Ramcell, Inc. v Alltel Corp., 2022 Del.

In this appraisal action to determine fair value, petitioner Ramcell Inc. exercised its appraisal rights in asking for a statutory appraisal of the value of its 155 shares of Jackson Cellular Telephone Co. Inc. The respondent, Alltel Corp. (dba Verizon Wireless), had converted the 155 shares at a value of $2,963 per share. The 155 shares represent less than 10% of the outstanding shares of Jackson. “Respondent’s expert opines that Jackson’s per-share value was $5,690.92 at the time of the merger. Petitioner’s expert has offered two appraisal ranges, opining that, at the high end, Jackson’s per-share value was $36,016 on the merger date.” Both parties agreed that the DCF method should be the sole method for determining the value. The Delaware Chancery Court, using that method, determines the fair value of each share at $11,464.57. The court noted that the disparity in the parties’ valuations was due to disagreements as to the inputs to the DCF model and how they should be calculated.

Background.

Parties, the merger, and procedural history. Respondent Alltel is a Delaware corporation. Alltel owned more than 90% of the outstanding stock of Jackson, a Delaware corporation. In 2019, Jackson was merged into Alltel for a consideration of $2,963 per share. Ramcell made a demand for appraisal of its 155.4309 shares.

The court conducted a two-day trial on March 2, 2022, and March 3, 2022. Valuation experts for each side testified: J Armond Musey, CFA, JD/MBA (Musey), for the petitioner and Joseph Thompson, CFA, ASA (Thompson), for the respondents.

Jackson history. A group of investors, including Ramcell, formed Jackson to better chances in the lottery. In 1986, the rights to the Jackson, Miss., area were awarded to Jackson. Ramcell received a minority interest of 0.99%. In 1988, Jackson converted to a corporation. By 2009, Alltel was the majority owner of Jackson. By 2018, there were five minority shareholders each with less than a 1% interest. On a second offer of $2,963 per share, two of the five shareholders accepted. Alltel effected a merger of Jackson at $2,963 per share.

Jackson’s business. Jackson was in the business of providing wireless communication products and services in the Jackson, Miss., area. The court then went into a discussion of the details of the locations and revenues of Jackson and how they were determined.

Jackson’s financing. Jackson financed capitalization and operations by borrowing from affiliates (noted as Due to Affiliate [DTA]). The DTA account reflected in flows and out flows. Beginning in 2013, Jackson EBITDA began decreasing DTA net borrowings. By 2018, the balance was down to $12.8 million. Interest was charged on the DTA.

Edge receivables. Important was Jackson’s practice of selling phones, financing, and securitizing the receivables. Around the valuation date, Jackson began selling customers their phones and financing them over two years. The receivables were securitized through a third party and are cash-neutral to Jackson.

United States, Jackson MSA, and wireless industry market outlook. Thompson and Musey came to different conclusions regarding the U.S. economy, Jackson market, and wireless industry market outlook. Thompson “paints a picture” of a slight slowdown nationally and a gloomy view of Jackson’s MSA. Musey rebutted Johnson’s view as overly pessimistic.

They also disagreed as to the wireless outlook. Thompson painted the view of declining revenues and restricted opportunities for growth. Musey saw 3.1% growth due to the rollout of 5G.

Competitive environment—C-Spire. The nature of Jackson’s competitive environment was another area of disagreement. Thompson said that the presence of competitor C-Spire hampered Jackson’s growth. Musey used the HHI index to discount any effect that C-Spire might have. That index showed that Jackson was an average market. At trial, Musey rebutted Thompson’s report and promoted further arguments as to why C-Spire was a significant competitor.

Historical financials and management projections. Verizon prepared annual financial statements for Jackson but did not, in the ordinary course of business, prepare projections for Jackson. The financial statements were unaudited. To effect the merger, Verizon prepared a 10-year forecast to determine the purchase price.

Analysis.

“The purpose of an appraisal proceeding is to give stockholders dissenting from a merger the opportunity to receive a judicially determined fair value for their shares.… The fair value that the court is to determine in the appraisal context is largely a judge-made creation ‘freighted with policy considerations‘ and should not be conflated with the general economic concept of fair value.” The basic concept was that the shareholder was entitled to be paid for what has been taken from him. In a statutory merger, the parties had the burden of proving their respective valuation positions including the propriety of a discount or premium. If the parties cannot agree, the court must make its own decision on the fair value.

The valuation should represent a going concern, if such was the case, at the date of valuation. Valuation was an art and not a science. Fair value was an estimation of value at the valuation date. “The value of a corporation is not a point on a line, but a range of reasonable values, and the judge’s task is to assign one particular value within this range as the most reasonable value in light of all the relevant evidence and based on considerations of fairness.” The court had broad discretion in the determination of fair value in light of the testimony given.

The parties agreed that the best “approach” to determine the fair value of Jackson was the discounted cash flow (DCF) method. Thompson concluded a fair value of $5,690.92 per share, and Musey concluded a value range of between $21,047 and $30,813. DCF was accepted by the Delaware courts.

The estimate of future cash flows. An accurate cash-flow estimate of future operations was the foundation of a DCF. The Delaware courts prefer management-prepared projections in the ordinary course of business. The court was inherently doubtful of post-merger, litigation-driven projections, but it has used them in the past. “Here, the financial projections on which Thompson relies were created by management in anticipation of a merger using historical records kept in the ordinary course. Management knew that appraisal litigation was possible if not probable. Musey’s projections were created post merger, for the purposes of this litigation.”

Musey’s approach and Thompson’s explanation. Musey prepared his own projections based on Verizon’s national performance. Musey listed his reasons why the Jackson management-prepared projections were not reliable, including rejecting Jackson’s historical financials as being accurate predictors of future performance. Musey prepared two sets of projections both assuming that Jackson’s performance would be on a par with Verizon nationally. The first scenario assumed that Jackson’s reported number of subscribers based on NPA-NXX was correct and would converge with Verizon’s. This assumed that Jackson’s market penetration would increase from 14% to approximately 47% over the 10-year projection period, and Verizon’s operating margin would be reached by 2028. Ramcell’s per-share value was between $21,047 and $21,403, depending on the DTA balance.

The second scenario assumed that Jackson had already achieved market penetration equal to Verizon nationally and would grow in line with Verizon’s projected growth nationally. Under this scenario, the per-share value was either $26,231 or $26,586, depending on the balance of the DTA. For both scenarios, Musey added “Excessive Capital Expenditures” to the value. Additionally, Musey added an amount to adjust the DTA to the appropriate value taking into account the excess capital expenditures. This increased Musey’s value to $30,833 (Scenario 1) or $36,016 (Scenario 2). Musey did not provide an adequate explanation of why these add-on values were appropriate. Nor does Musey convincing evidence as to why Jackson was underperforming Verizon nor that it should be performing at Verizon’s level.

Thompson provided four plausible explanations as to why Jackson’s results could be different at a national level.

The data concerns Musey identified do not justify throwing out management forecasts and replacing them with hypothesized numbers based on Verizon’s national performance. The court agreed that management’s historical financials were wrong “by some unknown percentage.” The NPA-NXX method for tracking subscribers was flawed. Service was being misallocated. “The fact that management’s financials are off by some percentage, however, does not justify adopting another set of financial projections that are also off by some percentage.” At a minimum, the historical trends were based on numbers in existence which “tethers the financial to reality, albeit inaccurately.”

DTA adjustment. The DTA adjustment was not adequately explained and was not justified.

Thompson’s approach. Thompson created his forecast by adjusting management’s forecasts made in anticipation of the Jackson merger. Most of Thompson’s adjustments were based on actual financial results existing as of the valuation date. He kept many of the assumptions from the original forecasts. “Thompson’s base model was one of a few models created in conjunction with the merger process and closely resembled the model used to calculate the merger consideration.” His most significant adjustment was to the EDGE receivables. Thompson disagreed with treating the EDGE receivables as a cash-flow adjustment. He treated any such adjustment as neutral to cash because of the securitizing of the EDGE receivables. The court accepted that the EDGE receivables were cash flow neutral. “Importantly, Thompson does not attempt to make any revenue adjustments to account for the shortcomings of the NPA/NXX subscriber tracking system.”

The court’s weighted average approach. Neither party established reliable cash flows. The court was left with the NPA/NXX subscriber system as the key revenue driver for the DCF model. The court created a blended share price. First, it gave Thompson’s financial forecast a 70% weight. The remaining 30% will incorporate Musey’s Scenario 2 wireless service revenue for 2019. The calculated weighted revenue was used as the starting year, and Thompson’s growth rates were used to complete the forecasts.

The discount rate. Thompson used Jackson’s cost of equity (CAPM model) as the discount rate. Musey used Verizon’s WACC rate as a discount rate. The court noted that the WACC was generally used to determine a discount rate because it takes into account the full invested capital of the firm. Thompson only included the cost of equity for Jackson and not the WACC. The court noted that the only debt that Jackson had access to was the DTA. “The proper approach to discounting the cash flows in the DCF was to use the cost of equity and account for the payoff of the DTA as performed in the Thompson Opening Report.” Thompson values Jackson as a stand-alone entity and not part of its parent.

The petitioner argued Thompson did not value Jackson as a going concern as of the date of valuation. The court disagreed and explained Thompson’s reasoning and methodology that he valued Jackson as a going concern.

Musey eschewed the CAPM model and assumed that Jackson’s rate was the same as Verizon’s.

The court’s blended approach. The court believed that both Thompson’s and Musey’s rates should be considered. “Jackson’s cost of capital must take into consideration the reality that Jackson benefits from its relationship with Verizon.” (Editor’s note: Doesn’t this violate the hypothetical buyer/seller rule? The court had noted that judicial FV was not the same as in the marketplace so perhaps that was the reasoning here.) The court here went into a discussion of the specifics of the CAPM elements in determining the discount rate. Doing so, the court adopted a WACC of 7.847%.

The terminal value. “The terminal value is the present value of all the company’s future cash flows beginning after the projection period.” (Editor’s note: This does not appear to be a correct definition, but the court appeared to have calculated the terminal value correctly nevertheless.) A perpetual growth rate was determined by the court to be appropriate. The court noted that determining such a rate was speculative and that it was essential to select the correct growth rate.

The growth rate. Thompson used “unconvincingly” generic growth rates to estimate the perpetuity growth rate. His rate effectively assumed no inflation growth and only a small amount of real growth. “Thompson’s approach is unconvincing because of its reliance on generic growth rates and its unreasoned decrease of the nominal United States growth rate by half.” He did not look at industry growth rates. Musey does look at industry growth. He used consensus rates including from SNL, Kagan, and a prior Chancery court case. His analysis was more convincing than Thompson’s. Thompson said that he checked Musey’s rates from the databases and they were not correct, so he corrected them. Musey did not address this at trial. Thompson also pointed out an outlier of 7% for one of Musey’s selected rates, which would provide a negative capitalization rate.

The court accepted Musey’s growth rate, after taking out the 7% rate and after other adjustments Thompson made. That rate was 2.2%.

Gordon growth versus value driver. The court selected the value driver model (VDM) Thompson proposed over the Gordon growth model (GGM) Musey used. The VDM linked the long-term growth rate and the net investment during the terminal period. The court here explained the VDM concept and why it believed it was a better determinate of the growth rate than the GGM.

The court’s selected terminal value calculation. The Chancery Court had accepted both the GGM and the VDM. “In this case, Thompson’s presentation of the MVD is more persuasive.… Using this model, Jackson’s terminal value is $161,900,000. In present value terms that is $80,498,000.” Using the second iteration, where Musey’s revenues were used, results in terminal values of $259,245,000. In present value terms, that was $128,898,000.
Using Thompson’s projections, this resulted in a per-share value of $9,679.29. Using Musey’s revenue projections results in a per-share value of $15,630.23. The average of these two was $11,464.57.

Conclusion.

The court concluded that the fair value of Jackson stock on the valuation date was $11,464.57. Ramcell sought appraisal of 155.4309 shares and was awarded $1,781,948.74.