcraft-common-
stock conversion on the per share trading value of Norcraft common stock). Upon
reviewing the record, it is unclear how such a conversion would affect Norcraft’s market
capitalization_and, by extension, the equity component of Norcraft’s capital structure. In
addition, Austin Smith’s calculation of Norcraft’s fully diluted market capitalization on the
Merger date does not account for the exercise of all outstanding options on Norcraft stock
on that date. See id. (“The total equity in Norcraft[’s] capital structure was $452 million . . .
not the 83 96 [million] calculated by Mr. Clarke. The operating cash flows of Norcraft were
supported not just by the equity of Norcraft Inc. but also by [Buller et al.’s] ownership
interest [in Norcraft] LLC.”); but cf id. at 13 & n.25 (“[Norcraft’s] implied fully diluted
market capitalization was $532 million based on the transaction price of $25.50 [multiplied
by] 20,869,976 fully diluted shares [outstanding].”) (emphasis supplied). Moreover, as
previously noted, Austin Smith’s calculation of Norcraft’s fully diluted shares outstanding
as of the Merger date is inconsistent with the information set forth in Norcraft’s Form 10-
Q for Ql FY2015 and the Funds Flow Memorandum prepared in connection with the
Merger. The inclusion of all options on Norcraft stock outstanding as of the Merger date
in the equity component of Norcraft’s fully diluted capital structure (together with all
Norcraft common stock and convertible Norcraft LLC units outstanding on that date)
implies a capital structure of approximately 76% equity and 24% debt. 1 am satisfied,
therefore, that Clarke’s estimation of Norcraft’s actual capital structure on the Merger date
captures Norcraft’s “operative reality” on that date. Accordingly, 1 have adopted that
estimation.
94
b. The Court’s DCF Valuation of Norcraft
Like Clarke and Austin Smith, 1 begin my DCF analysis with the Base Case
projections adjusted to deduct for income tax expense in each of the projected years
(based on a 38% tax rate).> This adjustment yields the following figures for
Norcraft’s net operating profit after taxes (“NOPAT”)360:
FY2015-E
(Stub)
$18.3 million $31.8 million $36.0 million $41.9 million $50.3 million
FY2016-E FY2017-E FY2018-E FY2019-E
1 next adjust the NOPAT figures to obtain unlevered free cash flow figures for each
projected year by (1) adding back non-cash charges_depreciation, amortization and
stock compensation expense; (2) deducting Norcraft’s capital expenditures; and
(3) deducting year-over-year change in Norcraft’s net working capital (“NWC”).
My adjustments with respect to each item track those made by both experts.361
339 For these same reasons, 1 refer to that same capital structure to calculate Norcraft’s
WACC (for weighting purposes).
360 The calculation of Norcraft’s NOPAT (and unlevered free cash flow) for FY2015 is
based on the Base Case projections for the May_December 2015 period. Hence the “Stub”
notation. Austin Smith took this same approach in her DCF analysis JX 20 (Austin Smith
Report), Ex. 6 (DCF Analysis). 1 have adopted Austin Smith’s approach in this regard,
given that the operative valuation date here is May 12, 2015 (the Merger date).
361 See JX 18 (Clarke Report), sched. 2-A (DCF Analyis); JX 20 (Austin Smith Report),
Ex. 6 (DCF Analysis). 1n calculating the period-over-period change in Norcraft’s NWC,
both experts excluded Norcraft’s current TRA liability in each of the projected years
JX 20 (Austin Smith Report), Ex. 6 (DCF Analysis) (“Working capital excludes tax-related
items.”); see JX 517 (native Excel version of Clarke’s DCF model). The rationale for this
95
The foregoing adjustments yield the following figures for unlevered free cash
flow in each of the projected years:
FY2015-13 FY2016-E FY2017-E FYZOIS-E FY2019-E
(Stub)
$20.8 million $36.73 million $40.06 million $44.36 million $49.84 million
To calculate the present value of these unlevered cash flows, like Clarke and
Austin Smith, 1 have applied a discount rate based on Norcraft’s estimated WACC.
My WACC calculation also uses CAPM to estimate Norcraft’s cost of equity_
based on the parties’ common risk-free rate of return (2.75%), equity risk premium
(6.21%) and size premium (2.69%)_and uses a 6.40% pre-tax cost of debt, which
yields a post-tax cost of debt for Norcraft of 3.97% (again based on a 38% tax rate).
exclusion appears to be that Norcraft’s payment obligations under the TRAs are non-
ordinary-course, non-operating liabilities See JX 18 (Clarke Report) at 29, 46. 1t is,
therefore, more accurate to describe the experts’ respective NWC-related computations as
calculating period-over-period change in Norcraft’s net operating working capital
(“NOWC”). The Court’s calculation of period-over-period change in Norcraft’s NWC_
or rather, its NOWC-likewise excludes Norcraft’s current TRA liability in each of the
projected years 1 also note that both experts departed from the Base Case projections’
forecast of Norcraft’s “current portion of long-term debt” in FYs 2018 and 2019. See JX 20
(Austin Smith Report), Ex. 6 (DCF Analysis); JX 517 (native Excel version of Clarke’s
DCF model); JX 509 (native Excel version of Base Case projections). Both experts
projected a $1.5 million figure for each year, whereas the Base Case projects zero for both
years Compare JX 20 (Austin Smith Report), Ex. 6 (DCF Analysis) and JX 517 (native
Excel version of Clarke’s DCF model), with JX 509 (native Excel version of Base Case
projections). The record is unclear as to why, exactly, the experts chose to depart from the
Base Case in this particular respect. Nevertheless, because both experts made the same
adjustment to the Base Case projections with regard to Norcraft’s “current portion of long-
term debt” in FYs 2018 and 2019, 1 have followed suit.
96
To derive a beta for my cost of equity calculation, 1 have unlevered the
observed weekly betas of my selected GPCs over a two-year lookback period
relative to the Merger date, using the Hainada unlevering formula and gross debt
rather than net debt. That computation yielded the following unlevered betas:
Guideline Public Company Levered Beta Unlevered Beta
American Woodmark 1.09 1.02
Masco 1.26 0.99
Fortune 1.15 1.07
Masonite 0.55 0.47
PGT 0.88 0.78
Ply Gem 1.60 0.98
The median of the unlevered GPC betas, 0.98, constitutes Norcraft’s
concluded unlevered beta. 1 then relevered that beta using Norcraft’s observed
capital structure of 75% equity and 25% debt (per Clarke’s estimation), resulting in
a levered beta for Norcraft of 1.187. Incorporating this levered beta into my WACC
calculation, along with the other inputs already mentioned_again using Norcraft’s
observed capital structure_l derived a WACC for Norcraft of 10.60%. Applying
Norcraft’s concluded WACC to discount its projected future cash flows to present
value, 1 have calculated the present value of those cash flows to be $149.7 million.
To calculate Norcraft’s terminal value, 1 have used the Perpetuity Growth
method (as did both experts),362 which posits that terminal value equals the quotient
362 JX 18 (Clarke Report) at 43 (“1 calculated [Norcraft’s] terminal value using the
Perpetuity Growth Method[.]”); JX 20 (Austin Smith Report) at 20 (“To calculate
97
of (1) the subject company’s terminal year free cash flow (here, $51.41 million); and
)363_discounted to present value
(2) the applicable capitalization rate (here, 7.10%
using the applicable discount rate (here, Norcraft’s WACC of 10.60%).364 This
yields a terminal value of 8477.2 million.
Summing together the present value of Norcraft’s projected unlevered cash
flows ($149.7 million) and its terminal value ($477.2 million) results in an operating
value for Norcraft of $626.9 million. To calculate Norcraft’s total equity value, 1
then made the following adjustments to Norcraft’s concluded operating value:
[Norcraft’s] terminal value 1 relied upon the Gordon Growth (or Perpetuity Growth)
model.”).
363 1n the Perpetuity Growth model, the capitalization rate is calculated as the positive
difference between the applicable discount rate and the subject company’s PGR. JX 18
(Clarke Report) at 43. 1 have used Norcraft’s WACC (10.60%) as the applicable discount
rate and a 3.5% PGR for Norcraft, which together imply a capitalization rate of 7.10%.
364 Id. Mindful of Clarke’s justified criticism of Austin Smith’s calculation of Norcraft’s
terminal year free cash flow, my calculation of that value adjusts for the fact that Norcraft’s
projected depreciation and amortization expense in the final year of the Base Case
projections (FY2019) exceeds Norcraft’s projected capital expenditures in that year by
approximately $100,000. The adjustment entails implying a 3:4 relationship between
Norcraft’s depreciation/amortization expense and capital expenditures in perpetuity and
thereby avoids “underinvesting in net PP&E.” JX 21 (Clarke Rebuttal Report) at 25; see
Hitchner, supra, at 138 (“[I]n a growing business, long-term annual estimated capital
expenditures exceed annual depreciation, primarily due to inflation.”); see also Gilbert E.
Matthews & Arthur H. Rosenbloom, Delaware’s Unwarranted Assumption that Capex
Should Equal Depreciation in a DCF Model, (May 15, 2018),
https://corpgov.law.harvard.edu/201 8/05/ 1 5/delawares-unwarranted-assumption-in-dcf-
pricing/ (“The assumption that depreciation equals capital expenditures is only appropriate
if it is also assumed that there is no growth and no inflation. However, . . . the normalized
capital expenditures of a [perpetually] growing company must materially exceed
depreciation over time.”).
98
l adding Norcraft’s excess cash as of the Merger date, calculated as
$62.6 million363;
l adding the value of the TRA-related tax benefits realized by Norcraft in
each of the projected years calculated as $4.3 million366; and
l deducting Norcraft’s long-term debt as of the Merger date, calculated as
$147.5 million.367
363 Both experts added Norcraft’s estimated excess cash to its operating value in order to
calculate the Company’s total equity value. JX 18 (Clarke Report), sched. 2-A (DCF
Analysis); JX 20 (Austin Smith Report), Ex. 6 (DCF Analysis). The experts differed,
however, in how they calculated Norcraft’s excess cash and thus reached different
estimates of that figure. As noted, Austin Smith calculated Norcraft’s excess cash on the
Merger date based on the “Cash from Norcraft” figure in the “Funds Flow Memorandum”
for the Merger ($54,396,335.01), JX 249 at 2, less a $20 million cash balance
(cash for operations per the Base Case proj ections), plus the product of (1) Norcraft’s total
options outstanding as of the Merger date (1,142,383) and (2) the weighted average
exercise price of those options ($16.01). JX 20 (Austin Smith Report), Ex. 6 (DCF
Analysis). Clarke, by contrast, calculated Norcraft’s excess cash on the Merger date as the
sum of (1) the cash balance indicated in Norcraft’s Ql FY2015 Form 10-Q ($63,135,000),
JX 248 at 4, and (2) the Merger-related fees indicated in that same filing ($1.2 million),
less $20 million cash for operations (per the Base Case projections). JX 18 (Clarke Report)
at 45. 1 have adopted Clarke’s approach, but have added to his excess cash figure
Norcraft’s cash receipts from the exercise of all options outstanding on the Merger date
(1,142,383) at the weighted average exercise price ($16.01). JX 248 (Norcraft’s Ql
FY2015 Form 10-Q) at 14. 1 find that this holistic approach best approximates Norcraft’s
“operative reality” as of the Merger date.
366 Clarke valued the TRA-related tax benefits realized by Norcraft in each of the projected
years at $4.4 million, JX 18 (Clarke Report) at 46, while Austin Smith valued them at
$4.2 million. JX 20 (Austin Smith Report), Ex. 7 (Tax Characteristics Analysis). Having
considered each expert’s (quite complicated) approach to valuing those tax benefits 1 find
that both approaches_and both resulting valuations_are reasonable (they differ by
approximately $200,000). Accordingly, 1 have adopted the average of the experts’
respective value estimates
367 Like Clarke and Austin Smith, 1 have drawn this figure directly from Norcraft’s Ql
FY2015 Form lO-Q. JX 248 (NOrCraft’S Ql FY2015 FOI‘m 10-Q) at 4; JX 18 (Clarke
Report) at 47; JX 20 (Austin Smith Report), Ex. 6 (DCF Analysis).
99
These adjustments to Norcraft’s operating value yield a total equity value for
Norcraft of $546.3 million. Dividing Norcraft’s total equity value by Norcraft’s
fully diluted shares outstanding as of the Merger date (20,880,123),363 1 conclude
that Norcraft’s equity value per share on that date was $26.16.
3. The Merger Price as a “Reality Check”
As explained above, 1 have determined that the Merger Price is not a reliable
indicator of Norcraft’s fair value as of the Merger date. That does not mean,
however, that the Merger Price is irrelevant for purposes of the Court’s fair value
determination To the contrary, it is appropriate to consider the Merger Price as a
“reality check” on the Court’s DCF valuation of Norcraft.369 1nsofar as 1 arn obliged
to articulate a principled, evidence-based explanation for the delta between the
Merger Price and the Court’s DCF valuation (here, $0.66 per share), 1 am satisfied
that the process infirmities 1 have identified resulted in the Board leaving $0.66 per
share on the bargaining table.370 With that said, 1 am also satisfied that the delta
363 JX 248 (Norcraft’s Ql FY2015 Form 10-Q) at 11.
369 See AOL, 2018 WL 103 7450, at *2 (“1 take the parties’ suggestion to ascribe full weight
to a [DCF] analysis . . . [and thus] 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.”).
370 1 am mindful that “[t]he issue in an appraisal is not whether a negotiator has extracted
the highest possible bid. Rather, the key inquiry is whether the dissenters got fair value
and were not exploited.” Dell, 177 A.3d at 33. Here, in light of the identified flaws in
Norcraft’s deal process (pre- and post-sign), 1 find it more likely than not that the Board
100
between the Merger Price and the DCF value is not so great as to cause me to
question whether the DCF value is grounded in reality.371
III. CONCLUSION
For the foregoing reasons 1 have found the fair value of Norcraft shares as of
the Merger date (May 12, 2015) was $26.16 per share. The statutory rate of interest,
compounded quarterly, shall accrue from the date of closing to the date of payment.
The parties should confer and submit an implementing final judgment within ten
(10) days
“left a portion of [Norcraft’s] fundamental value on the table.” Verition P ’rs Master Fund,
2018 WL 922139, at *44.
371 See AOL, 2018 WL 1037450, at *2.
101