Thursday, June 2, 2016

prices and appraisals

I'm fond of commenting that assets don't have prices; transactions have prices, and offers to transact have prices, but the best one can hope for in assigning a "price" to an asset is to expect that one can reasonably predict approximately what it will trade for, or would trade for, under some almost true counterfactual.[1]

A judge in Delaware has declared that Dell shareholders whose shares were taken in a leveraged buyout a few years ago were underpaid, and it would be in the spirit of Levine's commentary, though he doesn't quite do so himself, to note that their voting against the buyout at $13.75 per share is prima facie evidence that they valued the shares at a price above that, though possibly for strategic rather than fundamental reasons.[2]  The judge apparently argued that the $13.75 was based on a correct determination of long-run prospects, but that the bidder's cost of equity is higher than the sellers', and he thus calculated a "value" for the shares based on the bidder's assessment of future value and an imputed cost of equity for the sellers.

Let's repeat again that nobody was bidding a higher price than $13.75.  The value of the shares to an individual will depend on that individual's risk-preferences, cost of equity (related to risk-preferences), and assessment of the prospects for the shares;[3] insofar as an effective market mechanism gets the shares to their highest-valued owner, the market price would be the highest value that any owner, given those criteria, places on the shares.  As Levine notes,
This buyout didn't create value by changing Dell's business model; it created value by changing Dell's ownership -- by moving the shares from people who mostly didn't value them that highly (public markets) to people who did (private-equity buyers).
Some potential buyers may have a lower cost of equity (and thus would put a higher value on it), but a lower assessment of the prospects, or a lower ability to handle some idiosyncratic risks associated with them; others might have higher assessments or better risk-profiles to take on the risks but a higher cost of equity.  The judge seems to have hypothesized a non-existent bidder with the combined attributes that would maximize the value, without regard for the fact that the bidder is, in fact, non-existent.

I'm not sure that some kind of judicial overruling of a take-over price is never warranted, but it seems to me that procedural protections are on much firmer philosophical ground; the fact that there were a couple of apparently independent bids, and that the winning bidder here seems to have been assiduously fair in the process of securing the votes of the majority of shareholders, should in this case have been dispositive.  Especially insofar as the buyer's control affects its prospects,[4] "you have to pay what someone who doesn't exist would pay to buy a company you control" just doesn't make any sense.

[1] In particular, there's a legal dictum that "a fair price is what a willing buyer would pay a willing seller", which is sensible insofar as it has content, but that's not very insofar; the dictum is typically applied where there isn't both a willing buyer and a willing seller, at least not at the same price, and the price at which a hypothetical willing buyer and willing seller would trade depends entirely on why they are willing to buy and sell. The dictum might, therefore, be occasionally useful in framing analysis, but it never really contributes very much toward determining what a "fair price" ought to be.

[2] This is the classic hold-up problem, which eminent domain and buy-out procedures are supposed to mitigate; it's worth noting, perhaps here, that this judicial appraisal procedure itself is among the counter-protections in the buy-out process.

[3] It perhaps gets too confusing to note here that the "prospects for the shares" in fact consisted of their being bought by Dell at a price that would be overruled three years later by a Delaware judge.

[4] Though this appears in at least some sense not to have been a big part of this deal, the arguments about short-termism and R&D belie that at least somewhat.

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