In re Appraisal of Regal Entertainment Group

Summary.

In a merger action involving a publicly traded company, dissenting shareholders sued for a higher value than the deal consideration. Under the applicable appraisal jurisprudence, the court determined fair value using the deal price minus synergies and adjusting for the change in the value of the target between the signing and closing of the transaction.

Background.

The petitioners owned shares in Regal Entertainment Group (Regal). In February 2018, Cineworld Group (Cineworld) acquired Regal through a reverse triangular merger. The merger consideration was $23 per share. Regal’s board approved the merger agreement in early December 2017. In late December 2017, then President Trump signed the Tax Act into law. Most changes took effect starting Jan. 1, 2018. The merger closed in February 2018. The petitioners petitioned for appraisal with the Delaware Court of Chancery. Based on their experts’ discounted cash flow (DCF) analysis, the petitioners argued for a value of $33.83 per share. Cineworld (respondent) advocated using Regal’s unaffected trading price and the deal price minus synergies. Giving equal weight to both methods, the company argued for a value of $18.02 per share.

The court, looking at recent Delaware appraisal jurisprudence, determined that the deal price at signing ($23.00 per share) was the most reliable indicator of fair value. The court then deducted $3.77 for synergies allocated to Regal shareholders as part of the deal. In addition, to account for the anticipated value to the buyer from the 2017 Tax Cuts and Jobs Act (TCJA), which went into effect between the signing and closing of the merger, the court added back $4.37 per share for a resulting final value of $23.60 per share.

The target company.

Regal is a Delaware corporation headquartered in Knoxville, Tenn. The company exhibits theatrical films in hundreds of locations throughout the country. Until the closing of the contested merger, Regal’s shares traded on the New York Stock Exchange. Before the merger, there was a controlling shareholder corporation, Anschutz, controlled by a controlling owner, Philip Anschutz, who had held Anschutz since 1962. Anschutz owned about 67% of the company’s voting shares and 23% of the equity.

Financial analysts considered Regal one of the leaders in the industry. Its key business drivers were admissions, concessions, and “film rent,” ticket revenue a theater pays the studio producing the film for the right to show the movie. Over time, the theatrical release window, the period from when the films are released to theaters until the release to streaming and other channels occurs, was getting shorter—from six months in 1997 to 100 days in 2017. The release window is also a key element for revenue opportunities. Attendance peaked in 2002 and declined at a compound annual growth rate (CAGR) of 1.6% up through the announcement of the merger date. However, concessions were growing, per person, at a 5% CAGR for the five years before the merger. Beginning in 2011, Regal and other exhibitors made other investments to bring people into theaters. They offered “enhanced” concessions, mobile ticketing, and reserved seating. Regal added reclining seats, which increased attendance for 12 to 18 months.

At the time of the merger, there were six major studios, and the film rental fees had remained relatively constant, at just over 50% of box-office revenue. But, by 2013, Netflix and Amazon began producing their content, bypassing the studios and theaters.

In 2014, Regal’s board began looking at strategic alternatives. It hired Morgan Stanley as its financial advisor. Regal’s CFO prepared five-year projections to help the committee evaluate options. The 2014 projections were top-down projections and not theater-by-theater projections (i.e., bottom-up). A search of 71 potential buyers by Morgan Stanley yielded six potential financial buyers and one strategic buyer (Cineplex), all of whom signed nondisclosure agreements. But potential buyers saw the cinema sector as fully valued and saw long-term risks to Regal’s business model. Morgan Stanley also cautioned about the effect of Anschutz selling all or a portion of its interest and the risk of a “temporary overhang” for Regal’s stock price.

In 2015, there were rumblings that the theatrical window might shorten again. Regal’s board engaged Bain & Co. to analyze the “windowing strategies.” The board also discussed a possible acquisition of Cinemark.

Meanwhile, Anschutz looked to monetize all or part of its investment, including a block sale. In 2016 and 2017, Anschutz sold blocks of shares at $21.60 per share and $22.95 per share, respectively. Anschutz reduced its ownership of Class A common shares by 63.1%.

In March 2017, Cineworld (owned by the Greidinger brothers) expressed an interest in a potential deal involving Regal to Anschutz. In July 2017, the Greidingers were told that the timing was not good. Anschutz also questioned whether Cineworld could finance the deal. In August 2017, Regal reported disappointing earnings. Stocks in the sector all dropped, Regals by 5%.

Meanwhile, Cineworld explored financing for a transaction with HSBC and Barclays. Cineworld also asked Ernst & Young to evaluate tax-efficient ownership structures for a post-merger company. Cineworld believed it needed to show significant synergies to obtain financing.

In anticipation of a meeting between Regal’s CEO and the Greidingers, Regal prepared a new set of five-year projections. Regal’s representative testified that the 2017 projections were “optimistic but achievable.” As the parties continued negotiations, the United States Congress moved closer to a massive tax cut for corporations, reducing taxes from 35% to 21%. In November 2017, Cineworld made its final offer of $23.00 after consulting with the bankers and sharpening its pencil on the determination of synergies. Regal accepted with the condition there would be a “go-shop” provision that allowed Regal to seek other potential buyers post-signing. A reverse breakup fee was also included.

Meanwhile, Cineworld’s financial advisors kept working on merger-related synergy analyses, pointing to three categories that increased Regal’s per-share value: cost reduction opportunities, leverage of know-how and industry best practice, and tax benefits. “Using analyst consensus projections, Cineworld’s bankers valued the business initiatives at $6.40 per share and the tax benefits at $7.10 per share.” “Using the 2017 Projections, Cineworld’s bankers valued the business initiatives at $8.10 per share and the tax benefits at $7.10 per share.” At the same time, Morgan Stanley observed that the deal price exceeded the valuation estimates of nine equity research analysts. The go-shop process did not result in any other bidders.

Cineworld assured its shareholders that it could expect $100 million in synergies. Cineworld’s directors were skeptical about the $100 million amount. Cineworld anticipated up to $50 million of benefits related to the tax act. On the other side, on Feb. 1, 2018, Anschutz said it would vote its shares in favor of the merger. Anschutz’s move meant the approval of the transaction. The merger closed on Feb. 28, 2018.

Applicable legal principles.

Under Delaware’s appraisal statute (8 Del. C. § 262(h)), “the 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.” The time for determining the value is the date of the closing. “The underlying assumption in an appraisal valuation is that the dissenting shareholders would be willing to maintain their investment position had the merger not occurred.

The appraisal statute places the obligation to determine fair value squarely on the court. Under the law, the court can select one of the parties’ valuation models as its general framework or fashion its own. Both parties are burdened with proving their positions by a “preponderance of the evidence.”

Petitioners argue for the use of DCF-derived value. The petitioners’ expert performed a DCF value. The company’s expert did not do a DCF analysis but critiqued the opposing expert’s model. The petitioners had the burden of showing this valuation method was reliable.

The court, referencing appraisal jurisprudence, noted, “[i]n Dell and DFC, the Delaware Supreme Court cautioned against using the DCF methodology when a reliable market-based indicator is available.” This court favors market-based valuation indicators, the Court of Chancery noted. It concluded that the DCF value did not strain credulity regarding diverging from market indicators, “but the degree of divergence weights against using it to value Regal.”

The unaffected trading price.

Cineworld advocated for the use of the trading price and, therefore, bore the burden of proving its reliability. The court noted that the Delaware Supreme Court has found that the unaffected trading price can equate to fair value. Market efficiency is the key to the use of the trading price. Here, Regal was a public company trading on a major exchange. The court said the following factors typically must be considered in evaluating the trading price method:

• Vital public information.
• Central stock exchange listing.
• Highly active trading followed by equity and credit analysts.
• Low bid-asked spread; and
• Market capitalization.

The court found that Regal had sufficient attributes of an efficient market. However, for other reasons, including the presence of a controlling shareholder, the court found Cineworld failed in its burden to prove the use of the unaffected trading price.

The deal price minus synergies are adjusted for any changes in value between signing and closing.

Cineworld was a proponent of this method and had the burden of proof.

The court noted the appraisal statute requires that fair value be determined irrespective of the synergies. The deal price frequently represents a ceiling for determining offer value. The court found the deal price was a reliable indicator of fair value. The court noted that the transaction exhibited sufficient objective indicia of an arms-length transaction. The buyer was unaffiliated, most of the board’s members were disinterested, none of the board members joined the post-merger entity, there was sufficient “robust public information” about the company’s value, the parties negotiated over the price and the merger agreement allowed for bidding during the post-signing phase. The court found any flaws in the sale process to the petitioners pointed were not strong enough to undermine the persuasiveness of the deal price.

Synergies analysis.

The next step in the analysis was to exclude from the deal price any value arising from the accomplishment or expectation of the merger, the court explained. In essence, the court must identify synergies, quantify their value, and determine what value was captured by the seller in the deal price. “If a buyer overpays for a company based on the buyer’s subjective yet unrealistic synergy expectations, then the deal price reflects those expectations.” Here, Cineworld identified operational synergies and financial savings.

Operational synergies.

Cineworld’s financial advisor calculated operational synergies of $8.10 per share. The petitioners questioned the reliability of the estimates of operational synergies. They argued many of the initiatives appearing under operational synergies were not value arising from the merger because Regal had already been pursuing them. The court found that most of the categories of importance related to operational synergies were excluded from the accomplishment or expectation of the merger.

In determining the number of synergies to be excluded, the court found Cineworld increased its estimation of synergies from $70 million to $100 million to satisfy the bankers when pursuing financing for the deal, even if Cineworld’s board did not feel that the $100 million was attainable. Therefore, the court did not include the extra $30 million but only the $70 million in its initial calculation. Using 70% of the estimated value of $6.09 per share in operational synergies resulted in $4.26 per share. This was the amount that potentially qualified for exclusion under the appraisal statute, the court found.

Financial savings.

The court found that both parties assumed financial savings, but neither expert provided a reliable valuation. It valued financial savings at $2.73 per share. The company’s expert started with a value of financial savings of $7.10 per share. He adjusted that number to take into account the impact of the 2017 Tax Act. The court found his method “logical” and used it to calculate the per-share value of financial savings. But the court relied on Cineworld’s internal estimates of financial savings to calculate an appropriate value of financial savings Cineworld could achieve after the passage of the Tax Act. Notably, in January 2018, Cineworld reduced its estimate from $50 million to $10 million. The court determined that $44 million was the amount of savings Regal could achieve on its own after the impact of the Tax Act.

I am sharing synergies. 

Next, the court had to determine how to allocate the estimated synergistic value between the buyer and the seller. Delaware law recognizes that sellers receive a part of the synergies anticipated by the merger. The court noted that a synergy value of $6.99 per share was awaiting allocation between the parties. It pointed out that, under the Delaware Supreme Court’s decisions, the trial court must make a synergy allocation using its best judgment, no matter how difficult it may be.

Here, the court found the “strongest evidence that Regal extracted a portion of the anticipated synergies comes from the fact that the deal price of $23 per share reflected a premium of 46.1% over Regal’s unaffected trading price.” Also, market participants initially believed Cineworld was overpaying for Regal. Cineworld’s stock price declined after merger talks leaked and Cineworld disclosed the anticipated transaction price. The court noted that it recovered somewhat after the buyer declared its synergy estimates.“This pattern suggests that once market participants understood the combined company’s value, they inferred that Cineworld had not overpaid but merely allocated some of the anticipated synergies to Regal,” the court said.

However, there was also evidence that Regal did not extract any synergies, the court noted. There was no “explicit attempt” to bargain for synergies. The company’s expert admitted that he could not ascertain with certainty how the synergies were allocated. Therefore, he relied on a 2018 Boston Consulting Group (BCG) study that typically found that the sellers captured 54% of the value of synergies. The court found this study was “the best tool available for an imprecise task.” As a result, the court found that 54% of a value of $6.99 of allocable synergies resulted in a $3.77 per share included in the deal price. This amount was excludable under the appraisal statute.

Change in value between signing and closing. 

The court noted it was required to determine fair value at the closing and not at the signing date. Suppose the value of a company changes between the signing and the conclusion of the deal. In that case, the fair value determination must be based on the “operative reality” of the company at the merger’s closing. The court noted that Regal’s operative reality had changed when the Tax Act became law in late December 2017. Both sides agreed that the company’s value changed as the new Tax Act lowered corporate taxes to 21%. The court noted Regal’s lowered tax rate reduced the financial savings the buyer could achieve. After the Tax Act, the court said that those financial savings were part of the value available to Regal in its operative reality as a stand-alone entity. It added $4.37 per share to the deal price minus synergies. As a result, the court decided the fair value of the petitioners’ claims was $23.60 versus the $23 deal price.

Conclusion

In determining fair value, the court began by adopting the deal price of $23.00 per share and excluding the synergy value of $3.77 from this amount. The court then increased the resulting amount by $4.37 per share to account for the effect of the 2017 Tax Act on the target’s value at the close of the merger. Fair value was $23.60 per share, the court concluded.