In 2017, British American Tobacco (BAT) purchased a North Carolina-based tobacco company, Reynolds American Inc., for $49 billion. The deal allowed BAT to acquire the 57.8% of Reynolds it didn’t already own and brought many prominent cigarette brands under the same corporate roof. BAT remains one of the largest tobacco companies in the world.
While Reynolds shareholders strongly supported the transaction, including 99% of voted shares not already owned by BAT, a group of dissenting shareholders sought a judicial appraisal of the fair value of their shares. In appraisal settings, North Carolina follows the Delaware standard that “both sides have the burden of proving their respective valuation positions.” See Brigade Leveraged Cap. Structures Fund Ltd. v. Stillwater Mining Co., 240 A.3d 3, 17 (Del. 2020).
Following a trial, and post-trial briefing and argument, the Business Court concluded (2020 NCBC 35) in an exhaustive 189-page ruling that the “fair value” of Reynolds stock did not exceed the “deal price” that had resulted from negotiations between BAT and non-BAT-affiliated Reynolds board members. We wrote about pretrial disputes regarding whether the dissenters had appropriately “perfected” their claims here.
On appeal, the North Carolina Supreme Court affirmed that valuation determination, Reynolds Am. Inc. v. Third Motion Equities Master Fund Ltd, 2021-NCSC-162 (Dec. 17, 2021). This was the Court’s first consideration of a Business Court “fair value” determination.
The dissenting shareholders argued on appeal that Judge Bledsoe gave excessive deference to the negotiated “deal price,” even though this was an insider transaction not checked by the market. That improper deference, they argued, ran afoul of the Business Court’s obligation (N.C.G.S. § 55-13-01(5)) to use:
“customary and current valuation concepts and techniques generally employed for similar business in the context of the transaction requiring appraisal[.]”
Because the General Assembly had not “prescribe[d] any specific methodology the court must utilize in an appraisal proceeding,” the Supreme Court employed an “abuse of discretion” review standard where:
“it is left to the Business Court in the first instance to determine which valuation concepts and techniques should be utilized to ascertain the fair value of a dissenting shareholder’s shares and the weight to accord the results of any particular concept or technique it selects.”
2021-NCSC-162, ¶ 8.
Writing for a unanimous Court, Justice Earls found that “a careful reading of the Business Court’s comprehensive judgment” showed that it employed numerous valuation inputs that included Reynolds’ “competitive positioning and relationship with BAT,” industry regulatory dynamics, share price analyses and “valuations produced during the transaction process.” Id. ¶¶ 13-14. The opinion rejected the contention that the Business Court had found “fair value” based on the “deal price,” but instead held it had “utilized a range of acceptable valuation concepts and techniques to arrive at the conclusion that the deal price reflected fair value.” Id. ¶ 14.
Discounted Cash Flow Analysis (DCF)
The parties differed sharply over reliance on a DCF analysis, advanced by the dissenters, that determined a share value for Reynolds based on projections about how the company would perform over time. The Supreme Court, again in step with Delaware law, affirmed the Business Court’s discretion to reject the dissenters’ DCF where it found inputs to the analysis unreliable. See Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd, 177 A.3d 1, 37 (Del. 2017). The core dispute was between the growth rate and time spans that the analyses of the dissenters’ expert and those of financial advisors relied upon. The dissenters’ DCF focused on ten-year growth protections while the deal advisors’ projections considered “a long-term view of the prospects of the Company and the industry rather than the specifics of a few nearer-term years.” 2021-NCSC-162, ¶ 25. The windows of analysis are critical for tobacco industry shares given the clashing goals of health advocates and manufacturers, and the still unfolding narrative of tobacco use in potential growth markets across the globe.
The Supreme Court agreed that a DCF is an appropriate concept for the Business Court to use under N.C.G.S. § 55-13-01(5) but declined to say North Carolina law mandates it be employed “in every case.” Id. ¶ 22. The Business Court rejected the dissenters’ DCF as “an extreme outlier” when compared “with all other evidence of value” considered by the court. Id. ¶ 23. The proffered DCF advanced a $92.17 share value that the Business Court noted “implies a $50 billion mispricing of RAI’s shares” under the deal price. Id.
The Supreme Court also considered that the efficacy of a market price-based analysis is enhanced when the market has digested and assessed public information about the company such that it is “impounded into the Company’s stock price.” Id. ¶ 33. Reynolds did not introduce expert testimony on market efficiency, and in its absence the dissenters argued the Business Court could not make such a finding. The Supreme Court concluded that expert testimony is not required “if the party has presented sufficient evidence regarding the relevant factors to allow the trial court to make its own efficiency determination.” Id. ¶ 40.
The dissenters argued for inclusion of a “control premium” in the share price where their stock would afford BAT control of Reynolds. Justice Earls’ opinion notes the trial court “concluded that the price of publicly traded corporations categorically does not reflect an implicit minority discount.” Id. ¶ 56. Noting “the unsettled nature of the law and scholarship” on the issue, the Supreme Court declined to adopt such a “blanket rule.” Instead, the Court held that trial courts should decide on a case-by-case basis, dependent on the valuation methods employed, whether a minority discount is present and if it should result in a control premium. Id. ¶¶ 57-58.
- The Supreme Court’s inclination to afford the Business Court flexibility in conducting a judicial appraisal, and applying analytical factors as it deems appropriate, is underscored by Justice Earls’ observation that, “The fair value of a corporation cannot be determined by mathematical proof.” Id. ¶ 71.
Brad Risinger is a partner in the Raleigh office of Fox Rothschild LLP.