Merion Capital LP and Merion Capital II LP v. BMC Software, Inc.

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
MERION CAPITAL LP and MERION )
CAPITAL II LP, )
)
Petitioners,
)
v. ) C.A. No. 8900-VCG
)
BMC SOFTWARE, INC., )
)
Respondent. )
MEMORANDUM OPINION
Date Submitted: July 20, 2015
Date Decided: October 21, 2015
Stephen E. Jenkins, Steven T. Margolin, Marie M. Degnan, and Phillip R. Sumpter,
of ASHBY & GEDDES, Wilmington, Delaware, Attorneys for Petitioners.
David E. Ross and S. Michael Sirkin, of ROSS ARONSTAM & MORITZ LLP,
Wilmington, Delaware; OF COUNSEL: Yosef J. Riemer, P.C., and Devora W.
Allon, of KIRKLAND & ELLIS LLP, New York, New York, Attorneys for
Respondent.
GLASSCOCK, Vice Chancellor
This case presents what has become a common scenario in this Court: a
robust marketing effort for a corporate entity results in an arm‘s length sale where
the stockholders are cashed out, which sale is recommended by an independent
board of directors and adopted by a substantial majority of the stockholders
themselves. On the heels of the sale, dissenters (here, actually, arbitrageurs who
bought, not into an ongoing concern, but instead into this lawsuit) seek statutory
appraisal of their shares. A trial follows, at which the dissenters/petitioners present
expert testimony opining that the stock was wildly undervalued in the merger,
while the company/respondent presents an expert, just as distinguished and
learned, to tell me that the merger price substantially exceeds fair value. Because
of the peculiarities of the allocation of the burden of proof in appraisal actions—
essentially, residing with the judge—it becomes my task in such a case to consider
―all relevant factors‖ and determine the fair value of the petitioners‘ shares.
Here, my focus is the fair value of shares of common stock in BMC
Software, Inc. (―BMC‖ or the ―Company‖) circa September 2013, when BMC was
taken private by a consortium of investment firms (the ―Merger‖), including Bain
Capital, LLC, Golden Gate Private Equity, Inc., and Insight Venture Management,
LLC (together, the ―Buyer Group‖). Our Supreme Court has clarified that, in
appraisal actions, this Court must not begin its analysis with a presumption that a
particular valuation method is appropriate, but must instead examine all relevant
1
methodologies and factors, consistent with the appraisal statute.1 Relevant to my
analysis here are the sales price generated by the market, and the (dismayingly
divergent) discounted cash flow valuations presented by the parties‘ experts (only
Respondent‘s expert conducted an analysis based on comparable companies, and
only as a ―check‖ on his DCF valuation). Upon consideration of these factors in
light of a record generated at trial, I find it appropriate to look to the price
generated by the market through a thorough and vigorous sales process as the best
indication of fair value under the specific facts presented here. My analysis
follows.
I. BACKGROUND FACTS2
A. The Company
1. The Business
BMC is a software company—one of the largest in the world at the time of
the Merger—specializing in software for information technology (―IT‖)
management.3 Specifically, BMC sells and services a broad portfolio of software
products designed to ―simplif[y] and automate[] the management of IT processes,
mainframe, distributed, virtualized and cloud computing environments, as well as
1
8 Del. C. § 262(h); see Global GT LP v. Golden Telecom, Inc., 11 A.3d 214, 217–18 (Del.
2010).
2
The following are the facts as I find them by a preponderance of the evidence after trial. Facts
concerning the Company pertain to the period prior and leading up to the Merger. References in
footnote citations to specific page numbers indicate the exhibit‘s original pagination, unless
unavailable.
3
JX 254 at 4.
2
applications and databases.‖4 In addition, the Company provides professional
consulting services related to its products, including ―implementation, integration,
IT process, organizational design, process re-engineering and education services.‖5
From fiscal years 2011 to 2013,6 BMC‘s software sales, which it offers through
either perpetual or term licenses, accounted for approximately 40% of total
revenues, which share was steadily decreasing leading up to the Merger; BMC‘s
maintenance and support services, which it offers through term contracts,
accounted for approximately 50% of total revenues, which share was steadily
increasing leading up to the Merger; and BMC‘s consultation services accounted
for approximately 10% of total revenues, which share was also steadily increasing
leading up to the Merger.7
The Company is organized into two primary business units: Mainframe
Service Management (―MSM‖) and Enterprise Service Management (―ESM‖).8 As
explained by BMC‘s CEO and Chairman Robert Beauchamp, MSM consists
primarily of two product categories: mainframe products, which are designed to
maintain and improve the efficiency and performance of IBM mainframe
computers; and workload automation products, which are designed to orchestrate
4
Id.
5
Id. at 7.
6
The Company‘s fiscal year runs from April 1 to March 31 of the following calendar year and is
denoted by the calendar year in which it ends. Trial Tr. 11:10–15 (Solcher).
7
See JX 254 at 7.
8
Id. at 5.
3
the multitude of back-end ―jobs‖—each a series of executions of specific computer
programs—that a computer system must perform to carry out a complex
computing process, such as a large corporation running its bi-weekly payroll.9
ESM, on the other hand, is concerned more with providing targeted software
solutions to a business‘s needs, and consists primarily of the Company‘s consulting
division as well as three product categories: performance and availability
products, which are designed to alert BMC‘s customers in real time as to delays
and outages among their non-mainframe computer systems, and to diagnose and
fix the underlying problems; data center automation products, which are designed
to automate BMC customers‘ routine tasks concerning the design, construction,
and maintenance of data centers, both in local data centers and cloud data centers;
and IT service management products, which are designed to assist BMC‘s
customers troubleshoot their own customers‘ IT problems.10 In each of fiscal years
2011, 2012, and 2013, MSM and ESM accounted for approximately 38% and 62%
of BMC‘s total revenues, respectively.11
2. Stunted but Stable Performance
Beauchamp and BMC‘s CFO Stephen Solcher both testified that, at the time
of the Merger, BMC‘s business faced significant challenges to growth due to
9
Trial Tr. 362:3–364:3 (Beauchamp); see also JX 254 at 6.
10
Trial Tr. 367:8–370:10 (Beauchamp); see also JX 254 at 5–6.
11
JX 254 at 85–86; see also Trial Tr. 364:4–8 (Beauchamp).
4
shifting technologies. Foremost, MSM was in a state of stagnation, as hardly any
businesses were buying into the outdated, so-called ―legacy‖ technology at the
heart of MSM products and services—the IBM mainframe computer—and indeed
some of BMC‘s MSM customers were moving away from mainframe technology
altogether.12 Even though the market‘s migration away from the heavily
entrenched mainframe computer was expected to continue at only a crawl—in the
words of Beauchamp, a ―very slow, inexorable decline‖—the steadily falling price
of new mainframe computers meant that BMC still faced shrinking margins in
renewing MSM product licenses with customers that stayed with the technology. 13
BMC had managed to ease the downward pressure on its MSM business by
increasing the number of products it sold to each customer that remained with
MSM,14 but this side of the business remained flat, at best, in the years leading up
to the Merger.15
As a result of the decline in mainframe computing, BMC had become
entirely dependent on its ESM business for growth.16 Specifically, Solcher
identified ESM license bookings as the primary driver of growth for the
12
See Trial Tr. 364:19–365:24 (Beauchamp); id. at 24:3–9 (Solcher).
13
Id. at 364:22–23, 366:1–18 (Beauchamp).
14
Id. at 366:19–367:7, 651:15–652:6 (Beauchamp).
15
See e.g., id. at 24:5–7 (Solcher).
16
See id. at 23:22–24:9 (Solcher).
5
Company.17 However, the ESM side of BMC‘s business faced its own challenges,
principally high levels of competition—from a handful of the most established
software companies in the world to a sea of startups—brought on by the constant
innovation of ESM technologies, which competition in turn created significantly
lower margins on the ESM side of the business.18
Notwithstanding these challenges to its growth, BMC‘s business remained
relatively stable leading up to the Merger, aided in part by BMC‘s role as an
industry leader in several categories of products, in part by the overall diversity
and ―stickiness‖ of its products, and in part by its multiyear, subscription-based
business model, which spreads its customer-retention risk over several years.19 In
fiscal years 2011, 2012, and 2013, BMC generated total revenues of $2.07 billion,
$2.17 billion, and $2.20 billion, respectively, and net earnings of $456.20 million,
$401.00 million, and $331.00 million, respectively.20 During this period, total
bookings remained essentially flat, while ESM license bookings fell 11.3% from
fiscal years 2011 to 2012 and another 1.2% from fiscal years 2012 to 2013.21
17
Id. Bookings represent the contract value of transactions closed and recorded in any given
period of time. E.g., JX 254 at 24; Trial Tr. 23:11–13 (Solcher).
18
Trial Tr. 370:11–372:8 (Beauchamp); see also id. at 309:24–310:24 (Solcher) (―On the MSM
side was where we had the larger margins. We‘re 60-plus percent. And on the ESM side, you‘re
probably looking somewhere in the mid-20s.‖).
19
Id. at 383:10–384:5 (Beauchamp).
20
JX 254 at 56.
21
JX 254 at 24; JX 39 at 23.
6
3. M&A Activity
The primary way that BMC has historically dealt with the high rate of
innovation and competition in the IT management software industry is to lean
heavily on mergers and acquisitions (―M&A‖) to grow and compete.22 Along with
a corporate department devoted solely to M&A, the Company maintained a
standing M&A committee among its board of directors that met quarterly to
oversee the Company‘s M&A activity (the ―M&A Committee‖), which
Beauchamp explained was designed to spur the Company‘s management to
continuously and rapidly seek out and execute favorable transactions.23
Management played an active role in all M&A activity, but formal decision-
making authority was stratified across the board, the M&A Committee, and
management based on the size of potential transactions (as estimated by
management): deals over $50 million were evaluated and recommended by the
M&A Committee and had to be approved by the board as a whole; deals between
$20 million and $50 million were evaluated by the M&A Committee and could be
approved by that Committee without prior approval or consideration by the board;
and transactions under $20 million could be evaluated and approved by
management, without prior approval or consideration of the M&A Committee or
22
See, e.g., Trial Tr. 385:13–386:19 (Beauchamp); id. at 73:24–74:4, 91:8–16 (Solcher).
23
Id. at 393:3–394:5 (Beauchamp); see also id. at 78:10–21 (Solcher).
7
the board.24
At trial, Beauchamp and Solcher both conceptually clustered the Company‘s
M&A activity into two general categories, what they referred to as ―strategic‖
transactions and ―tuck-in‖ transactions.25 As they described it, strategic
transactions are large ―move-the-needle type transactions,‖26 ones that would
change the Company in a fundamental way, such as acquiring a new business
unit.27 These types of transactions were relatively rare for the Company, it having
only engaged in one such acquisition in the five years leading up to the Merger—
the approximately $800 million acquisition of a company called ―BladeLogic‖ in
fiscal year 2009, through which BMC acquired its current data center automation
business.28 Tuck-in transactions, on the other hand, are everything else—smaller
transactions by which the Company would buy an individual product or technology
that it could ―tuck in‖ or ―bolt on‖ to an existing business unit.29
24
See id. at 548:21–556:16 (Beauchamp).
25
See, e.g., id. at 388:18–390:19 (Beauchamp); id. at 74:5–75:5 (Solcher).
26
Id. at 86:19–24 (Solcher).
27
E.g., id. at 388:18–389:3 (Beauchamp).
28
JX 204 at 4; Trial Tr. 387:6–388:17 (Beauchamp); id. at 75:20–23 (Solcher); see also JX 254
at 5 (describing the BladeLogic suite of products).
29
E.g., Trial Tr. 390:7–16 (Beauchamp); id. at 74:5–75:5 (Solcher). At trial, the Petitioners
stressed the fact that the M&A Committee in its meeting presentation materials had consistently
used a different, value-based categorization for M&A deals in describing BMC‘s M&A pipeline:
deals over $300 million were labeled as ―scale,‖ deals over $100 million were labeled as
―product,‖ and deals under $50 million were labeled as ―tuck-in.‖ See, e.g., id. at 163:13–173:5
(Solcher). However, as my analysis below illustrates, the Petitioners‘ focus on this semantic
difference misses the point. For the sake of this appraisal, I am concerned with how those who
prepared the projections that will be used in my valuation (i.e., management) conceptualized
BMC‘s M&A activity, in order to understand how M&A activity was forecasted in those
8
As explained by Beauchamp and Solcher, it was these latter, smaller
acquisitions that formed the basis of BMC‘s inorganic growth strategy.30 The
Company carried out over a dozen tuck-in transactions in the years leading up to
the Merger: three deals totaling $117 million in fiscal year 2008; one deal totaling
$6 million in fiscal year 2009, the same year of the $800 million acquisition of
BladeLogic; three deals totaling $97 million in fiscal year 2010; two deals totaling
$54 million in fiscal year 2011; six deals totaling $477 million in fiscal year 2012;
and one deal totaling $7 million in fiscal year 2013, the year in which BMC began
and ran much of the sales process for the Merger.31 Beauchamp and Solcher
explained that, had the Company remained public, it had every intention of
continuing its tuck-in M&A activity into the future,32 and indeed the M&A
projections and to what extent the forecasts are reasonable. Thus, in this Memorandum Opinion,
I adopt management‘s nomenclature in reference to BMC‘s M&A activity, referring to
transactions so significant that they change the Company‘s business in a fundamental way—
those valued at over $300 million and labeled ―scale‖ by the M&A Committee—as ―strategic‖
and to all other transactions as ―tuck-in.‖ See, e.g., id. at 86:7–87:18 (Solcher).
30
See id. at 390:7–19 (Beauchamp) (―Q: . . . [W]hat do you think of when you‘re talking about
tuck-in? A: Well, tuck-in is . . . if you‘re the president or the general manager of one of these
units, you have a whole set of competitors and things are changing pretty quickly. And you also
have a lot of customers telling you, ‗We want this and we want that.‘ You have regular meetings
with your customers. You either have to build those features or you have to go buy those
features. And so tuck-ins, to me, is responding to the competitive pressures or the customer
demands by using build versus buy. And frequently we use buy.‖); id. at 74:22–75:5 (Solcher)
(―Q: . . . [W]hy was tuck-in important at BMC? A: Well, we had to fill out our portfolio, for
one. We had to acquire talent. This industry is rapidly evolving, and tech is something that
you‘ve got to constantly be thinking about the next move you‘re going to make. So we‘re
always looking for that next widget to go acquire, whether it be the individual or the actual
technology itself.‖).
31
See JX 204 at 4.
32
E.g., Trial Tr. 85:5–93:5 (Solcher); id. at 392:16–20 (Beauchamp).
9
Committee‘s presentation materials throughout fiscal year 2013 and into fiscal year
2014, after BMC had agreed to the Merger, identified dozens of tuck-in merger
targets of varying sizes and stages of development in the Company‘s M&A
pipeline.33
4. Stock-Based Compensation
Like many technology companies, in order to attract and maintain talented
employees, BMC compensated a significant portion of their employees using
stock-based compensation (―SBC‖).34 The Company had two forms of SBC: (1)
time-based stock options that vested over a specific period of time, which the
Company valued using the price of BMC‘s stock on the date of the grant; 35 and (2)
performance-based stock options, reserved for select executives, that vested based
on the performance of BMC‘s stock compared to a broad index and were valued
using a Monte Carlo simulation which accounted for the likelihood that the
performance targets would be met.36 The Company expensed the fair value of the
stock options, less expected amount of forfeitures, on a straight-line basis over the
vesting period.37 SBC expense grew substantially each year and in 2013 was
33
See JX 204 at 11; JX 312 at 10.
34
Solcher testified that approximately 20% of BMC‘s employees were compensated, in part, by
SBC. Trial Tr. 42:3–16 (Solcher).
35
Id. at 45:2–46:12 (Solcher); JX 254 at 78–79.
36
Trial Tr. 45:5–46:6 (Solcher); JX 254 at 78–79.
37
Trial Tr. 45:2–46:18 (Solcher); JX 254 at 78–79.
10
approximately seven percent as a percentage of revenue.38
Because the Company believed SBC was vital to maintaining the strength of
its employee base, management had no plans to stop issuing SBC had it remained a
public company.39
5. Financial Statements
a. Regular Management Projections
BMC in the ordinary course of business created financial projections—
which it called its ―annual plan‖40—for the upcoming fiscal year.41 Under the
oversight of Solcher,42 management began formulating its annual plan in October
using a bottom-up approach that involved multiple layers of management
representing each business unit.43 Preliminary projections were presented to the
board in the fourth quarter,44 who then used a top-down approach to provide input
before the annual plan was finalized.45
The annual plan was limited to internal use and represented optimistic goals
38
Trial Tr. 43:14–18 (Solcher).
39
Id. at 42:12–43:7 (Solcher). Additionally, in order to avoid dilution of the Company‘s shares,
each time the Company issued stock pursuant to SBC it would also buy BMC stock in the open
market. Id. at 46:19–47:7 (Solcher).
40
See, e.g., id. at 329:4–10 (Solcher).
41
Id. at 11:16–18 (Solcher).
42
Id. at 11:23–12:3 (Solcher).
43
Id. at 12:4–13:9 (Solcher).
44
Id. at 12:8–12 (Solcher).
45
Id. at 16:19–17:4 (Solcher).
11
that set a high bar for future performance.46 Although management intended the
projections to be a ―stretch‖ and the Company often did, in fact, fail to meet its
goals, management maintained that meeting the projections included in its annual
plan was always attainable.47
Also in October of each year, BMC would begin to prepare high-level three-
year projections that were not as detailed as the one-year annual plan.48
Additionally, as part of a separate process, the finance group prepared detailed
three-year projections that Solcher presented to ratings agencies, usually on an
annual basis.49 Although the projections presented to the ratings agencies were
prepared in the ordinary course of business, they were prepared under the direction
of Solcher and were not subject to the same top-down scrutiny as the high-level
three-year projections.50
b. Reliability of Projected Revenue from Multiyear Contracts
Although management‘s projections required many forecasts and
assumptions, BMC benefited from the predictability of their subscription-based
46
Id. at 13:24–14:13 (Solcher).
47
Id. at 13:24–16:15 (Solcher).
48
See, e.g., id. at 264:11–268:22 (Solcher) (―Q: In the regular course of its business, did BMC
management prepare statements of cash flows that projected out three years? A: We projected
out captions within a statement of cash flow . . . Q: So what you did internally was . . . a six-line
cash flow statement, not a 20-line cash flow statement. A: Right.‖) (emphasis added); see also,
e.g., id. at 276:8–16 (Solcher) (―I just would characterize it that the board and the rest of the
management team did [three-year projections] at a very high level in the October time frame.‖).
49
Id. at 270:21–273:20 (Solcher).
50
See id. at 276:12–277:19 (Solcher).
12
business model. A significant amount of the Company‘s revenue derived from
multiyear contracts that typically spanned a period of five to seven years.51
Depending on the nature of the contract, the Company did not immediately
recognize revenue for the entire contract price in the year of sale.52 Instead,
general accounting principles dictated that the sales price be proportionately
recognized over the life of the contract.53 Therefore, upon the signing of certain
multiyear contracts—such as an ESM or MSM software license54—the Company
recorded deferred revenue as an asset on the balance sheet and then, in each year
for the life of the contract, recognized revenue for a portion of the contract.55 As a
result, management was able to reliably predict a significant portion of revenue
from multiyear contracts many years into the future.
c. Management Projections Leading Up to the Merger
BMC created multiple sets of financial projections leading up to the Merger.
In July 2012, BMC began preparing detailed multiyear projections as the Company
began exploring various strategic alternatives, including a potential sale of the
Company.56 Building off of the 2013 annual plan, management created three-year
51
Id. at 23:22–25:1 (Solcher).
52
Id. at 24:13–25:1 (Solcher); id. at 384:6–24 (Beauchamp).
53
Id. at 384:6–20 (Beauchamp); JX 254 at 27–28.
54
According to the Company‘s 2013 Form 10-K, of the software license transactions recorded in
fiscal years 2011, 2012, and 2013, only 51%, 54%, and 54% of the transactions were recognized
as license revenue upfront in each of those years, respectively. JX 254 at 27.
55
Trial Tr. 384:6–20 (Beauchamp); id. at 24:13–25:1 (Solcher); JX 254 at 27–28.
56
Trial Tr. 32:8–19 (Solcher).
13
financial projections using a similar top-down and bottom-up approach that was
historically employed to create the Company‘s internal annual plan.57 Consistent
with their regular approach, management used optimistic forecasts in their detailed
multiyear projections.58 In October 2012, management finalized their first set of
projections (the ―October Projections‖) that were included in a data pack used by
the financial advisors to shop the Company.59
As discussed in more detail below, the Company quickly abandoned their
initial efforts to sell the company. In January 2013, however, following poor
financial results in the third quarter, BMC again decided to explore strategic
alternatives, requiring management to update the October Projections.60 In
February, using the same approach, the Company revised the multiyear projections
(the ―February Projections‖), resulting in lower projected results that were
provided to the financial advisors to create a second data pack.61 Finally, in April,
management provided the financial advisors a slight update to their projections (the
―April Projections‖), on which the financial advisors ultimately based their fairness
opinion and used to create a final data pack.62 The financial advisors also
57
Id. at 34:2–16 (Solcher). Solcher testified at trial that, although both approaches were used,
projections for years two and three were generated using mainly a top-down approach. Id. at
34:15–6 (Solcher).
58
Id. at 34:17–35:8 (Solcher).
59
Id. at 33:6–34:1 (Solcher); see also JX 88.
60
Trial Tr. 36:12–37:6 (Solcher).
61
Id. at 36:12–38:12 (Solcher); see also JX 146.
62
Trial Tr. 38:13–39:11 (Solcher); see also JX 210.
14
extrapolated the April Projections to extend the forecast period an additional two
years, creating a total of five years of projections that were provided to potential
buyers.63
d. SBC in Management Projections
As I have described above, SBC was an integral part of BMC‘s business
before the Merger and management had no reason to believe that SBC would
decrease if the Company had remained public. Additionally, because BMC had a
regular practice of buying shares to offset dilution, management believed SBC was
a true cost and, therefore, included SBC expense in their detailed projections.64
With the help of human resources and third-party compensation consultants,
management projected SBC expenses of $162 million for both fiscal years 2014
and 2015, and $156 million for fiscal year 2016.65
e. M&A in Management Projections
Management believed tuck-in M&A was integral to the Company‘s revenue
growth and, therefore, its projected revenues took into account continued growth
63
See Trial Tr. 40:21–24 (Solcher).
64
See id. at 47:15–49:20 (Solcher) (―We had a historical practice of offsetting that dilution.
So . . . it‘s cash out the door.‖).
65
Id. at 47:15–49:20 (Solcher); JX 225 at 32. Although management and the financial advisors
believed that the inclusion of SBC was the most accurate way to present BMC‘s financial
projections, most of the presentations, as well as the proxy, also included financial projections
that were ―unburdened‖ by SBC. Trial Tr. 48:20–52:3 (Solcher). According to the proxy
statement, the board requested that the financial advisors perform for ―reference and
informational purposes only‖ discounted cash flow analysis that included, among other changes,
financial projections unburdened by SBC. Id. at 51:10–52:3 (Solcher) (emphasis added); JX 284
at 59.
15
from tuck-in M&A transactions.66 Furthermore, management believed that BMC
would continue investing in tuck-in M&A if it had remained a public company.67
Since growth from tuck-in M&A was built into their revenue projections,
management also included projected tuck-in M&A expenditures.68 Larger strategic
deals, however, were too difficult to predict and were, therefore, excluded from
management‘s projections.69 Based on the first three quarters of M&A activity in
fiscal year 2014, management projected $200 million in total tuck-in M&A
expense for fiscal year 2014 and, based on the Company‘s historical average tuck-
in M&A activity, management projected $150 million in M&A expenditures for
both fiscal years 2015 and 2016.70
B. The Sales Process
1. Pressure from Activist Stockholder
In May 2012, in response to ―sluggish growth‖ and ―underperformance,‖
66
Trial Tr. 91:13–92:1 (Solcher) (describing M&A as part of the Company‘s ―core fabric‖).
67
Id. at 92:24–93:5 (Solcher). BMC did reduce actual M&A activity in January 2013. This was
not a permanent shift in the Company‘s strategy, but was instead an intentional and temporary
reduction in spending in order to conserve cash in anticipation of closing the Merger. See id. at
88:16–89:13 (Solcher); id. at 392:21–393:21 (Beauchamp).
68
See, e.g., id. at 81:15–82:9, 85:16–86:1 (Solcher). Despite management‘s repeated testimony
that tuck-in M&A was necessary to the Company‘s revenue projections, Petitioners argue that
certain presentations made to potential buyers and lenders described M&A as ―upside‖ to
management‘s base projections and were, therefore, not already included. See Pet‘r‘s Opening
Post-Trial Br. at 17–19. Management, however, included a separate line item for M&A
expenditures in its projections which informed each of the three data packs used during the sales
process. See JX 88 at 6 (October Projections); JX 146 at 7 (February Projections); JX 210 at 6
(April Projections).
69
Trial Tr. 77:21–23 (Solcher).
70
Id. at 80:14–81:24 (Solcher); JX 146 at 7.
16
activist investors Elliott Associates, L.P. and Elliott International, L.P. (together,
―Elliot‖) disclosed that Elliot had increased its equity stake in BMC to 5.5% with
the intent to urge the Company to pursue a sale.71 To accelerate a sales process,
Elliott commenced a proxy contest and proposed a slate of four directors to be
elected to BMC‘s board.72 According to Beauchamp, BMC‘s CEO, Elliot‘s
engagement had a negative impact on the Company‘s business operations: BMC‘s
competitors used customer concerns as a tool to steal business; it hurt BMC‘s
ability to recruit and retain sales employees; and it generally damaged BMC‘s
reputation in the marketplace.73
On July 2, 2012, after discussions with other large stockholders, BMC
agreed to a settlement with Elliott that ended its proxy contest.74 Under the
settlement, the Company agreed to increase the size of the board from ten to twelve
directors and to nominate John Dillion and Jim Schaper—two members of Elliott‘s
proposed slate—as directors at the upcoming annual meeting.75 In return, Elliott
agreed to immediately terminate its proxy contest and agreed to a standstill
agreement that restricted Elliott‘s ability to initiate similar significant stockholder
engagement moving forward.76
71
See JX 43.
72
See id.
73
Trial Tr. 526:9–527:20 (Beauchamp).
74
See id. at 396:1–399:7 (Beauchamp); JX 57.
75
See JX 57.
76
See id.
17
2. The Company on the Market
a. The First Auction
In July 2012, in conjunction with its settlement with Elliott, BMC‘s board
formed a committee (the ―Strategic Review Committee‖) to explore all potential
strategic options that could create shareholder value, including a sale.77 BMC
retained Bank of America Merrill Lynch to help explore strategic options and to
alleviate any concerns that Morgan Stanley, the Company‘s longstanding financial
advisor, was too close to management.78
On August 28, 2012, the board instructed Beauchamp to begin contacting
potential strategic buyers and instructed the team of financial advisors to begin
contacting potential financial buyers to gage their interest in an acquisition.79 Even
though all potential strategic buyers ultimately declined to submit an initial
indication of interest, BMC received two non-binding indications of interest from
potential financial buyers: one from Bain Capital, LLC (―Bain‖) for $45-47 per
share and one for $48 per share from a team of financial sponsors (the ―Alternate
Sponsor Group‖).80
The Strategic Review Committee evaluated the indications of interest and,
encouraged by BMC‘s improved financial results in the second quarter of fiscal
77
Trial Tr. 395:10–24, 399:23–400:14 (Beauchamp).
78
Id. at 401:17–403:4 (Beauchamp).
79
Id. at 403:17–408:23 (Beauchamp); JX 68 at 2.
80
Trial Tr. 409:19–410:6 (Beauchamp); JX 284 at 27.
18
year 2013,81 unanimously recommended that the board reject the offers.82 On
October 29, 2012, the board unanimously rejected a sale of the Company and,
instead, approved a $1 billion accelerated share repurchase plan that was publicly
announced two days later.83
b. The Second Auction
Despite the Company‘s renewed confidence following improved quarterly
results, in December 2012 Elliott sent a letter to the board that expressed continued
skepticism of management‘s plans and reiterated its belief that additional drastic
measures, like a sale, were required to maximize stockholder value.84 Shortly
thereafter, BMC reported sluggish third quarter financial results which revealed
that management‘s previous financial projections—specifically ESM license
bookings—had been overly optimistic.85
The board called a special meeting on January 14, 2013 to reevaluate their
options, which included three strategic opportunities: (1) a strategic acquisition of
Company A, another large software company; (2) a modified execution plan that
included less implied growth and deep budget cuts; and (3) a renewed sales process
targeted at the previously interested financial buyers.86 The board decided to
81
See Trial Tr. 412:8–24 (Beauchamp); JX 104.
82
Trial Tr. 410:7–411:13 (Beauchamp).
83
Id. at 411:14–413:7 (Beauchamp); JX 105.
84
Trial Tr. 417:6–20 (Beauchamp); JX 112.
85
Trial Tr. 417:21–418:19 (Beauchamp).
86
Id. at 420:1–421:20 (Beauchamp); JX 116.
19
pursue all three strategies. In late January, building on previous consulting work
provided by BMC‘s management consultants, the Company began implementing
Project Stanley Cup, which mainly focused on reducing costs to increase BMC‘s
margins and earnings per share.87 In addition, the Company reached out to
Company A regarding a potential acquisition of Company A by BMC. Although
their initial meetings led to preliminary interest, the diligence efforts moved slowly
and finally, following Company A‘s poor financial performance, BMC abandoned
their pursuit of an acquisition.88
In March 2013, after contacting potential financial buyers,89 the Company
received expressions of interest from three buyers: one from a new financial
sponsor (―Financial Sponsor A‖) for $42-44 per share, one from the Alternate
Sponsor Group for $48 per share, and one from Bain, who had received permission
to partner with Golden Gate to form the Buyer Group, for $46-47 per share.90
Despite encouragement from BMC‘s financial advisors, Financial Sponsor A
declined to increase its bid and was, therefore, not invited to proceed with due
87
See JX 120.
88
Negotiations with Company A ended in April 2013. See Trial Tr. 429:16–430:6 (Beauchamp);
JX 284 at 31–33.
89
See Trial Tr. 423:21–424:5. BMC did not reach out to potential strategic buyers in the second
auction because it did not receive any indications of interest in the first auction and, considering
it had just released negative financial results, BMC believed that a strategic buyer would only
show interest if it could obtain an extremely low price. Id. at 425:4–20 (Beauchamp).
90
Id. at 426:19–427:11 (Beauchamp); JX 225 at 3.
20
diligence.91 In early April, the Alternate Sponsor Group told the Company‘s
financial advisors that it could not make the April 22 deadline the Company had
established and needed more time to complete due diligence.92 The board decided
that it was important to keep the Alternate Sponsor Group engaged and thus
continue negotiations.93 On April 18, one of the financial sponsors dropped out of
the process leaving its former partner to consider proceeding with a valuation that
was closer to the then current trading price of $43.75 and requesting an extension
of one month to submit a bid.94
On April 24, 2013, the Buyer Group submitted a bid of $45.25.95 Over the
next two days, the board met with the financial advisors to consider the
developments and voted to create an ad hoc planning committee to review
alternative options in the event a transaction was not approved or failed to close.96
On April 26, the financial advisors requested that the Buyer Group increase their
price to at least $48 and that their bid also include a 30-day go-shop period.97 On
that same day, the Buyer Group responded with a counteroffer of $45.75 that
included a 30-day go-shop period.98 Following further pushback from BMC‘s
91
Trial Tr. 431:1–9 (Beauchamp); JX 284 at 31.
92
JX 196 at 2.
93
Id.
94
Trial Tr. 431:1–13 (Beauchamp); JX 465 at 1.
95
Trial Tr. 431:14–17 (Beauchamp).
96
Id. at 433:10–434:8 (Beauchamp); JX 464 at 1–5.
97
See Trial Tr. 431:14–432:12 (Beauchamp); JX 284 at 34–35.
98
See Trial Tr. 432:13–433:1 (Beauchamp); JX 284 at 35.
21
financial advisors, on April 27, the Buyer Group responded with their final offer of
$46.25.99
3. The Company Accepts the Buyer Group‘s Offer
Starting on April 27, 2013 and continuing over the next few days, the board
met with the financial advisors to discuss the details of the Buyer Group‘s final
offer, which included: a 30-day go-shop period that started upon signing the
Merger agreement; a two-tiered termination fee of a 2% and 3%; and a 6% reverse
termination fee.100 On May 3, the financial advisors presented their fairness
opinion to the board, opining that the transaction was fair from a financial
standpoint.101 On that same day, the board approved the signing of the Merger
agreement and recommended that BMC‘s stockholders approve the Merger, which
was formerly announced on May 6.102
The go-shop period lasted from May 6, 2013 through June 5, 2013.103
During this period, the financial advisors contacted both financial and strategic
entities—many of whom were contacted during the first and second sales
processes104—and, in addition, the board waived any provisions pursuant to
standstill agreements that would have prohibited a potential bidder from
99
Trial Tr. 432:13–433:9 (Beauchamp); JX 284 at 35.
100
JX 284 at 35.
101
Trial Tr. 436:5–15 (Beauchamp); JX 229 at 1.
102
Trial Tr. 441:6–11 (Beauchamp); JX-229 at 3–9.
103
JX 284 at 37.
104
Trial Tr. 442:19–444:13 (Beauchamp).
22
reengaging with the Company.105 Despite these efforts, only two parties entered
into confidentiality agreements and, ultimately, no alternative proposals were
submitted.106
On May 10, 2013, a group of stockholders brought a breach of fiduciary
duty action to challenge the sales process.107 On June 25, BMC filed its definitive
proxy statement that urged stockholders to vote in favor of the Merger.108 The
stockholders approved the transaction on July 24 with 67% of the outstanding
shares voting in favor.109 On September 10, the Merger closed. On April 28, 2014
this Court approved a settlement between stockholders and the Company and
described the sales process as fair and the Revlon claims as weak.110
C. The Expert Opinions
The Petitioners‘ expert witness, Borris J. Steffen, exclusively relied on the
discounted cash flow (―DCF‖) method and determined that the fair value of BMC
was $67.08 per share; 111 that is, 145% of the Merger price and 148% of the pre-
105
Id. at 444:21–445:3 (Beauchamp).
106
JX 284 at 37.
107
The cases were consolidated as In re BMC Software, Inc. S’holder Litig., 8544-VCG (Del.
Ch. June 6, 2013).
108
See JX 284.
109
See JX 316.
110
See In re BMC Software, Inc. S’holder Litig., 8544-VCG (Del. Ch. Apr. 28, 2014)
(TRANSCRIPT).
111
Trial Tr. 831:11–832:9 (Steffen); JX 386 ¶ 109.
23
announcement market price.112 Steffen considered using other methodologies,
such as the comparable company method and the comparable transaction method,
but ultimately decided that those methodologies were not appropriate given the
specific facts in this case.113
The Respondent‘s expert witness, Richard S. Ruback, similarly relied on the
DCF method to conclude that the fair value of BMC was $37.88 per share,114 16%
below the pre-announcement market price and little more than half the fair value as
determined by Steffen. In addition, Ruback performed two ―reality checks‖ to test
his DCF valuation for reasonableness: first, he performed a DCF analysis using
projections derived from a collection of Wall Street analysts that regularly
followed the Company, which he called the ―street case‖; second, he performed a
comparable companies analysis using trading multiples from selected publicly-
traded software companies.115
Although the difference between the experts‘ estimates is large, the
contrasting prices are the result of a few different assumptions, which I now
describe below.116
112
The Company‘s common stock closed at $45.42 on May 3, 2013, the last day trading day
before the merger was announced. JX 284 at 105.
113
Trial Tr. 832:15–834:4 (Steffen); JX 386 ¶ 16–21.
114
JX 383 at ¶ 68.
115
Trial Tr. 1028:11–1030:12 (Ruback); JX 383 at ¶¶ 68–69.
116
In addition to the diverging key assumptions described in detail here, Steffen included an
adjustment for additional cost savings that neither management nor Ruback included. Steffen
believed—based on his interpretation of a chart presented to potential buyers—that certain cost
24
1. Financial Projections
Steffen based his calculation of free cash flow on management‘s projections
for 2014 through 2018 that BMC reported in its proxy statement dated June 25,
2013.117 He concluded the use of management‘s projections was reasonable based
on his analysis of other contemporaneous projections prepared by management;
BMC‘s historical operating results; and the economic outlook for the software
industry.118
Ruback, however, concluded that management‘s projections were biased by
―overoptimism‖ and, therefore, reduced management‘s revenue projections used in
his calculation of free cash flow by 5%.119 He believed this reduction was
appropriate because, although management thought their projections were
savings were misidentified by management as ―public-to-private‖ savings and thus improperly
excluded from management‘s projections. Id. at 866:18–867:19 (Steffen); JX 386 ¶ 110–113.
But at trial, Solcher testified that management had already implemented and included in its
projections all cost saving strategies that it believed were available to BMC as a public company.
Trial Tr. 58:12–59:11 (Solcher); see also id. 64:3–68:9 (Solcher) (specifically referring to those
cost savings identified by Steffen). Without more evidence that management misclassified these
expenses, Steffen‘s decision to include additional cost savings appears to be overly speculative
and, therefore, my DCF analysis does not include a similar adjustment.
117
Trial Tr. 837:5–11 (Steffen).
118
Id. at 844:18–845:10 (Steffen). Steffen did not form an opinion as to whether BMC was more
likely or not to meet its projections, but instead relied on management‘s assertion that they were
reasonable. Id. at 846:16–22 (Steffen).
119
Id. at 1031:18–24 (Ruback). Ruback calculated the average amount by which the Company
failed to meet their projections; he first recognized management‘s alleged bias after BMC‘s
financial performance for the quarter following the announcement of the Merger fell short of
management‘s projections and also after hearing Solcher‘s deposition where he characterized
management‘s forecasts as a ―stretch.‖ Id. at 1032:1–1034:24 (Ruback).
25
―reasonable,‖ a DCF model requires projections that are expected.120 Ruback‘s
adjustment decreased his valuation by approximately $2.82 per share.121
2. Discount Rate
Steffen used a discount rate of 10.5% while Ruback used a discount rate of
11.1%. The difference in discount rates is almost entirely explained by the
experts‘ contrasting views of the equity risk premium (―ERP‖). Steffen calculated
his discount rate using a supply-side ERP of 6.11%, which he believed was
preferable since valuation calculations are forward-looking.122 Ruback calculated
his discount rate using the long-run historical ERP of 6.7%.123 Ruback used the
long-run historical ERP because he believed it is the most generally accepted ERP
and that any model that attempts to estimate future ERP is subject to intolerable
estimation errors.124
3. Terminal Growth Rate
Steffen selected a long-term growth rate of 3.75%.125 To determine this
number, Steffen first created a range of rates between expected long-run inflation
of 2% and nominal GDP rate of 4.5%.126 Steffen ultimately concluded that BMC‘s
120
Id. at 1036:3–19 (Ruback).
121
Id. at 1050:4–17 (Ruback).
122
Id. at 969:15–970:7 (Steffen); JX 386 at ¶ 94. Steffen also cited his belief that Delaware law
dictated the use of a supply-side ERP in Golden Telecom. See Trial Tr. 969:15–970:7 (Steffen).
123
Id. at 1056:18–1057:14 (Ruback).
124
Id. at 1061:10–1063:7 (Ruback).
125
JX 386 ¶ 87.
126
Trial Tr. 848:14–849:17 (Steffen).
26
long-term growth rate would be 50 basis points greater than the midpoint between
this range.127 Ruback used a rate of inflation of 2.3% as his long-term growth rate
because he believed that the real cash flows of the business would stay constant in
the long run;128 he viewed BMC as a ―mature software business‖ in a ―mature part
of the software industry.‖129
4. Excess Cash
Steffen used an excess cash value of $1.42 billion, which he calculated by
reducing cash and cash equivalents as of September 10, 2013 by the minimum cash
required for BMC to operate of $350 million.130 Steffen did not account for
repatriation of foreign cash because he believed that it was the Company‘s
policy—as publicly disclosed in its 10-K filings—to maintain its cash balance
overseas indefinitely.131
Ruback started with cash and cash equivalents as of June 30, 2013132 and, in
addition to the same $350 million deduction for required operating expenses,
further reduced excess cash by $213 million to account for the tax consequences of
127
See id. at 849:13–17 (Steffen).
128
Id. at 1050:19–1051:20 (Ruback). Ruback tested the reasonableness of his growth rate by
comparing it to other growth rates that he implied from exit multiples used by the financial
advisors and the multiples used in his comparable company analysis. Id. at 1051:21–1056:17
(Ruback). Ultimately, Ruback noted that both experts in this case used a growth rate that was
greater than those he implied in his reasonableness analysis. Id.
129
JX 383 ¶ 37.
130
Trial Tr. 858:3–8 (Steffen).
131
Id. at 858:9–21 (Steffen).
132
Id. at 1156:8–13 (Ruback).
27
repatriating the cash held in foreign jurisdictions that the Company would be
forced to pay tax in order to access it in the United States.133
5. Stock-Based Compensation
Steffen‘s analysis did not account for SBC in his free cash flow
projections.134 Instead, Steffen calculated shares outstanding using the treasury
stock method, which increases the number of shares outstanding to account for the
dilutive economic effect of share-based compensation that has already been
awarded.135
Conversely, Ruback included SBC as a cash expense that directly reduced
his free cash flow projections.136 Ruback used management‘s estimates of future
SBC expense—an accounting value—to directly reduce free cash flow.137 The
difference between the two approaches is that Steffen‘s analysis accounts for SBC
that had been awarded as of the date of his report, whereas Ruback‘s analysis also
accounts for SBC that is expected to be issued in the future.
133
Id. at 1065:12–21, 1163:8–19 (Ruback).
134
Id. at 998:21–1000:3 (Steffen).
135
Id. at 859:3–7 (Steffen) The treasury stock method assumes that all stock options are
exercised immediately—thus resulting in the issuances of new shares—and the cash proceeds
received from the exercise are used to repurchase shares, the net of effect of which increases the
number of shares outstanding and, in turn, decreases the value per share. See id. at 859:8–20.
136
Id. at 1015:13–1016:10 (Ruback). Ruback illustrated his belief that SBC expense is a
reduction in the value of the Company by showing that a hypothetical company would
supposedly lose the same amount of value if it compensated its employees in cash or in stock.
See id. at 1017:9–1023:12 (Ruback).
137
Id. at 1152:23–1153:14 (Ruback).
28
6. M&A Expenses
Steffen did not deduct M&A expenditures from free cash flow. He believed
that management‘s projections were not dependent on M&A activity since he did
not find that management deducted M&A expenditures in their own analysis.138
Ruback, on the other hand, did include management‘s projections of M&A
expenditures in his valuation. Ruback believed that management‘s revenue
projections included the impact of tuck-in M&A and that the Company planned to
continue tuck-in M&A activity if it remained a public company.139 Moreover,
although the financial advisors did not include M&A expenditures for years 2017
and 2018—these being the years the financial advisors extrapolated from
management‘s projections—Ruback used the same $150 million in M&A
expenditures projected for 2016 in his projections for year 2017, 2018, and the
terminal period.140
D. Procedural History
On September 13, 2013, Petitioners Merion Capital LP and Merion Capital
II LP commenced this action by filing a Verified Petition for Appraisal of Stock
pursuant to 8 Del. C. § 262. Immediately prior to the Merger, Petitioners owned
7,629,100 shares of BMC common stock. On July 28 2014, Respondent BMC
138
Id. at 870:15–871:12 (Steffen).
139
Id. at 1025:10–21 (Ruback).
140
Id. at 1026:10–1027:2 (Ruback).
29
filed a Motion for Summary Judgment, arguing that Petitioners lacked standing to
pursue appraisal because they could not show that each of their shares was not
voted in favor of the Merger. I denied the Motion in a Memorandum Opinion
dated January 5, 2015.141
I presided over a four-day trial in this matter from March 16 to March 19,
2015. The parties submitted post-trial briefing and I heard post-trial oral argument
on June 23, 2015. Finally, in July the parties submitted supplemental post-trial
briefing regarding the treatment of synergies. This is my Post-Trial Opinion.
II. ANALYSIS
The appraisal statute, 8 Del. C. § 262, is deceptively simple; it provides
stockholders who choose not to participate in certain merger transactions an
opportunity to seek appraisal in this Court. When a stockholder has chosen to
pursue its appraisal rights, Section 262 provides that:
[T]he 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.142
Section 262 vests the Court with significant discretion to consider the data
and use the valuation methodologies it deems appropriate. For example, this Court
141
See Merion Capital LP v. BMC Software, Inc., 2015 WL 67586 (Del. Ch. Jan. 5, 2015).
142
8 Del. C. § 262(h) (emphasis added).
30
has the latitude to select one of the parties' valuation models as its general
framework, or fashion its own, to determine fair value. The principal constraint on
my analysis is that I must limit my valuation to the firm's value as a going
concern and exclude ―the speculative elements of value that may arise from the
accomplishment or expectation of the merger.‖143
Ultimately, both parties bear the burden of establishing fair value by a
preponderance of the evidence. In assessing the evidence presented at trial, I may
consider proof of value by any techniques or methods which are generally
considered acceptable in the financial community and otherwise admissible in
court. Among the techniques that Delaware courts have relied on to determine the
fair value of shares are the discounted cash flow approach, the comparable
transactions approach, and comparable companies approach. This Court has also
relied on the merger price itself as evidence of fair value, so long as the process
leading to the transaction is a reliable indicator of value and any merger-specific
value in that price is excluded.
Here, the experts offered by both parties agreed that the DCF approach, and
not the comparable transactions or comparable companies approach, is the
appropriate method by which to determine the fair value of BMC. Thus, I will
start my analysis there.
143
Weinberger v. UOP, Inc., 457 A.2d 701, 713 (Del. 1983) (quotations omitted).
31
A. DCF Analysis
In post-trial briefing and at closing argument, the parties helpfully laid out
the limited areas of disagreement between their two experts as to DCF inputs. I
will briefly explain my findings with respect to those areas in contention, but I note
at the outset that, while I have some disagreements with the Respondent‘s expert,
Ruback, I generally found him better able to explain—and defend—his positions
than the Petitioners‘ expert, Steffen. Since I generally find Ruback more credible,
I start with his analysis as a framework, departing from it as noted below.
1. Financial Projections
The parties‘ experts both relied on the same management projections.
Ruback, however, made a 5% reduction to projected revenue based on his analysis
that the Company had historically fallen short of its projected revenues. Although
it is apparent to me that the management projections, while reasonable, harbored
something of a bias towards optimism, I ultimately find Ruback‘s approach too
speculative to accurately account for that bias. Thus, in conducting my own DCF
valuation of the Company, I use the management projections as is, without a 5%
deduction.
2. Discount Rate
The parties contend that the key difference in their experts‘ respective
discount rates is that the Petitioners‘ expert used a supply side ERP, while the
32
Respondent‘s expert used a historical ERP. This calculation is forward-looking,
and this Court has recently tended to employ the supply side ERP approach. In
then-Chancellor Strine's decision in Global GT LP v. Golden Telecom, Inc.,144 this
Court noted that using the supply side ERP as opposed to the historical ERP is a
decision "not free from doubt," but it nevertheless adopted it over a historical ERP
as a more sound approach.145 The Chancellor followed that approach again in In re
Orchard Enterprises,146 where he noted that the respondent there had ―not
provided [him] with a persuasive reason to revisit‖ the debate.147 In other cases,
this Court has explicitly adopted a supply side ERP.
While it may well be the case that there is an argument in favor of using the
historical ERP, nothing in Ruback‘s testimony convinces me to depart from this
Court‘s practice of the recent past. I note, however, that the testimony at trial
showed this to be a vigorously debated topic, not just between these two experts,
but in the financial community at large; scholarship may dictate other approaches
in the future. Here, though, I ultimately find the most appropriate discount rate,
using the supply side ERP, to be 10.5%.148
144
993 A.2d 497 (Del. Ch.), aff'd, 11 A.3d 214 (Del. 2010).
145
Id. at 516.
146
2012 WL 2923305 (Del. Ch. July 18, 2012).
147
Id. at *19.
148
I find it of some relevance to note, however, that had I used a discount rate of 10.8%—which
is the midpoint between the experts‘ diverging discount rates—my DCF analysis would have
resulted in a per share price for BMC of $46.44, closely consistent with the $46.25 Merger price.
33
3. Terminal Growth Rate
The Respondent‘s expert adopted the inflation rate as the Company‘s growth
rate, but I did not find sufficient evidence in the record to support the application
of a growth rate limited to inflation. In Golden Telecom, and again in Towerview
LLC v. Cox Radio, Inc.,149 this Court noted that inflation is generally the ―floor‖ for
a terminal value.150 Testimony and documentary evidence are inconclusive on the
Company‘s prospects for growth as of the time of the Merger. Ultimately, I find it
most appropriate to follow this Court‘s approach in Golden Telecom and apply a
terminal growth rate that is at the midpoint of inflation and GDP.
The Petitioners‘ expert purported to use this methodology, but arbitrarily
opted to add 50 basis points to the midpoint of inflation and GDP, an approach I do
not find supported in the record. Therefore, though I find the midpoint approach to
be sound, I reject Steffen‘s addition of 50 basis points and use 3.25% as my growth
rate.
I note that the Respondent‘s expert did an analysis of implied EBITDA
growth rates for comparable companies, which he found to be an average of -1.7%.
149
2013 WL 3316186 (Del. Ch. June 28, 2013).
150
Id. at *27 (―As noted, the rate of inflation generally is the ―floor for a terminal value.
Generally, once an industry has matured, a company will grow at a steady rate that is roughly
equal to the rate of nominal GDP growth.‖); Global GT LP v. Golden Telecom, Inc., 993 A.2d
497, 511 (Del. Ch.) (―A viable company should grow at least at the rate of inflation and, as
Golden's expert Sherman admits,85 the rate of inflation is the floor for a terminal value estimate
for a solidly profitable company that does not have an identifiable risk of insolvency.‖), aff'd, 11
A.3d 214 (Del. 2010).
34
I do not find there to be sufficient evidence of the true comparability of those
companies such that the approach I am adopting, just discussed, is unreasonable.
4. Excess Cash
The Petitioners‘ expert used an excess cash figure as of the Merger date,
while the Respondent‘s expert used a figure from the last quarterly report prior to
the Merger. I found credible the testimony at trial that the Company was
preserving its cash balance in contemplation of closing the Merger and that, but for
the transaction, the Company would not have conserved an extra $127 million in
cash.151
The Respondent‘s expert also made an adjustment to excess cash for the
expense associated with repatriating cash held abroad. The Petitioners argued that
this was inappropriate because the Company‘s 10-K stated its intent to maintain
cash balances overseas indefinitely. These funds, however, represent opportunity
for the Company either in terms of investment or in repatriating those funds for use
in the United States, which would likely trigger a taxable event. Accordingly, I
find it appropriate to include a reasonable offset for the tax associated with
repatriating those funds.
151
See Trial Tr. 114:11–115:1 (Solcher); see also id. 952:7–953:15 (Steffen) (noting that he was
not aware of the Company‘s merger-driven conservation of cash before trial and did not account
for it); Gearreald v. Just Care, Inc., 2012 WL 1569818, at *8 (Del. Ch. Apr. 30, 2012) (―This
Court previously has rejected the proposition that changes to a company's capital structure in
relation to a merger should be included in an appraisal.‖).
35
5. Stock-Based Compensation
It is abundantly clear to me that, as a technology company, BMC‘s practice
of paying stock-based compensation is an important consideration in this DCF
valuation. Both experts accounted for stock-based compensation, but only the
Respondent‘s expert did so in a way that accounted for future stock-based
compensation, which I find to be the reasonable approach. His approach was to
treat estimated stock-based compensation as an expense, which I find reasonable in
light of the Company‘s history of buying back stock awarded to employees to
prevent dilution; in that sense, it is clearly in line with a cash expense. The
Petitioners have argued strenuously that this overstates the cost, but they presented
only the methodology of Steffen—which fails to account for future SBC—as an
alternative. Accordingly, I adopt Ruback‘s calculation as it relates to stock-based
compensation.
6. M&A Expense
The parties also disagreed as to whether so-called ―tuck-in‖ M&A expenses
should be deducted in calculating free cash flows. I find that the projections
prepared by management and used throughout the sales process, including those
projections that formed the basis for the fairness opinion, incorporated the
Company‘s reliance on tuck-in M&A activity in their estimation of future growth
and revenues. Those projections expressly provided a line-item explaining the
36
Company‘s expected tuck-in M&A expenses in each year of the projections, and
the Company‘s CFO, Solcher, credibly testified that, because the Company
planned to continue with its inorganic growth strategy had it remained a public
company, he prepared the management projections with growth from tuck-in M&A
in mind.152 Thus, those projections are inflated if M&A, and its accompanying
expense, is not taken into account in the valuation. Although it is not
determinative of my analysis, I also note that the multiple potential buyers through
the course of the Company‘s sales process must have similarly determined that
tuck-in M&A was embedded in the Company‘s growth projections, or else those
buyers would have been forgoing up to $1.89 billion in value by not topping the
Buyer Group‘s winning bid. In any event, because I find that management‘s
projections incorporated M&A in their forecast of future performance, the
expenses of that M&A must be deducted from income to calculate free cash flow.
7. Conclusion
Taking all of these inputs and assumptions together, I conducted a DCF
analysis that resulted in a per share price for BMC of $48.00.153
152
See Trial Tr. 92:12–23 (Solcher) (―Q: And when you prepared those projections, were you
assuming there would be revenue through companies bought through tuck-in M&A? A: We did.
Q: If you had not assumed that there would be such tuck-in M&A, would the revenues you were
showing have been higher or lower? A: Lower.‖); id. at 119:7–120:15 (Solcher).
153
Because I ultimately rely on deal price here, I will not attempt to set out my DCF analysis in
further detail.
37
B. The Merger Price
Having found a DCF valuation of $48.00, I turn to other ―relevant factors‖ I
must consider in determining the value of BMC. Neither expert presents a value
based on comparables, although Ruback did such an analysis as a check on his
DCF. Thus, I turn to consideration of the merger price as indication of fair value.
As our Supreme Court recently affirmed in Huff Fund Investment Partnership v.
CKx, Inc.,154 where the sales process is thorough, effective, and free from any
spectre of self-interest or disloyalty, the deal price is a relevant measure of fair
value. Even where such a pristine sales process was present, however, the
appraisal statute requires that the Court exclude any synergies present in the deal
price—that is, value arising solely from the deal.
1. The Sales Process Supports the Merger Price as Fair Value
The record here demonstrates that the Company conducted a robust, arm‘s-
length sales process, during which the Company conducted two auctions over a
period of several months. In the first sales process, the Company engaged at least
five financial sponsors and eight strategic entities in discussing a transaction from
late August 2012 through October 2012. As a result, the Company received non-
binding indications of interest from two groups of financial sponsors: one for $48
per share and another, from a group led by Bain, for $45-$47 per share. Ultimately
154
2015 WL 631586 (Del. Feb. 12, 2015), aff’g 2013 WL 5878807 (Del. Ch. Nov. 1, 2013).
38
the Company decided at the end of October to discontinue the sales process based
on management‘s confidence in the Company‘s stand-alone business plan, which
was temporarily bolstered by positive second quarter financial results.
However, when the Company returned to underperforming in the third
quarter, it decided to reinitiate the sales process. In the second sales process,
which was covered in the media, the Company reengaged potential suitors that had
shown interest in acquiring the Company in the previous sales process, from late
January 2013 through March 2013. As a result, the Company received non-
binding indications of interest from three different groups of financial sponsors in
mid-March, one for $42-$44 per share, one from the Buyer Group, led by Bain, for
$46-47 per share, and one from the Alternate Sponsor Group for $48 per share.
Negotiations with the low bidder quickly ended after it refused to raise its bid. The
Company, therefore, proceeded with due diligence with the two high bidders
through April 2013, distributing a draft merger agreement to them, and setting the
deadline for the auction process at April 22, 2013.
On April 18, 2013, just days before the impending deadline, one of the
sponsors in the Alternate Sponsor Group backed out of the auction and the
remaining financial sponsor explained that it could no longer support its prior
indication of interest but was considering how to proceed in the auction at a
valuation closer to the stock‘s then-current trading price of $43.75. The Company
39
agreed to extend the auction deadline at the request of the Alternate Sponsor Group
in an attempt to maintain multiple bidders. On April 24, the Buyer Group
submitted an offer of $45.25 per share. The remaining financial sponsor told the
Company that it was still interested in the auction, but that it would need an
additional month to finalize a bid and reiterated that if it did ultimately make a bid,
it would be below the initial indication of interest from the Alternative Sponsor
Group. On April 26, the Company successfully negotiated with the Buyer Group
to raise its offer to $45.75 per share, and then to raise its offer again, on April 27,
to $46.25 per share.
On May 6, 2013 the Company announced the Merger agreement, which
included a bargained-for 30-day market check or ―Go Shop,‖ running through June
5. As part of the Go Shop process, the Company contacted sixteen potential
bidders—seven financial sponsors and nine strategic entities—but received no
alternative offers.
The sales process was subsequently challenged, reviewed, and found free of
fiduciary and process irregularities in a class action litigation for breach of
fiduciary duty. At the settlement hearing, plaintiffs‘ counsel noted that the activist
investor, Elliot, had pressured the Company for a sale, but agreed that the auction
itself was ―a fair process.‖
I note that the Petitioners, in their post-trial briefing, attempt to impugn the
40
effectiveness of the Company‘s sales process on three grounds. First, the
Petitioners argue that Elliot pressured the Company into a rushed and ineffective
sales process that ultimately undervalued the Company. However, the record
reflects that, while Elliot was clearly agitating for a sale, that agitation did not
compromise the effectiveness of the sales process. The Company conducted two
auctions over roughly the course of a year, actively marketed itself for several
months in each, as well as vigorously marketed itself in the 30-day Go Shop
period. The record does not show that the pre-agreement marketing period or the
Go Shop period, if these time periods can be said to be abbreviated, had any
adverse effect on the number or substance of offers received by the Company. In
fact, the record demonstrates that the Company was able to and did engage
multiple potential buyers during these periods and pursue all indications of interest
to a reasonable conclusion. The Petitioners‘ argument that Elliot could force the
Company to carry out an undervalued sale is further undermined by the fact that
the Company chose not to pursue the offers it received in the first sales process,
despite similar agitations from Elliot, because management was then confident in
the Company‘s recovery. In sum, no credible evidence in the record refutes the
testimony offered by the Company‘s chairman and CEO, which testimony I find to
be credible, that the Company ultimately sold itself because it was
underperforming, not because of pressure from Elliot. The pressure from Elliot,
41
while real, does not make the sales price unreliable as an indication of value.
Second, the Petitioners argue that the Company‘s financial advisors were
leaking confidential information about the sales process to the Buyer Group,
allowing it to minimize its offer price. For this contention the Petitioners rely
solely on a series of emails and handwritten notes prepared by individuals within
the Buyer Group, which purport to show that the Buyer Group was getting
information about the Alternate Sponsor Group from a source inside Bank of
America, one of the Company‘s financial advisors.155 As a preliminary matter, I
don‘t find sufficient evidence to conclude that the Company‘s financial advisors
were actually leaking material information to the Buyer Group. But even if that
could be sustained by the emails and handwritten notes presented by the
Petitioners, nothing in those documents or elsewhere in the record shows that the
Buyer Group had any knowledge as to the Alternate Sponsor Group‘s effective
withdrawal from the sales process leading up to the bid deadline. To the contrary,
the argument that the Buyer Group did have such information is directly
contradicted by the actual actions of the Buyer Group, which increased its bid for
the Company twice after its initial submission despite being (unbeknownst to the
Buyer Group) the lone bidder in the auction. At trial, Abrahamson, the Bain
principal leading the BMC deal, credibly testified that the Buyer Group raised its
155
See Trial Tr. 489:20–526:1; JX 497.
42
bid multiple times because it believed the auction was still competitive and that the
Buyer Group did not learn it was the only party to submit a final bid until it viewed
the draft proxy after executing the Merger agreement. And in fact, the emails and
notes relied upon by the Petitioners actually indicate that at the time the Buyer
Group submitted its bid, it had no idea where the Alternate Sponsor Group stood
and was seeking out that information.156 Even as far along as April 29, 2013, two
days after the Buyer Group had raised its bid for the second and final time, emails
within the Buyer Group show that it believed the Alternate Sponsor Group was still
vying for the Company.157 Therefore, I do not find that the sales process was
compromised by any type of ―insider back-channeling.‖
Finally, the Petitioners argue that the same set of emails and notes from
within the Buyer Group show that the Company made a secret ―handshake
agreement‖ or ―gentleman‘s agreement‖ with the Buyer Group after receiving its
final offer of $46.25 per share that the Company would not pursue any other
potential bidders, including the Alternate Sponsor Group. The Petitioners allege
that this handshake agreement prevented the Company from further extending the
auction deadline to accommodate the additional month requested by the Alternate
Sponsor Group and thus precluded a second bidder that would have maximized
value in the sales process. Again, I note as a preliminary matter that I do not find
156
See JX 497.
157
See id. at Tab F; Trial Tr. 665:21–667:3.
43
that the Petitioners have sufficiently proven the existence of such a so-called
handshake agreement. But in any case, even if the Company had made such an
agreement, the record shows that by the time such an agreement would have been
made the Alternate Sponsor Group had already notified the Company that one of
its members had dropped out, that it could no longer support the figure in its prior
indication of interest, and that if it was going to make a bid, that bid would come in
closer to $43.75. I also note that by this time the Company had already extended
its initial auction deadline by several days to accommodate the Alternate Sponsor
Group. Finally, the Alternate Sponsor Group could have pursued a bid during the
ensuing go-shop period, but did not do so. In light of these facts, the Company‘s
decision not to wait the additional month requested by the Alternate Sponsor
Group before moving forward with the only binding offer it had received was
reasonable and does not to me indicate a flawed sales process.
For the reasons stated above, I find that the sales process was sufficiently
structured to develop fair value of the Company, and thus, under Huff, the Merger
price is a relevant factor I may consider in appraising the Company.
2. The Record Does Not Demonstrate that the Merger Price Must be
Reduced to Account for Synergies in Calculating Fair Value
The appraisal statute specifically directs me to determine fair value
―exclusive of any element of value arising from the accomplishment or expectation
44
of the merger . . . .‖158 The Court in Union Illinois 1995 Investment LP v. Union
Financial Group, Ltd.159 thoughtfully observed that this statutory language does
not itself require deduction of synergies resulting from the transaction at issue,
where the synergies are simply those that typically accrue to a seller, because
―such an approach would not award the petitioners value from the particular
merger giving rise to the appraisal‖ but instead would ―simply give weight to the
actual price at which the subject company could have been sold, including therein
the portion of synergies that a synergistic buyer would leave with the subject
company shareholders as a price for winning the deal.‖160 Instead, the mandate to
remove all such synergies arises not from the statute, but from the common-law
interpretation of the statute to value the company as a ―going concern.‖161 Mindful
that this interpretation is binding on me here, to the extent I rely on the merger
price for fair value, I must deduct from the merger price any amount which cannot
158
8 Del. C. § 262(h) (emphasis added).
159
847 A.2d 340 (Del. Ch. 2003).
160
Id. at 356.
161
Id. The well-known standard that requires a corporation to be valued as a going concern was
established over 65 years ago in Tri-Continental Corp v. Battye, where the Supreme Court
declared that the appraisal statute entitles a dissenting stockholder ―to be paid for that which has
been taken from him, viz., his proportionate interest in a going concern.‖ 74 A.2d 71, 72 (Del.
1950); see, e.g., Montgomery Cellular Holding Co. v. Dobler, 880 A.2d 206, 220 (Del. 2005)
(citing Cede & Co. v. Technicolor, Inc., 684 A.2d 289, 298 (Del. 1996)). However, the Court in
Tri-Continental also described what the stockholder is entitled to receive as the ―intrinsic value‖
of his stock, which, I note, may not be equal to the going-concern value of the corporation. See
74 A.2d at 72.
45
be attributed to the corporation as an independent going concern,162 albeit one
which employs its assets at their highest value in that structure.163 Understanding
that such synergies may have been captured by the sellers in the case of a strategic
acquirer is easily comprehended: if company B, holding a patent on the bow, finds
it advantageous to acquire company A, a manufacturer of arrows, synergies could
result from the combination that would not have composed a part of the going-
concern or the market value of company A, pre-merger (and excluding merger-
specific synergies). In other words, company B‘s patent on the bow might make it
value company A more highly than the market at large, but that patent forms no
part of the property held by the stockholders of company A, pre-merger.
Assuming that the record showed that the acquisition price paid by company B
included a portion of this synergistic value, this Court, if relying on deal price to
establish statutory fair value, would be required to deduct that portion from the
appraisal award.
Here, the acquisition of BMC by the Buyer Group is not strategic, but
financial. Nonetheless, the Respondent alleges that synergistic value resulted from
the acquisition, and that if the Court relies on the purchase price to determine fair
value, those synergies must be deducted. They point to tax savings and other cost
162
See Union Illinois, 847 A.2d at 356 (stating the Court is bound to employ ―going concern‖
valuation).
163
See ONTI v. Integra Bank, 751 A.2d 904, 910–11 (Del. Ch. 1999) (stating that valuation using
assets at highest use is consistent with case law interpreting appraisal statute).
46
savings that the acquirer professed it would realize once BMC is a private entity.
If I assume that inherent in a public company is value, achievable via tax savings
or otherwise, that can be realized by an acquirer—any acquirer—taking the
company private, such a savings is logically a component of the intrinsic value
owned by the stockholder that exists regardless of the merger. Therefore, to the
extent some portion of that value flows to the sellers, it is not value ―arising
from . . . the merger,‖ and thus excludable under the explicit terms of the statute;
but is likely properly excluded from the going-concern value, which our case law
has explained is part of the definition of fair value as I must apply it here.164
However, as discussed below, to the extent value has been generated here by
taking BMC private, the record is insufficient to show what, if any, portion of that
value was included in the price-per-share the Buyer Group paid for BMC.
During trial and in post-trial briefing, Respondent offered the testimony of a
Bain principal to show that the Buyer Group would have been unwilling to pay the
Merger price had they not intended to receive the tax benefits and cost reductions
associated with taking the Company private. In fact, had these savings not existed,
164
See In re Sunbelt Beverage S’holder Litig., 2010 WL 26539 (Del. Ch. Feb. 15, 2010) (holding
increased value inherent in taking company from a C corp. to an S corp. not recoverable as ―fair
value‖). It is interesting to compare Sunbelt with ONTI, 750 A.2d at 910-11, and to note that
non-speculative increases in value that could be realized by a company as a going concern—even
though management may have eschewed them—are part of fair value; but non-speculative
increases in value requiring a change in corporate form are excluded from fair value: this is an
artifact of the policy decision to engraft ―going concern‖ valuation onto the explicit language of
the appraisal statute itself. See Union Illinois, 847 A.2d at 356.
47
the Buyer Group would have been willing to pay only $36 per share, an amount
that resembles the going-concern value posited by Respondent‘s expert. However,
demonstrating the acquirer‘s internal valuation is insufficient to demonstrate that
such savings formed a part of the purchase price. Here, the Respondent‘s expert
did not opine on the fair value of the Company using a deal-price-less-synergies
approach. Instead, the Respondent offered only the testimony of the buyer and its
internal documents to show that the purported synergies were included in their
analysis. While it may be true that the Buyer Group considered the synergies in
determining their offer price, it is also true that they required a 23% internal rate of
return in their business model to justify the acquisition,165 raising the question of
whether the synergies present in a going-private sale represent a true premium to
the alternatives of selling to a public company or remaining independent. In other
words, it is unclear whether the purported going-private savings outweighed the
Buyer Group‘s rate of return that was required to justify the leverage presumably
used to generate those savings.
When considering deal price as a factor—in part or in toto—for computing
fair value, this Court must determine that the price was generated by a process that
likely provided market value, and thus is a useful factor to consider in arriving at
fair value. Once the Court has made such a determination, the burden is on any
165
Trial Tr. 719:4–720:5 (Abrahamson).
48
party suggesting a deviation from that price to point to evidence in the record
showing that the price must be adjusted from market value to ―fair‖ value. 166 A
two-step analysis is required: first, were synergies167 realized from the deal; and if
so, were they captured by sellers in the deal price? Neither party has pointed to
evidence, nor can I locate any in the record, sufficient to show what quantum of
value should be ascribed to the acquisition, in addition to going-concern value; and
if such value was available to the Buyer Group, what portion, if any, was shared
with the stockholders. I find, therefore, that the Merger price does not require
reduction for synergies to represent fair value.
C. Fair Value of the Company
I undertook my own DCF analysis that resulted in a valuation of BMC at
$48.00 per share. This is compared to, on the one end, a value of $37.88 per share
offered by the Respondent, and on the other, a value of $67.08 per share offered by
the Petitioners. Although I believe my DCF analysis to rely on the most
appropriate inputs, and thus to provide the best DCF valuation based on the
information available to me, I nevertheless am reluctant to defer to that valuation
in this appraisal. My DCF valuation is a product of a set of management
projections, projections that in one sense may be particularly reliable due to
BMC‘s subscription-based business. Nevertheless, the Respondent‘s expert,
166
Merlin P’ship v. AutoInfo, Inc. 2015 WL 2069417 (Del. Ch. Apr. 30 2015).
167
Of course, the Petitioner may point to market distortions imposed on the sellers as well.
49
pertinently, demonstrated that the projections were historically problematic, in a
way that could distort value. The record does not suggest a reliable method to
adjust these projections. I am also concerned about the discount rate in light of a
meaningful debate on the issue of using a supply side versus historical equity risk
premium.168 Further, I do not have complete confidence in the reliability of taking
the midpoint between inflation and GDP as the Company‘s expected growth rate.
Taking these uncertainties in the DCF analysis—in light of the wildly-
divergent DCF valuation of the experts—together with my review of the record as
it pertains to the sales process that generated the Merger, I find the Merger price of
$46.25 per share to be the best indicator of fair value of BMC as of the Merger
date.
III. CONCLUSION
As is the case in any appraisal action, I am charged with considering all
relevant factors bearing on fair value. A merger price that is the result of an arm‘s-
length transaction negotiated over multiple rounds of bidding among interested
buyers is one such factor. A DCF valuation model built upon management‘s
projections and expert analysis is another such factor. In this case, for the reasons
above, I find the merger price to be the most persuasive indication of fair value
168
Had I used a discount rate equal to the median of the rates suggested by the parties‘ experts,
but kept my other inputs the same, my DCF value would be remarkably close to the deal price.
See supra note 148.
50
available. The parties should confer and submit an appropriate form of order
consistent with this opinion.
51