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  • Delaware Chancery Court Utilizes DCF Method to Determine Fair Value of ISN Software Corp.
     

    08/22/2016
    On August 11, 2016, Vice Chancellor Sam Glasscock III of the Delaware Court of Chancery relied on his own discounted cash flow (“DCF”) analysis to determine the fair value of ISN Software Corp. (“ISN”) in an appraisal action brought by two minority shareholders following the merger of ISN with its wholly-owned subsidiary.  In re ISN Software Corp. Appraisal Litig., C.A. No. 8388-VCG (Del. Ch. Aug. 11, 2016).  In so ruling, the Court rejected not only the valuation advocated by ISN’s expert but also the valuations espoused by the minority shareholders’ experts, noting that “[i]n a competition of experts to see which can generate the greatest judicial skepticism regarding valuation . . . this case, so far, takes the prize.” 

    ISN is a privately held corporation that provides a subscription-based database designed to help contractors and companies hiring contractors to meet compliance requirements.  On January 9, 2013, ISN effectuated a merger with its wholly-owned subsidiary.  Shareholder approval was obtained by written consent from the majority shareholder who controlled ISN and ISN’s CEO.  Two minority shareholders, Polaris and Ad-Venture, filed appraisal petitions pursuant to Section 262 of the Delaware General Corporation Law.    
    Each of the three parties, petitioners Polaris and Ad-Venture, and respondent, ISN, presented expert testimony—with each expert utilizing combinations of varying valuation methods—on the value of ISN (and its shares) at the time of the merger.  The Court referred to the gap between the valuations as “alarmingly” wide:  $820 million for Polaris’s expert, $645 million for Ad-Venture’s expert, and $106 million for ISN’s expert. 

    The Court rejected various methodologies used by the experts, finding them inappropriate for a number of reasons.  First, the “guideline public companies” method (a comparison to publicly traded companies) was, according to the Court, less reliable here because ISN had no public competitors and its “industry includes various and divergent software platforms.”  Second, the direct capitalization of cash flow method was appropriate only when a company had “reached a steady state” and “where no other feasible valuation methods exist,” neither of which was the case here.  Third, the Court found that two prior transactions were unreliable indicators of fair value because ISN’s stock is illiquid and each of the prior transactions was undertaken in the context of potentially confounding factors and included incompatible forms of consideration, such as financial options and land, which are difficult to value.

    Instead, Vice Chancellor Glasscock concluded that a DCF analysis “is the most reliable indicator of fair value” and conducted his own DCF analysis deriving various factors from the three experts’ DCF analyses.  For example, the Court selected the shortest of the three projection periods used by the experts—5 years as used by ISN’s expert—noting that “projections out more than a few years owe more to hope than reason.”  Because the Court applied ISN’s expert’s 5-year projection period, it started with ISN’s DCF model as a “framework” and made its own adjustments (e.g., it adopted Polaris’s expert’s approach to working capital) to arrive at a value of approximately $357 million, or $98,783 per share, as of the date of the merger.
    CATEGORY: Fiduciary Duties

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