Summary
determining that a merger and acquisition analysis was unhelpful for appraising the going concern value of a company, given that the "merger and acquisition data undoubtedly contain[ed] post-merger value, such as synergies with the acquirer, that must be excluded from appraisal value."
Summary of this case from In re Sunbelt Beverage Corp.Opinion
Civil Action No. 11107.
Submitted: March 31, 1995.
Decided: June 15, 1995.
Craig B. Smith, Esquire, of SMITH, KATZENSTEIN FURLOW, Wilmington, Delaware; OF COUNSEL: Thomas J. Fleming, Esquire, of OLSHAN, GRUNDMAN, FROM ROSENZWEIG, New York, New York, Attorneys for Petitioners.
Allen M. Terrell, Jr., Esquire, and Daniel Dreisbach, Esquire, of RICHARDS, LAYTON FINGER, Wilmington, Delaware; OF COUNSEL: Kenneth M. Kramer, Esquire, and James R. Warnot, Jr., Esquire, of SHEARMAN STERLING, New York, New York, Attorneys for Respondent.
MEMORANDUM OPINION
Petitioners, holders of 400,000 shares of Class B common stock of Silgan Corporation ("Silgan" or "Respondent"), seek an appraisal, pursuant to 8 Del. C. § 262, to assess the fair value of their shares. Petitioners seek an appraisal as a result of a June 30, 1989 merger, by which Silgan merged into a wholly owned subsidiary of Silgan Holdings, Inc. ("Silgan Holdings"). In the merger, Silgan's Class B shareholders received $6.50 per share for their stock. During the trial of this action, the Court heard testimony from expert witnesses whose opinions of the value of Silgan stock ranged from $4.88 per share to $12.65 per share. For the reasons set forth below, I find the fair value of Silgan on the date of the merger to be $5.94 per share, and award simple interest at a fair rate of 9.5%.
I. BACKGROUND
Silgan, a Delaware corporation, was organized in August 1987 under the name MS/SH Holdings, Inc. Silgan had three classes of common stock, Classes A, B and C. Classes A and B are identical, except that each class votes separately to elect two directors. Class C stock is non-voting. R. Philip Silver ("Silver") and D. Greg Horrigan ("Horrigan") beneficially owned all of the Class A stock. The Morgan Stanley Group, and the Morgan Stanley Leveraged Equity Fund, L.P. (MSLEF I), owned more than two thirds of the Class B stock. Morgan Stanley Leveraged Capital Fund, Inc., an affiliate of Morgan Stanley, and CIGNA Leveraged Capital Fund, Inc., an affiliate of CIGNA Corporation, are the general partners of MSLEF I.
From its inception, Silgan planned to enter the container industry under the direction of Silver and Horrigan, both experienced container industry executives. In August of 1987, Silgan acquired, through wholly owned subsidiaries, two container operations: Innopak Plastics Corporation and The Carnation Corporation's metal containers division. Silgan rapidly became a major manufacturer and distributor of steel, aluminum and plastic containers.
On April 28, 1989, Silgan entered into a merger agreement with Silgan Holdings, whereby Silgan was to combine with Silgan Holdings' wholly owned subsidiary, Silgan Acquisition Inc. Under the terms of the merger agreement, Class B stockholders were to receive $6.50 per share, and Class A stockholders were to receive $12.2 million in cash and shares of Class A common stock of Silgan Holdings equal to 50% of Silgan Holdings's voting stock. Silgan retained William Blair Co. to render a fairness opinion on the price offered to Silgan stockholders. Silgan distributed the fairness opinion, as well as management's financial projections for Silgan, along with its Solicitation of Stockholders Consents. The merger was approved by a majority of Silgan stockholders, with Morgan Stanley and MSLEF I consenting to the merger. The merger was completed on June 30, 1989, making Silgan a wholly owned subsidiary of Silgan Holdings.
Petitioners dissented to the merger and validly exercised their appraisal rights pursuant to 8 Del. C. § 262. The parties tried this appraisal action before the Court from November 29, 1994, through December 1, 1994. During the trial, Petitioners and Respondent presented expert testimony as to the value of Silgan. Petitioners' expert, Louis Paone ("Paone"), who was associated with Williamette Management Associates when he drafted his report, but joined Houlihan, Lokey, Howard Zukin prior to testifying at trial, valued Silgan at $12.65 per share. Respondent's expert, James Kovacs ("Kovacs"), of Price Waterhouse, valued Silgan at $4.88 per share. In addition to the parties' experts, the Court appointed a neutral expert, Joel Lawson ("Lawson"), of Howard Lawson Co. Lawson critiqued the opinions of the parties' expert witnesses, but the Court instructed him not to provide an independent valuation of Silgan.
II. THE EXPERTS' VALUATION METHODS
Paone and Kovacs used fairly similar methods to appraise Silgan. Paone conducted a reconstructed market analysis, which looked at market prices of comparable publicly traded corporations and at the price paid in comparable mergers. He also conducted a discounted cash flow ("DCF") analysis to establish a present value for Silgan's projected returns. Like Paone, Kovacs conducted a market analysis and a DCF analysis. However, he did not look at comparable mergers in his market analysis. I will weigh the reliability of each method employed by the experts, then adopt the methods that most reliably measure Silgan's fair value as of June 30, 1989.
In addition to Paone's opinion testimony and report, Petitioners contend that the amount of money Silgan Holdings borrowed to finance the acquisition of Silgan represents Silgan's value. Respondent's expert, Kovacs, testified that the money market's willingness to lend money to Silgan Holdings relates to the lenders' confidence in being repaid, but does not provide a credible value for Silgan. I agree that the amount of money loaned to Silgan Holdings does not reliably correlate to the value of Silgan. I consider this method of valuing Silgan untrustworthy, and assign it no weight.
III. MARKET ANALYSIS
Both experts used a comparative market analysis as part of their evaluations. Kovacs analyzed five similar publicly traded companies in order to estimate the market value of Silgan's stock. Paone considered the same five companies plus Kerr Glass in his analysis. The most dramatic difference in the approaches taken by the experts is Paone's inclusion of an 86% premium over market price to adjust for an inherent minority discount in the price of publicly traded shares. In addition to a study of similar publicly traded companies, Paone reviewed eight merger transactions that involved companies he believed were similar to Silgan.
Respondent contends that Paone's market analysis is improper as a matter of law, citing several decisions of this Court for the proposition that the appraisal value of a corporation does not include a "control premium." Petitioners respond that Paone did not include a "control premium," but merely adjusted the price for minority interests available in publicly traded markets to reflect the enterprise value of the entire corporation.
Section 262 provides two fundamental guideposts for an expert witness opining on the value of a corporation for the purposes of a § 262 appraisal. The expert should value the entire corporation as a going concern, then allocate that value pro rata among the shareholders. Cavalier Oil v. Harnett, Del. Supr., 564 A.2d 1137, 1145 (1989). In determining the enterprise value of the corporation, the expert cannot consider "any element of value arising from the accomplishment or expectation of the merger."In re Shell Oil Co., Del. Supr., 607 A.2d 1213, 1218 (1992) (quoting 8 Del. C. § 262(h)). Both Petitioners and Respondent recognize that these principles provide the framework for conducting an appraisal. Yet the parties disagree over whether these legal rules require or exclude a premium over the price available in a market for publicly traded shares. Petitioners believe a control premium must be applied to the market price to reflect the enterprise value of a corporation, while Respondent believes a control premium includes forbidden post-merger value.
Paone premised his use of a control premium on the theory that the market price for publicly traded shares contains an inherent minority discount. Paone's decision to remove a minority discount imbedded in the market price does not violate Delaware law. Long ago, this Court rejected placing absolute confidence in the market price for a share of stock. See Chicago Corp. v. Munds, Del. Ch., 171 A. 452 (1934). See also Smith v. Van Gorkom, Del. Supr., 488 A.2d 858, 876 (1985) ("publicly-traded stock price is solely a measure of the value of a minority position and, thus, market price reflects only the value of a single share"). However, Petitioners cannot add a premium to the market price unless they prove that publicly traded shares include a minority discount.
Paone testified that the market price reflects the value of a minority interest in a corporation because only small lots of stock are available at the market price. Kovacs, the Respondent's expert, and Lawson, the Court's neutral expert, also expressed a belief that publicly traded shares trade below the proportionate enterprise value of the stock. Respondent's expert stated at trial that "the preponderance of opinion is that there is some minority interest that's implicit in a publicly traded company's price." Upon the record presented, I conclude that both experts should have adjusted market value to compensate for an inherent minority discount.
I am aware that Vice Chancellor Berger faced this same issue inSalomon Brothers, Inc. v. Interstate Bakers Corp., Del. Ch., C.A. No. 10154, Berger, V.C. (May 1, 1992), and came to the opposite conclusion, but our different conclusions result from differences in the records presented by the parties in the respective cases. Vice Chancellor Berger was "not satisfied from the record in [Salomon Brothers] that a market value adjustment to compensate for an implicit minority discount is a valuation method that is generally accepted in the financial community."Id. at 12. In this case, the record compels me to find that the market price for publicly traded stock includes a minority discount.
Although Kovacs erred in not attempting to account for an implicit minority discount in the market data, I find his market analysis much more reliable than Paone's market analysis. Paone purportedly adjusted the available market data to remove the imbedded minority discount, but his methods do not discriminate between a minority discount and a premium that includes post-merger value. In prior appraisal actions, this Court has rejected the use of a control premium derived from merger and acquisition data because the control premium incorporates post-merger value. Salomon, supra, Mem. Op. at 12-13; Cooper v. Pabst Brewing Corp., Del. Ch., C.A. No. 7244, Hartnett, V.C. (June 8, 1993), Mem. Op. at 22. Kovacs and Lawson testified that the premium over market price paid by an acquiror includes more than an adjustment for a minority discount. The acquiror may value the target corporation above its going concern value because of potential synergies or because the acquiror believes it will manage the target better. This portion of a control premium cannot be included in the appraisal value of a corporation because it reflects value arising from the accomplishment or expectation of the merger. Cede Co. v. Technicolor, Del. Ch., C.A. No. 7129, Allen, C. (Oct. 19, 1990), Mem. Op. at 50-51, rev'd on other grounds, Del. Supr., 634 A.2d 345 (1993). Paone applied a premium in his market analysis that explicitly includes value arising from the expectation of a merger.
Paone looked at control premiums paid in merger transactions in the years just prior to 1989. In the studies he reviewed, the median control premiums ranged from 34% to 48%. Paone believed that Silgan would have fetched an even higher premium because it was highly leveraged. Paone testified that he found a strong positive relationship between the amount of leverage employed by a company and the control premium paid for that company's common equity. Because of the purported effect leverage has on control premiums, Paone believed that Silgan would receive an 86% premium over market price.
For reasons based in law and in fact, I do not give Paone's control premium study any weight. First, Paone has failed to demonstrate a strong correlation between leverage and a control premium that justifies an 86% premium for Silgan. Kovacs persuasively demonstrated at trial that leverage has only a slight relationship to the size of a control premium. Lawson also found only a slight correlation between these factors. Paone has not demonstrated a factual foundation for enhancing the control premium above the 34-48% range. Paone's study also strays from the clear directive of Delaware law to exclude value arising from the merger. Had Paone used a 34-48% premium, he would have included some value arising from synergies or new management plans. Instead of increasing the premium to 86%, Paone should have discounted the control premium data so that it reflected just the minority discount. Lawson explained that the premium necessary to remove the minority discount inherent in publicly traded stock is somewhere between zero and the control premium which Paone's study places between 34-48%.
Kovacs did not attempt to account for a minority discount in the price of publicly traded stock because Respondent's counsel instructed him that it was improper as a matter of law. Had Kovacs attempted to present such evidence, he probably would have been stymied anyway. Lawson states in his report that setting an exact figure for the minority discount comes down to an arbitrary determination. Respondent asserts that the Court should not adjust the market data to remove the minority discount because no reliable proof has been presented on the issue. It seems to me that acknowledging the existence of the minority discount, but setting it at zero, is more arbitrary than endeavoring to find its true value. At trial, Kovacs stated that a reasonable estimate of the minority discount is around 10-15%. Based on that testimony, I will adjust Kovacs' market analysis by 12.5% to account for the minority discount inherent in publicly traded shares.
In addition to an analysis of similar publicly traded corporations, Paone conducted an analysis of eight mergers involving companies similar to Silgan. For the same reasons that I give Paone's control premium data no weight, I consider his merger and acquisition analysis unhelpful for appraising the going concern value of Silgan. The merger and acquisition data undoubtedly contains post-merger value, such as synergies with the acquiror, that must be excluded from appraisal value. See Cooper, supra, Mem. Op. at 22. Kovacs' analysis of similar publicly traded companies, with the adjustment for a minority discount, is a more reliable indication of Silgan's market value than either Paone's market study or Paone's merger and acquisition analysis.
IV. DISCOUNTED CASH FLOW ANALYSIS
Kovacs and Paone each valued Silgan by using a DCF analysis. Kovacs labels his study an Income Approach, while Paone refers to his study as a Discounted Future Returns Analysis, but they used nearly identical methods. They estimated Silgan's revenues from 1989-1995 on a debt free basis, set a terminal value for the company at the end of the period, and then discounted those future values to reach a present value for Silgan's market value of invested capital ("MVIC"). Because they valued Silgan's revenues on a debt free basis, they subtracted the market value of Silgan's debt from its MVIC to reach a value for Silgan's common equity. Lawson provided helpful criticism of the methods employed by Kovacs and Paone, but I instructed him not to create an independent analysis.
In an appraisal action, the Court determines the fair value of a corporation through an adversarial proceeding. I have used Lawson's report to critically evaluate each expert's opinion, but I will not construct my own DCF model. See Cede, supra, Mem. Op. at 16-17, 17 n. 17. From the evidence presented by all three experts, I will choose the DCF analysis that best represents Silgan's value. Next, with the assistance of Lawson's testimony and report, I will scrutinize that DCF analysis to remove the adversarial hyperbole that inevitably influences an expert's opinion in valuation proceedings. In my discussion of the experts' methods, all dollar values are stated in thousands.
A. Managements' Projections
As this Court has noted before, the outcome of a DCF analysis depends heavily on the projections used in the model. Neal v. Alabama By-Products Corp., Del. Ch., C.A. No. 8282, Chandler, V.C. (Aug. 1, 1990), Mem. Op. at 21, aff'd, Del. Supr., 588 A.2d 255 (1991). Prior to the merger, Silgan's management projected Silgan's costs and revenues for the period from 1989-1995 for use by Silgan's lenders. Silgan distributed these projections with its Solicitation of Stockholder Consents. Both experts relied heavily on these projections in their DCF analyses, but Kovacs revised some of the estimates. Kovacs testified that he needed to revise some of management's original projections because they were not generated for use in an appraisal proceeding. He altered some of the projections based on Silgan's books and records, discussions with Silgan's management, and general trends in the industry. Petitioners criticize Kovacs for revising management's contemporaneous projections to reach a lower value for Silgan's stock. Paone worked exclusively from the original projections, adjusting them only for the purposes of a debt free analysis. Petitioners contend that by conducting interviews with Silgan's managers Kovacs improperly considered evidence that was unavailable as of the merger date. Petitioners request that I prevent Respondent from revising its optimistic pre-merger forecast to suit its purposes in this lawsuit.
The Court will not bar Respondent from presenting evidence relevant to the fair value of Silgan, Bell v. Kirby Lumber Co., Del. Supr., 413 A.2d 137, 149 (1980), but Respondent's revisions of its original projections merit close inspection. The revisions may impeach the credibility of Respondent's expert witness. Therefore, I will carefully consider the justification for each revision.
B. June 30, 1989-1995 Cash Flows
In both DCF models, the experts used management's projections to estimate Silgan's cash flows from June 30, 1989 through the end of 1995. In his estimates of cash flows, Kovacs revised management's original projections in several respects. Each revision merits close scrutiny.
Kovacs revised management's 1989 forecast concerning Silgan's 1994 investment in working capital. Kovacs testified that management's forecast of investment in working capital for 1994 struck him as unusual. The projections show an increase in additional working capital every year except for 1994, which has a dramatic drop in investment in working capital. Silver, the co-executive officer of Silgan, testified that Silgan was to begin paying cash interest on merger related debt in 1994, and those payments had a negative effect on investment in working capital. Kovacs believes that interest on merger related long-term debt should not be considered in working capital, so he ignored the figure projected for 1994. He constructed his own estimate of investment in working capital from the averages of 1993 and 1995.
Petitioners contend that Kovacs should not have adjusted management's projection for 1994, despite unrebutted evidence of a problem with the projection. I find that Kovacs properly adjusted investment in working capital for 1994.
Petitioners also complain that Kovacs' improperly reduced management's projected deferred taxes. In management's projections, deferred taxes rise throughout the 1989-1995 period. Kovacs considered the projected steady rise in deferred taxes impossible, so he adjusted the figure. Kovacs explained that deferred taxes must correspond to purchases of capital assets because they result from the tax code's accelerated recognition of depreciation. In the projections, Silgan does not make the large investments in capital assets necessary to justify the yearly increases in deferred taxes. Lawson concurs with Kovacs' adjustment. I find that Kovacs properly adjusted management's projection of deferred taxes.
Petitioners also challenge Kovacs' estimate of cash flows for the remainder of 1989. On this issue, Petitioners do not assert that Respondent improperly altered Silgan's original projections. Rather, they claim that Respondent's expert erred as a matter of law in relying on the June 30, 1989, balance sheet, a document that was unavailable on the date of the merger.
In estimating the cash flows for the 1989 stub, Kovacs subtracted the actual figures in the June 30, 1989 balance sheet from management's projection for the entire year. Instead of using the actual figures from the first half of 1989, Paone divided the projected earnings for 1989 in half. Petitioners contend that Respondent cannot use the June 30, 1989, balance sheet for this appraisal because it was not available until a few months after the merger date. Respondent replies that the balance sheet was not yet available, but the information reflected on the balance sheet relates to Silgan's pre-merger financial position.
In assessing fair value pursuant to 8 Del. C. § 262(h), the Court considers all elements of value that are "known or susceptible of proof as of the date of the merger and not the product of speculation." Weinberger v. UOP, Inc., Del. Supr., 457 A.2d 701, 713 (1983). The June 30, 1989, balance sheet contains information about events that occurred prior to June 30, 1989. Silgan may not have described this information in the form of a balance sheet as of June 30, but the data was "susceptible of proof as of the date of the merger." See id. Subtracting the real figures for the first half of 1989 provides a more credible estimate of the earnings for the remainder of 1989 than dividing the annual estimate in half. I accept Kovacs' treatment of the 1989 stub.
The last material disagreement in the experts' estimation of cash flows for the projection period is their treatment of working capital interest. Kovacs treated some of Silgan's working capital interest as an expense to be deducted from cash flow. Because Silgan's working capital interest fluctuates, Kovacs treated most of it as an expense, excepting a "fixed working capital interest" figure, which Silgan's working capital interest historically never dipped below. Paone categorized all working capital interest as debt, subtracting it from the debt free value of Silgan. Petitioners assert that Paone's approach is preferable. However, Kovacs' treatment of working capital interest actually increases the fair value of Silgan in Kovacs' DCF model. Lawson describes Kovacs' approach to working capital interest as non-traditional, but he advocates adopting it. I find that treating working capital interest as an expense provides a more reliable indication of Silgan's fair value.
C. Terminal Value
In addition to estimating cash flows for the projection period, the DCF model requires the experts to set a value for Silgan at the end of the period, which is labeled a terminal value. The two experts' extremely divergent estimates of Silgan's terminal value account for much of the difference in the outcomes of the two experts' DCF analyses. Kovacs estimated Silgan's terminal value with a "growth in perpetuity model," which sets a flat growth rate for Silgan and projects it into perpetuity. Paone applied a growth in perpetuity model as one factor in setting Silgan's terminal value, but he also considered a hypothetical sale of Silgan at the end of the projection period. Paone estimates Silgan's terminal value at $685,530, while Kovacs places it at $415,336.
Kovacs' terminal value differs drastically from Paone's because he did not use management's projections for 1989-1995 to create a terminal value. Paone extrapolated a value in perpetuity from Silgan's expected performance from 1989 through 1995. Kovacs believes that management's projections for the specific time period, 1989 through 1995, cannot be used to value Silgan in perpetuity. During the projection period, Silgan's depreciation exceeds its investment, which Kovacs believes cannot be sustained in the long run. Kovacs believes Paone's extrapolation of the current data ignores Silgan's need to make new capital investments to sustain its growth. Lawson developed his own terminal value calculation, which disagrees with Kovacs' approach in some respects, but largely concurs with Kovacs' treatment of capital investment and depreciation.
I find that Kovacs' has presented the more reliable terminal value calculation. Paone's model unrealistically extrapolates Silgan's short run circumstances into perpetuity. Kovacs correctly recognized the need for an adjustment in the data so that capital investment relates to growth and depreciation in a sustainable manner. Kovacs projected Silgan's future capital expenditures from the historical trends of the company and comparable industry data. Kovacs testified that capital investment should slightly exceed depreciation to sustain perpetual growth. Lawson generally agrees with Kovacs' approach to terminal value. Rather than completely adopting Kovacs' approach, Lawson did an independent calculation of terminal value. Lawson's approach differs from Kovacs' because he believes that capital investment and depreciation should "zero out" in the long run. Lawson's independent calculation is a useful reference for checking on the parties' experts' work, but I do not adopt it. Kovacs' theory that capital expenditures should slightly exceed depreciation is just as plausible as the "zero out" approach, so I will not alter Kovacs' terminal value calculation.
I do not give Paone's "hypothetical sale" approach any weight. Paone's hypothetical sale approach incorporates the problems associated with comparable market data into the DCF analysis, which undercuts the greatest advantage of the DCF model. A DCF model actually values Silgan as a going concern, rather than looking at the comparable merger and acquisition data. Using a hypothetical sale at the end of the projection period brings the uncertainties inherent in the acquisition data, such as discounting for a "control premium," into the DCF model. In some circumstances a hypothetical sale may have advantages over the growth in perpetuity approach, but in this case it has no such advantage. Kovacs provided the most credible estimate of Silgan's terminal value with his growth in perpetuity approach.
D. Respondent Has Presented The More Reliable DCF Analysis
In every respect, Respondent has provided more reliable valuations of Silgan's cash flows and terminal value. I carefully scrutinized Respondent's revision of the original projections, but each revision is supported by well-reasoned analysis. In contrast, Petitioners' steadfast refusal to reassess any of the original figures damages their expert witness' credibility. I conclude that Kovacs' DCF analysis is a better indicator of Silgan's fair value than Paone's DCF analysis. Yet, many aspects of Kovacs analysis reflect an overly adversarial approach. I have accepted Kovacs' conclusion as to Silgan's MVIC, but, as discussed below, I cannot accept his discounting methods and deductions from MVIC without adjustment. By contrasting the methods used by Kovacs and Paone, and employing Lawson's very helpful critique of both experts' opinions, I will make those adjustments.
E. Discounting Future Returns To Present Value
In a DCF analysis, the future returns must be discounted to their present value. The parties' experts used similar discount rates: Kovacs, 12.8%, Paone, 12.5%. Kovacs rounded the 12.8% rate to 13% for his calculations. Kovacs offered no justification for rounding the figure, and I believe it was done to create as low a final result as possible. I will remove the effect of this rounding from Kovacs' DCF analysis.
Kovacs also timed Silgan's cash flows in a manner that unreasonably lowers Silgan's value. Kovacs assumed that Silgan receives all of its cash at the end of the year. Paone assumed a mid-year receipt of cash flows as a surrogate for receipts occurring over the course of the year. Respondent submitted some evidence that Silgan, a company with a seasonal business, receives most of its cash at the end of the year. Other evidence in the record indicates that Silgan received cash throughout the year. I find the mid-year point to be the better estimate for receipt of Silgan's cash flows. The end-year receipt is insufficiently supported by the record.
F. Deductions From MVIC
In their DCF analyses, Kovacs and Paone arrived at a debt free present value for Silgan, then deducted the value of debt, preferred stock, and options to reach the value of Silgan's common equity. Lawson provided an independent estimate of deductions from Silgan's market value. All three valuations are surprisingly similar: Paone — $283,450; Kovacs — $268,700; and Lawson — $255,400. Paone's figure is highest because he treated all working capital interest as debt rather than categorizing some of it as an expense to be deducted from cash flows. The experts disagree over the values of Silgan's senior notes, long-term liabilities, and preferred stock. They also differ over whether accrued interest and bank overdrafts should be considered by the Court at all. I discuss each disputed item individually.
1. Accrued Interest
Petitioners contend that Respondent improperly took into account an accrued interest liability shown on the June 30, 1989, balance sheet. Paone and Lawson used the March 31, 1989, balance sheet, which does not show the accrued interest liability. As I previously discussed, the Court can consider the information on the June 30, 1989, balance sheet in this appraisal action. Kovacs noted a relevant factor, then made a proper deduction.
2. Working Capital Loans
Kovacs' categorized some of working capital interest as an expense to be deducted from cash flow. The remainder of working capital interest, which Kovacs described as fixed working capital, he treated as debt. As I have already discussed, Kovacs' approach to working capital interest provides a more reliable indication of Silgan's value.
3. Senior Notes
The parties' experts, Kovacs and Paone, valued the senior notes at their principle amount. In his report, Lawson states that the market value of these notes probably exceeds their principle amount because of changes in interest rates. Lawson's effort to slightly adjust the value of the debt has merit, but I decline to alter the figure that the parties' experts agreed upon.
4. Other Long-Term Liabilities
Kovacs made another revision to management's projections concerning long-term liabilities. Paone used the figure employed by management in 1989, but Kovacs adjusted it to reflect long-term liabilities reflected in Silgan's books prior to the merger. Lawson concurs with Kovacs inclusion of these liabilities, but he discounts them to present value. Kovacs properly took account of liabilities evident on Silgan's books, but he should have discounted them to present value.
5. Preferred Stock
Paone and Lawson used the book value of Silgan's preferred stock. Kovacs' concluded that the preferred stock has a lower market value based on one transaction. Lawson criticized Kovacs' reliance on one transaction as an indication of market value, stating that one sale is not equivalent to a market. Lawson is right. Kovacs should have deducted the book value of preferred stock.
6. Bank Overdrafts
Paone included bank overdrafts as a separate deduction. Kovacs did not, stating that bank overdrafts are part of working capital. Lawson also believes that bank overdrafts are included in working capital. Kovacs properly omitted bank overdrafts.
7. Stock Options
In his report, Kovacs deducted a market value of stock options from MVIC. At trial, Kovacs changed his position, agreeing with Paone and Lawson that the stock options should be treated as fully outstanding and the proceeds from the exercise of these options included in the equity value.
G. Present Value of Silgan's Common Equity
Kovacs' DCF analysis, with some adjustments, provides a good method for valuing Silgan's common equity. As discussed above, I conclude that several adjustments to this value are necessary. Kovacs should have used a 12.8% discount rate and timed Silgan's cash flows at mid-year. In his deductions from MVIC, Kovacs should have adjusted long-term liabilities to present value and used the book value of Silgan's preferred stock. As Kovacs testified at trial, his treatment of the stock options also needs to be altered. With these adjustments, I find that Kovacs' DCF analysis reliably values Silgan's stock.
V. FAIR VALUE
I have decided that Kovacs' market study and DCF analysis, with some adjustments, provide reliable methods for valuing Silgan. In reaching a final conclusion as to fair value, I do not give the two approaches equal weight. I give greater weight to the DCF model because it actually values Silgan as a going concern, rather than comparing Silgan to other businesses. I apply 2/3 weight to the DCF analysis and 1/3 weight to the market study to reach a value of Silgan's common equity of $79,429, unadjusted for stock options. For the purposes of this appraisal, all of the experts agree that the stock options should be treated as fully outstanding and the proceeds from the exercise of these options included in the equity value. Kovacs subtracted a market value for the options in his original report, so I add back that $9,100. Finally, I add $1,646 to reflect the exercise price of the options to reach a fair value of Silgan's common equity of $90,177. Dividing $90,177 by 15,179,000 shares, I find the fair value for Silgan's stock as of the merger date to be $5.94 per share.
VI. INTEREST
The appraisal statute directs the Court to fix a "fair rate of interest" after considering "all relevant factors." 8 Del. C. § 262(h). In setting the fair rate of interest, the Court primarily considers two factors, the "prudent investor rate," and the surviving corporation's cost of borrowing. Chang's Holdings, S.A. v. Universal Chemicals and Coatings, Inc., Del. Ch., C.A. No. 10856, Chandler, V.C. (Nov. 22, 1994). The Court may also consider the legal rate of interest, as defined in 6 Del. C. § 2301, as a relevant factor for determining the fair rate of interest. See Neal, supra, Mem. Op. at 52. In its discretion, the Court can award simple or compound interest.Rapid-American Corp. v. Harris, Del. Super., 603 A.2d 796, 807 (1992). As set forth below, I consider each relevant factor individually, then weight them according to their importance to reach a fair rate of interest of 9.5%.
A. Legal Rate
Petitioners ask the Court to award the legal rate of interest, which is 12.5%, as the fair rate of interest. Petitioners note that the Court has relied solely on the legal rate in previous appraisal actions. See, e.g., Neal, supra, Mem. Op. at 52. Petitioners further argue that the legal rate approximates the average cost of borrowing for Silgan and Silgan's parent company, Silgan Holdings.
I give no weight to the legal interest rate because the parties have presented sufficient evidence to set a prudent investor rate and Silgan's cost of borrowing rate. See Chang's Holdings,supra, slip. op. at 6. I do not consider Petitioners' contention that the legal rate approximates Silgan's cost of borrowing because I can directly determine Silgan's cost of borrowing.
B. Cost of Borrowing
Section 262(h) specifically states that the Court should consider the surviving corporation's cost of borrowing in setting a fair rate of interest. 8 Del. C. § 262(h). This factor accounts for the benefit the corporation received from having use of Petitioners' money during the pendency of the appraisal action. Chang's Holdings, supra, slip op. at 2. The Court does not employ an objective test to determine what interest rates were available to the corporation during the relevant period, but applies the surviving corporation's actual cost of borrowing. Id. at 10.
Respondent provided a summary of the average interest rates for its borrowings from 1989 through 1994. The combined average rate for these borrowings is 10.51%. Respondent contends that the rate for its revolving credit line, which is 9.08%, represents its actual costs of borrowing for the purposes of this appraisal action. According to Respondent, Silgan would have used this source of credit to increase its borrowings had it not had use of Petitioners' funds. Petitioners argue that the Court should ignore secured debt like the revolving credit line in determining Respondent's cost of bargaining. Petitioners portray Silgan's retention of their money as an unsecured loan, thus Silgan's rate for unsecured borrowing is the relevant rate.
In determining Silgan's borrowing rate, I will not exclude any of Silgan's sources of credit. Silgan's aggregate borrowing rate best reflects the benefit it received from having use of Petitioners' funds during the pendency of this proceeding. See Cooper, supra, Mem. Op. at 28 (seeking evidence of the surviving corporation's average cost of debt). The evidence provided by Respondent shows that its average cost of borrowing for the relevant period was 10.51%.
Petitioners argue that the Court should also consider the borrowing rate of Silgan Holdings, Respondent's parent corporation. Petitioners submit that the combined rate for the borrowing of Silgan and Silgan Holdings is 12.1%. Respondent replies that § 262(h) instructs the Court to consider only the surviving corporation's cost of borrowing, not a related corporation's cost of borrowing.
Pursuant to § 262(h), this Court considers "all relevant factors" in determining the fair rate of interest, which may include the borrowing rate of the surviving corporation's parent.See Cede, supra, Mem. Op. at 81. In Cede, the parent corporation did all the borrowing for the surviving corporation, so the parent corporation's cost of borrowing was a relevant factor. Id. Unlike the circumstances in Cede, Silgan has engaged in a substantial amount of independent borrowing since 1989. I can determine Respondent's rate of borrowing without referring to the borrowing of its parent, Silgan Holdings, so I do not believe Silgan Holdings's rate of borrowing is a relevant factor. The relevant cost of borrowing rate is the average cost of Silgan's debt — 10.51%.
C. Prudent Investor Rate
Another relevant factor is the prudent investor rate, which is the return on investment that a hypothetical prudent investor could have received during the relevant period. Lebman v. National Union Elec. Corp., Del. Ch., 414 A.2d 824, 829 (1980). Respondent has offered evidence that the prudent investor rate ranged from 8.34% to 9.09% during the applicable period. Petitioners have not attempted to calculate the prudent investor rate. I set the prudent investor rate at 9.0%.
D. Fair Rate of Interest
Based on the evidence presented, I arrive at a prudent investor rate of 9.0% and a cost of borrowing rate of 10.51%. I do not give these factors equal weight. Under these circumstances, I believe the prudent investor rate is the most important factor.See Cede, supra, Mem. Op. at 83. Applying a 2/3 weight to the prudent investor rate and a 1/3 weight to the cost of borrowing rate, I award 9.5% simple interest from the date of the merger.
VII. COSTS
The Court may allocate the costs of this proceeding as it deems equitable under the circumstances. 8 Del. C. § 262(j). This is the first appraisal in which I have appointed a neutral expert and I must determine who should bear the considerable cost of his services. I direct the parties to share equally the cost of Mr. Lawson's services. Respondent shall pay all other court costs.
The parties shall confer and try to agree on a form of Order that will implement this decision.