Appraisal Rights and Tech Fears
(Bloomberg View) -- Dell!
Way back in 2013, Michael Dell teamed up with Silver Lake Partners to take his company, Dell Inc., private at $13.75 per share. That was well above Dell's $9.35 stock price at the time, but some shareholders thought that the price was too low, and they sued under the Delaware law that allows them to demand appraisal of their shares. Last year, Delaware Vice Chancellor Travis Laster agreed with them that the deal price was too low. The fact that it was above the market price proved nothing: There was "compelling evidence of a valuation gap between the market's perception and the Company's operative reality," and while Michael Dell had tried to explain that reality to shareholders and get them to appreciate his long-term vision, "analysts' focus on short-term, quarter-by-quarter results" had kept the price down. Similarly, the fact that Dell had run a more-or-less fair auction and contacted a number of bidders, and that $13.75 was the highest price it got, proved nothing: Strategic buyers would not be willing to pay a fair price for Dell because of "the massive integration risk," while private-equity buyers demand internal rates of return of over 20 percent, and so will only buy companies at a deep discount to their fair value. So Vice Chancellor Laster valued Dell himself, using a discounted cash flow model, and came up with $17.62 per share. And he ordered Dell and Silver Lake to pay the extra money, plus interest, to the objecting shareholders.
That ... was a weird decision. I said at the time that Vice Chancellor Laster's reasoning seemed to be that "The proof that $17.62 was the fair price is that no one was willing to pay it:" Public shareholders are myopic, private-equity firms only buy at a discount, strategic buyers are afraid of risk. But that reasoning suggests that no merger can ever get fair value, that all actually existing markets pay less than the Platonic value of a firm. Perhaps that is true as a philosophical statement, but it's a weird theory to build an appraisal jurisprudence around. As I wrote:
When Michael Dell proposed a buyout, the company's price was wrong. Everyone involved in this case agrees on that. Michael Dell thought -- and said -- that Dell was undervalued. The Dell board said that it was undervalued. Its financial advisers said it was undervalued. Silver Lake thought it was undervalued. When the deal was announced, Carl Icahn said it was undervalued. When the deal closed, the appraisal plaintiffs sued, saying it was undervalued. And now a judge has decided it was undervalued.
But Michael Dell and Silver Lake are the ones who did something about it. Everyone says Dell's market price was too low; they skipped the talk and just offered to pay more.
Yesterday the Delaware Supreme Court reversed Vice Chancellor Laster's decision. It concluded that "the market for Dell's shares was actually efficient and, therefore, likely a possible proxy for fair value," and that there was "no evidence in the record that investors were 'myopic' or shortsighted. Rather, the record shows analysts understood Dell’s long-term plans. But they just weren’t buying Mr. Dell’s story." And it rejected the Vice Chancellor's substitution of his own discounted cash flow analysis for the deal price:
The Court of Chancery’s DCF value was the antithesis of any economist’s definition of fair market value. The Court of Chancery conceded that its DCF value did not reflect a value deemed attractive to the buyers of Dell’s 1,765,369,276 publicly traded shares. Further, it did not reflect the value that private equity buyers (including the biggest players such as KKR, TPG, and Blackstone) put on it, as it was too high for any of them to pay. The trial court also picked a price higher than any strategic would pay because, in economic terms, no strategic believed it could exploit a purported $6.8 billion value gap because the risks and costs of acquiring Dell and integrating it into its company dwarfed any potential for profit and synergy gains if Dell were purchased at the Court of Chancery’s determination of fair value. And, of course, as to all buyers, strategic and financial, the Court of Chancery found that a topping bid put them at hazard of overpaying and succumbing to a winner’s curse.
When an asset has few, or no, buyers at the price selected, that is not a sign that the asset is stronger than believed—it is a sign that it is weaker. This fact should give pause to law-trained judges who might attempt to outguess all of these interested economic players with an actual stake in a company’s future. This is especially so here, where the Company worked hard to tell its story over a long time and was the opposite of a standoffish, defensively entrenched target as it approached the sale process free of many deal-protection devices that may prevent selling companies from attracting the highest bid. Dell was a willing seller, ready to pay for credible buyers to do due diligence, and had a CEO and founder who offered his voting power freely to any topping bidder.
Dell was transparent about its financial situation and its operating plans with the market, and the market valued it at $9.35. It then ran a fair and competitive auction to sell itself, and the auction came back with a top bid of $13.75. The fact that a judge valued it at $17.62 is an interesting curiosity, but not a good reason to force the actual buyer to pay more.
Here's a weird blog post from Sam Altman of Y Combinator bemoaning political correctness in Silicon Valley:
Earlier this year, I noticed something in China that really surprised me. I realized I felt more comfortable discussing controversial ideas in Beijing than in San Francisco. I didn’t feel completely comfortable—this was China, after all—just more comfortable than at home.
"This will be very bad for startups in the Bay Area," writes Altman. "Restricting speech leads to restricting ideas and therefore restricted innovation—the most successful societies have generally been the most open ones." And: "I’ve seen credible people working on ideas like pharmaceuticals for intelligence augmentation, genetic engineering, and radical life extension leave San Francisco because they found the reaction to their work to be so toxic." And: "If SpaceX started in San Francisco in 2017, I assume they would have been attacked for focusing on problems of the 1%, or for doing something the government had already decided was too hard."
It's pretty standard stuff mostly, but it fits strangely with the tech industry's self-image. Silicon Valley entrepreneurs are bold iconoclastic innovators who move fast and break things and question established paradigms to change the world, unless someone makes fun of them. In which case they crumple instantly? There's no suggestion of actual censorship in Altman's post, no chance of the government suppressing controversial opinion (as it does in China!). It is just a sort of cringing terror that someone might disagree with you, say that you're wrong, criticize your priorities, make jokes at your expense. "How can I change the world if someone might mock me on Twitter?"
Meanwhile here is Elon Musk on public transit and his fellow human beings:
“I think public transport is painful. It sucks. Why do you want to get on something with a lot of other people, that doesn’t leave where you want it to leave, doesn’t start where you want it to start, doesn’t end where you want it to end? And it doesn’t go all the time.”
“It’s a pain in the ass,” he continued. “That’s why everyone doesn’t like it. And there’s like a bunch of random strangers, one of who might be a serial killer, OK, great. And so that’s why people like individualized transport, that goes where you want, when you want.”
Elon Musk isn't constrained by political correctness! He's not crying into his Soylent because people make fun of him on Twitter! He's out building trucks and blasting rockets to Mars and sneering at the plebes like a boss! Come on, man.
Therapist insider trading.
The normal pattern in insider trading is (1) a corporate insider tells a corporate outsider a nonpublic fact, (2) the outsider trades on that fact, and (3) the fact becomes public and the outsider makes a lot of money. There are two ways for this to be illegal. One way is that the insider tells the outsider the information so that the outsider can trade. It is a conspiracy, and the insider is in on it: He expects a cut of the outsider's profits, or the outsider is his brother-in-law and he wants to give him a present, or whatever. The law on this is complicated and changing but generally that will be illegal.
The other way is that the insider tells the outsider the information in confidence, and the outsider betrays that trust. The law here too is a bit complicated -- you need a "duty of trust and confidence" for the violation of it to be illegal -- but generally this too will be illegal. Crucially, though, this is only illegal for the outsider. The insider has done nothing wrong. He is not a co-conspirator; he's an innocent victim who has been wronged by the outsider's betrayal.
It can occasionally be hard, from the outside, to tell which is which. In general when a wife tells her husband about a secret deal, and the husband trades, you might assume they were in on it together, but sometimes the wife is the unwitting victim of the husband's betrayal. The most complex relationship of all is, of course, the one between golf buddies: Sometimes when a corporate executive tells his golf buddy about an upcoming deal, it will look like an intentional trading tip and the executive will be charged with insider trading; other times it will look like a confidential golf-course discussion and only the traitorous golf buddy will be charged. You can get different results even at the same golf course.
A Seattle-based therapist has agreed to settle SEC charges that he traded in the stock of zulily, Inc. (Zulily) based on information he learned from a Zulily employee during confidential counseling sessions.
The SEC's complaint alleges that, in July 2015, during counseling sessions, the Zulily employee told Kenneth Peer that Zulily was going to be acquired by Liberty Interactive, a media holding company. On three occasions between July 21, 2015 and August 10, 2015, after counseling sessions with the Zulily employee, Peer purchased a total of over $28,000 of Zulily stock.
Yeah don't do that. Maybe don't talk about upcoming corporate actions with your therapist either, but who am I to judge.
Bitcoin bitcoin bitcoin.
These days there is probably enough material for a whole daily newsletter on just the topic of "Implausible Company Pivots to Bitcoin Mining." Here's a press release titled "Rich Cigars, Inc., Becomes Intercontinental Technology, Inc. to Reflect New Direction including Multi-national Patent Ownership and Aggressive Cryptocurrency Mining." They were tired of setting $100 bills on fire to light their cigars, so now they will light them with bitcoins, is I assume the reasoning in the press release, which I have not read. Rich Cigars trades on OTC Markets and closed yesterday at $0.70 per share, for a $2.4 million market capitalization, up 2,233 percent on the day. It's the aggressive cryptocurrency mining that really adds value. Anyway, the point here is that Money Stuff Business Thing LLC is changing its name to Bitcoin Stuff Crypto Thing LLC to reflect its new focus on bitcoin stuff and crypto things, and it has become eight thousand times more valuable since I started typing this sentence.
Elsewhere, "a Danish hockey team has reached a sponsorship agreement to rename its home Bitcoin Arena and offer to pay players in the digital currency," and one player has agreed "to become the first professional sports athlete to be paid fully and exclusively in Bitcoin." How will he eat? Here at Bitcoin Stuff we are of course all sophisticated enough to know that "bitcoin is not a useful medium of exchange" is not a good argument against it as a store of value. But we are also aware that bitcoin is not a useful medium of exchange! It's not super easy to convert into dollars or kroner either. If you get paid in bitcoin you might quickly become extremely rich as the price of bitcoin rises, but you'll find it hard to buy a sandwich.
And: Long Island woman was indicted for allegedly defrauding banks, converting the proceeds into "Bitcoin and other cryptocurrencies," and then sending them to support ISIS. And: Bank of Canada Governor Stephen Poloz says that buying bitcoin is "closer to gambling than investing." And: "China, which gets about 60 percent of its electricity from coal, is the biggest operator of computer 'mines' and probably accounts for about a quarter of all the power used to create cryptocurrencies." And: "Money raised from initial coin offerings has surged past $4 billion for the first time, even as regulators world-wide have escalated warnings about the new form of corporate funding." And: Tyler Cowen argues that the big social gain of cryptocurrencies is that "by serving as efficient stores of value and by providing a new kind of insurance, they help people spend more money," though perhaps not the hockey guy.
Blockchain blockchain blockchain.
Vanguard is launching a new platform that uses blockchain technology to simplify the process of sharing data with index providers. The platform, which it expects to introduce early next year, has the potential to reduce errors and increase cost savings and returns for investors, according to spokeswoman Carolyn Wegemann.
Under the current system, Vanguard constantly receives updated files from index providers about corporate actions throughout the day, which are then manually processed. The data transmission usually involves multiple parties and distribution channels. The new platform will allow index data to move instantly between index providers and market participants through one decentralized database.
I mean. Look. This is good. You have a bunch of participants (index providers) on one side. You have a bunch of participants (indexed investment managers) on the other side. A centralized database run by S&P Dow Jones Indices wouldn't work because you'd also want to include data from FTSE Russell. (Not that either of those is included in this pilot project, which is limited to Center for Research in Security Prices indexes.) A centralized database run by Vanguard wouldn't work because you'd also want State Street to be able to use it. (Not that State Street or any other asset manager seems to be using this one yet, but you get the idea.) Ideally you could plug the corporations themselves into the database of corporate actions and cut out a step. You want a database that isn't run by any single participant, so that it has a hope of being extensible and universal. We have for a long time had the technology to do that, with industry-wide organizations like the Depository Trust Company and the International Swaps and Derivatives Association and so forth. But "the blockchain" is quite possibly a better technology. It lets the participants run the database directly, as it were, instead of by setting up a new intermediary organization. The governance lives in the database (the blockchain) rather than in a board of directors of a new database organization .
My skepticism of blockchain-for-everything is softening a little bit, I guess. (Disclosure: I am an investor in Vanguard funds.) Still it always looks a little silly in pilot projects. This announcement is not much more than "CRSP has changed the format of how it will email Vanguard about corporate actions." But you gotta start somewhere.
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Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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