Global GT LP v. Golden Telecom, Inc., C.A. No. 3698-VCS (Del. Ch. Apr. 23, 2010), read opinion here.

This 51-page post-trial opinion in an appraisal action is heavily weighted with economic analysis and includes such geopolitical insights as the projected growth of the Russian economy. The copious footnote activity would be delightful reading for an economist or a financial analyst.

Background

The petitioners in this case owned over one million shares of Golden Telecom, Inc., a Russian-based telecommunications company that was listed on the NASDAQ. The petitioners claim that Golden was undervalued in the 2007 merger in which Golden was purchased for $105 per share by a related company called Vimpel Communications (“VimpelCom”), a major Russian provider of mobile telephone services whose two largest stockholders were also the largest stockholders of Golden.

The issue in this appraisal case, as is common, was which expert testimony the Court would give greater weight to, or if the Court would reject or modify both valuation experts presented by each party. Although the Court found both experts to be qualified in the valuation of a public company, the Court determined that “neither had a deep knowledge of the Russian telecommunications market or of Golden itself.” The expert for Golden valued the company at only $88 per share and the petitioner came up with a value of $139 per share.

The Court used the DCF methodology which is the method that both experts viewed as the most reliable, but the Court rejected the argument by Golden that weight should be given to the merger price itself on the theory that the merger reflected a market-tested price. That argument was rejected for the following reasons: (1) The Special Committee that negotiated the merger never engaged in any active market check, either before or after signing the Merger Agreement; as well as (2) The passive market check that is supposed to instill confidence required market participants to assume that Golden’s two largest stockholders would both sell their Golden stake to another bidder, despite the fact that they had an economic interest in VimpelCom that was far more substantial that their stake in Golden – – “an unlikely prospect made even more doubtful by a public announcement by one of the stockholders that it did not intend to sell its 26% stake in Golden in another transaction.” Thus there was no open market check that provided a reliable insight into the value of Golden.

The Court then reviewed the differences between the DCF valuations of each expert, which involved primarily the terminal growth rate of Golden and the appropriate equity risk premium and beta used in calculating a discount rate. The Court then used the DCF model to determine a share value of $125.49 per share which was supplemented with an award of interest at the applicable statutory rate.

Overview of Court’s Analysis

The extensive factual aspect of the Court’s analysis is beyond the temporal or space limitations of this short blurb, nor will the 163 meaty footnotes in the opinion be covered in a material manner in this cursory overview.

Section 262(e) of Title 8 of the Delaware Code provides that the Court in an appraisal action must “determine the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation, together with interest, if any, to be paid upon the amount determined to be the fair value. The entity must be valued as a going concern based on its business plan at the time of the merger, and any synergies or other value expected from the merger giving rise to the appraisal proceeding itself must be disregarded.” See footnotes 61 to 63.

The Court rejected the ”novel argument” that the fact that only a single investor has brought an appraisal claim demonstrates the fairness of the merger price. Neither the appraisal statute itself or common knowledge would support the analysis of a deal based on the size of the appraisal class. For example, investors may forego appraisal claims because they are expensive to pursue and petitioners get none of their merger consideration during the pendency of the case. Also, the Court acknowledged that some institutional investors may be happy to take a modest gain generated by a merger for purposes of quarterly reporting even if they think that the stock is worth more.

Each of the experts gave little weight to the comparable companies and transactions analyses in their report. Similarly, the Court did not find either expert to be convincing in terms of their knowledge of the telecommunications industry or the Russian economy and therefore the Court relied on the Discounted Cash Flow method (DCF) as the basis for its award. See footnote 80.
The major area of disagreement between the experts about the cash flows of Golden was the terminal growth value to be used in applying the Growth Model Version of the DCF which was employed by both experts. The smaller argument about the cash flows was the tax rate to be applied to them.

After resolving those arguments, the Court then addressed the two critical differences the experts had that are relevant to determining the rate at which Golden’s expected future cash flows are to be discounted back to the present value. Both experts purported to apply the Capital Asset Pricing Model (“CAPM”).

Terminal Growth Rate

In a DCF analysis, future cash flows are projected for each year during the set period, typically five years. After that time, a terminal value is calculated to predict the company’s cash flow into perpetuity. Generally, once an industry has matured, a company will grow at a rate that is roughly equal to the rate of nominal GDP growth. See footnote 84. This required the experts to predict the growth rate of the Russian economy through the year 2017 and beyond, as well as the inflation rate of the Russian economy. One of the experts noted that the risk of revolutionary change in Russia could also put Golden out of business. The Court gave credence to the use of the average of the Russian GDP inflation rate, and adopted a 5% Terminal Growth Rate.

Equity Risk Premium

In order to figure out the cost of capital by which to discount Golden’s future cash flows, both experts had to determine the cost of equity. One of the two major sources of disagreement between the experts was over what equity risk premium (ERP) to use. One expert selected the ERP from the 2008 Ibbotson SBBI Valuation Yearbook and the other expert selected the ERP based on his teaching experience and the relevant literature, as well as the supply side ERP reported in the 2007 Ibbotson Yearbook.

The Court referred to valuation icon Shannon Pratt regarding his recommendation that “ERP as of the beginning of 2007 should be in the range of 3.5% to 6%.” See footnotes 115 and 116. The Court was more convinced by the expert for the petitioners who argued that the use of historic ERP was not justifiable.

Beta

The experts for each side also sparred over what beta to use in the calculation of Golden’s cost of equity capital. The Court observed that: “This battle of the experts is one that I am poorly positioned to resolve, and it appears unlikely that a finance professor would fare any better.” Even after asking the parties to submit supplemental literature on the topic, and after doing its own independent review, the Court admitted that it found “no literature that sheds reliable light on this question of whether to use a historical or the supposedly forward-thinking Barra beta, which is a so called predictive beta from a financial consultancy called MSCI Barra.

The Court also noted that the use of the Barra beta was inconsistent with the DCF valuation submitted by one of the experts in this case, to the Court in Doft & Co. v. Travelocity.com, Inc., 2004 WL 1152338 (Del. Ch. 2004).

Although the Court emphasized that it was not rejecting the Barra beta for use in later cases, the author of this opinion declined to adopt the Barra beta for purposes of the current appraisal. Moreover, the Court rejected the argument of the expert for petitioners to use the Barra beta, the Court was persuaded that the simple use of the historical beta is not the best method to use in calculating Golden’s cost of equity. The Court remarked that: “Although beta is a somewhat metaphysical concept, the literature does tend to suggest that, as a matter of theory anyway, companies that are more unstable in leverage, less established and financially and competitively secure, and in colloquial terms “riskier,” should have higher betas.” See footnote 151.

The Court found that a beta that gives a 2/3 weight to the Bloomberg historic raw beta of 1.32 and 1/3 weight to the 1.24 industry beta is the best approach to this DCF analysis. The Court thus applied a beta of 1.29 to the DCF analysis for a cost of equity of 12.3%.

Conclusion

The Court concluded that it would adopt a terminal growth rate of 5%, a tax rate of 31.6%, an equity risk premium of 6%, and a beta of 1.29. After applying those inputs to the DCF model, the Court came up with a value of $125.49 per share, plus interest from the Valuation Date to the date of payment at the rate provided by statute, compounded quarterly.