NEW YORK (Reuters Breakingviews) - It turns out lawsuits can actually add value to deals. A recent ruling against genealogy website Ancestry.com makes it easier to sue for higher merger prices in so-called appraisal rights cases. Unlike most M&A claims, these ones are typically strong - and potentially a good check on the M&A process.
Appraisal rights allow stockholders who opposed a deal to ask a judge to set the price for their shares. In Tuesday’s ruling on the 2012 Ancestry.com buyout, a Delaware jurist said Merion Capital could exercise those rights, even though its shares were technically owned by stock-certificate aggregator Cede and the hedge fund couldn’t prove how they were voted. That didn’t matter, the judge ruled, because Cede voted more shares against the deal than Merion eventually owned.
The decision could prompt even more appraisal cases, a development that might normally be bad for M&A. Some 95 percent of deals face lawsuits, according to Cornerstone Research. And with notable exceptions like the conflict-of-interest challenge to Kinder Morgan’s $21 billion purchase of pipeline operator El Paso in 2012, many suits are filed merely for their nuisance value.
Appraisal actions are surprisingly successful, though. Delaware courts have granted investors increases between 8.5 percent and 149 percent above the merger price in seven of the nine cases decided since 2010, according to New York law firm Fried Frank. Most had low deal premiums or were going-private transactions that arguably stiffed minority shareholders.
It makes sense for investors to bring only strong claims. Cases can consume years of costly court wrangling. And holders take the risk of an award below the merger price. The upside is that statutory interest on their claims accrues at 5 percent plus the federal funds rate, currently an attractive return.
The potential payouts seem enough to have driven a surge in Delaware appraisal filings, from about 10 in 2010 to nearly 30 in 2013, according to a Brooklyn Law School study. The value of claims in 2013 was almost $1.5 billion.
Profit motive aside, the cases may give minority shareholders an effective check on unfair transactions and deter abusive deals generally. It’s the rare litigation strategy that can benefit investors more than their lawyers.
- The Delaware Court of Chancery on Jan. 6 made it easier for shareholders to win higher payouts by challenging merger prices in court.
- Court Vice Chancellor Sam Glasscock ruled in two cases that hedge fund Merion Capital could exercise what are known as appraisal rights to ask a judge to decide the fair value of its 1.8 million shares in genealogy website Ancestry.com and 7.6 million shares in BMC Software.
- Glasscock said Merion could seek a higher valuation for its shares even though it did not vote against either the 2012 buyout of Ancestry.com by private equity firm Permira or the 2013 acquisition of software company BMC by Bain Capital and Golden Gate Capital.
- Appraisal rights have typically enabled shareholders to ask for a better price in a deal they opposed. Hedge funds have recently bought large amounts of stock in transactions they considered undervalued and then pursued appraisals to win big payouts, a strategy known as appraisal arbitrage.
- On Feb. 11, the Delaware Supreme Court will consider how judges can determine the price of stock subject to appraisal rights. In a case involving private equity firm Apollo Global Management’s 2011 purchase of CKx, owner of American Idol and other entertainment properties, a judge ruled that the merger price was fair value for CKx shares. A CKx stockholder is challenging that decision, arguing that the judge was legally required to do his own calculation of a fair value and couldn’t just rely on the merger price. (The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)