Opinion ID: 2052857
Heading Depth: 1
Heading Rank: 3

Heading: Merger Discussions and Negotiations

Text: Until his death on June 6, 1976, J. Paul Getty, the majority shareholder of Getty, had continually opposed the merger of Getty and Skelly. His reasons were varied, but they apparently centered on his notion that a healthy competition existed between the two companies which enhanced their profitability to a greater extent than the synergy to be anticipated from a merger. However, there were others with differing views. At the May 1976 annual meeting of Mission an attorney representing Joseph Gruss, a Skelly minority shareholder, argued for a merger of Mission into Getty, and threatened suit on his client's behalf. In late June or early July 1976, after Mr. Getty's death, Harold E. Berg, then Getty's executive vice president and chief operating officer, met with C. Lansing Hays, Jr., a Getty director and counsel to Getty, and Moses Lasky, another Getty lawyer, to explore the anti-trust implications of a merger. [5] They noted that since a Getty-Mission merger also would require a valuation of Mission's 72.6% interest in Skelly, a merger of all three companies would be more efficient. At trial Berg testified that one of the reasons for the proposed merger was to minimize stockholder dissension by meeting the demands of persons like Joseph Gruss. On July 12, 1976, Berg called James E. Hara, president of Skelly, to inform him that a combination of Getty, Skelly, and Mission was being considered. Berg suggested a conference of high-level Getty and Skelly personnel. This meeting was held in Dallas, Texas, on July 15, 1976, attended by the principal officers of both companies. All acknowledged the desirability of a merger. The consensus was that the fairest way to achieve this result would be an exchange of common stock, continuing shareholder participation in a larger postmerger company. Thereafter, a memorandum was distributed summarizing the pertinent legal considerations affecting the proposal. Generally, it was agreed at the July 15 meeting that DeGolyer and MacNaughton (D & M), a Dallas, Texas, petroleum engineering firm with an outstanding reputation, would assist the parties in evaluating their respective oil, gas and mineral reserves. D & M had worked periodically with both Skelly and Getty since 1939, and had prepared annual estimates of oil and gas reserves for both companies for many years. In addition, D & M had begun preparing annual reports on Getty's mineral properties for the last several years prior to the merger. Accordingly, D & M was contacted on July 15, 1976 by Getty and Skelly and asked to estimate the reserves of both companies, to make an economic valuation based on those estimates, and then to deliver this analysis to the companies for their use in negotiating the merger exchange ratio. After the July 15 Dallas meeting, Getty and Skelly promptly began evaluating their respective surface and subsurface assets. It is clear that both parties devoted substantial internal resources in preparing to negotiate the exchange ratio of Getty and Skelly stock. In addition, both companies hired reputable investment banking firms to assist in the valuation task, and to render opinions on the fairness of the merger's ultimate terms. Getty retained Blyth, Eastman, Dillon & Co. (Blyth Eastman), and Skelly chose Smith Barney, Harris Upham & Co. (Smith Barney). Significantly, Skelly and Getty approached the merger with entirely different objectives which remained constant throughout the negotiations. Already, Getty had been threatened with suit by Gruss, a Skelly minority shareholder, and had every expectation that the transaction would lead to litigation. Thus, it carefully sought to comply with applicable Delaware law in meeting the test of complete fairness. It was for this reason that in negotiating the exchange ratio Getty recommended use of the Delaware Block method to value the companies' stock. [6] Skelly's object on behalf of its minority shareholders was one of direct economic interest  to obtain the best possible price for its stock by a highly favorable exchange ratio of Skelly to Getty shares. In utilizing the Delaware Block method, Skelly attempted to maximize the weight given to surface assets, while minimizing the importance of subsurface properties, i.e., oil, gas, and mineral reserves. This tactic was born of Getty's far more significant estimated reserves. Skelly also emphasized current earnings, because of its 1976 record profits. Finally, because the market price of Getty's stock was much higher, Skelly tried to reduce the weight given this element of value. As to their surface properties, each company began compiling an asset book cataloging an item by item value of all their respective above-ground holdings, such as refineries, manufacturing plants, pipelines, transport facilities, etc. Along with the dollar amount accorded each item, there also was a description of the valuation method or methods used to calculate that figure. The asset books, once completed, were to be exchanged. The two companies would then negotiate surface property values for inclusion in their asset factors under the Delaware Block formula. As to their respective subsurface holdings, D & M was to update the reserve estimates of Getty and Skelly with the assistance of each company's personnel. D & M was then to make an economic projection, based on these estimates, for use by the parties in negotiating an exchange ratio. On September 29, 1976, Getty and Skelly exchanged asset books. Getty immediately discovered that for every item of property listed, Skelly had selected the particular valuation method, irrespective of consistency, which produced the highest asset value. There is testimony that this adversarial approach angered Getty personnel. In contrast, Getty had applied a more consistent, conservative technique of valuing its surface assets. It claims to have done so because of the threat of post-merger litigation. Despite this disparity in approach, Getty and Skelly maintained contact and sought to resolve their differences through hard bargaining. Eventually, they reached accord. However, while the surface asset books were compiled, exchanged, and their contents negotiated, the companies had numerous meetings with D & M regarding the valuation of their reserves. D & M had begun a field-by-field, lease-by-lease analysis of the oil, gas, and mineral reserves of the parties, working with the Getty or Skelly personnel most familiar with the specific field under study. D & M also examined proprietary information each company maintained regarding its own reserve estimates. D & M then took this information and began preparing an economic analysis for use by the companies in their negotiations. This study required the selection and use of certain projections, including future prices, interest and discount rates, and future expenses, such as taxes and operating costs. Invariably, disputes arose between the two sides as to the values used by D & M, particularly regarding future prices of petroleum products. Therefore, at the suggestion of the parties D & M made an alternative analysis using (1) different pricing projections provided by Getty, Skelly, and their respective investment bankers and (2) a D & M alternative pricing scheme based on anticipated Federal Energy Administration reduction of price differentials for different grades of oil. This economic analysis of the Getty and Skelly subsurface assets was completed by D & M around October 25, 1976. However, Getty and Skelly continued to disagree on the variables applied by D & M, particularly its projection of future prices in valuing the reserves. It therefore became evident to the chief negotiators on each side that they would be unable to agree upon such variables, even though both parties concurred in D & M's reserve estimates. This pessimism was reinforced by the difficulties encountered in the earlier, but by then completed, surface asset negotiations. On October 25th and 26th, Getty, Skelly, their investment bankers, and D & M met to finalize the previously negotiated surface asset values, and to discuss subsurface asset problems. With the issues of the surface asset values then behind them, the parties focused on disputes regarding the dollar value of their respective reserves. At issue were the imponderables to be used by D & M in appraising the reserves, and it soon became apparent that the parties were at an impasse. Thus, on October 27, 1976, Berg of Getty proposed that each side delegate to D & M the task of calculating the present fair market value of their respective reserves, given the obstacles presented by the projections and variables. Skelly concurred, and D & M accepted the task with the understanding that its methods would not be revealed to the parties. In addition, Getty, Skelly, and Mission agreed that D & M's valuation would be final and binding upon them. With this accord, D & M rendered its estimates on October 29, 1976. On the morning of November 1, 1976, the parties and their investment bankers then met to determine a stock exchange ratio for the merger based upon valuations utilizing the Delaware Block method. In particular, the parties sought to negotiate per share values for the asset, earnings, and market price factors, as well as the percentage weight to be assigned each element. Getty anticipated an exchange ratio of between .46 to .55 shares of its common stock for one share of Skelly common. Morgan, Skelly's spokesman, stressed the importance of earnings over assets and emphasized the market's undervaluation of Skelly stock. He therefore proposed .7 as the right figure. There was testimony that this suggestion angered the Getty representatives, who viewed it as absurdly high. Kenneth Hill of Getty countered with a possible exchange ratio of .5. Thereafter, the parties discussed the elements of assets, earnings, and market price, including their subratios, and how they should be weighted under the Delaware Block method. While each side criticized the other, the negotiations slowly progressed. By the afternoon of November 1, Getty was offering a ratio of .57 and Skelly was proposing .61. However, at this point the parties reached an impasse. Berg of Getty suggested terminating the discussion. Hays, a Getty director and its counsel, drafted a press release announcing the end of merger negotiations. As the meeting broke up, Hara of Skelly strongly urged Berg to continue the discussions. He persuaded Berg to consult with the Getty board of directors at its next meeting on November 5, 1976. Berg did so, and at their meeting, Getty's directors concluded that .58 was the highest acceptable exchange ratio. Berg relayed this to Hara by telephone on the afternoon of November 5. Hara then suggested another meeting between Getty and Skelly on November 7 at the annual session of the American Petroleum Institute, a function which certain Getty and Skelly personnel would have attended anyway. Berg agreed. At the November 7 meeting, Berg reiterated Getty's firm position that .58 was the highest acceptable exchange ratio. After discussion, the Skelly representatives left the room and met privately. At this point, a Skelly team member suggested that their company's earnings be adjusted to reflect a weighted average of only the last three years, rather than the past five years. It was noted that two of the last three years saw Skelly's highest historical earnings, and that Getty itself had used such a method in a prior transaction. Skelly presented this adjustment with a correlative new exchange ratio of .5875 to Getty. After a private caucus Getty agreed to the earnings revision and offered a ratio of .5875 Getty shares for one share of Skelly stock. Skelly accepted. Thus, as finally negotiated, the parties agreed to the following valuation: Ratio of value Weighted Ratio of Skelly Share Percentage of Skelly Share to Getty Share Weighting to Getty Share Assets .525 47.5% .2494 Earnings .667 47.5% .3168 Market Price .427 5.0% .0213 ______ Exchange Ratio .5875 On November 13, 1976, the Skelly and Getty boards met to consider the merger. After a thorough review of the whole matter, Skelly's independent directors, and then its entire board, approved the agreement for submission to Skelly's shareholders. Similarly, Getty's board voted unanimously for the merger. On January 25, 1977, the shareholders of both companies assented to the transaction. Of Skelly's minority shares voted at the meeting, 89.4% favored the merger. In terms of all outstanding Skelly minority shares, this represented a vote of 58% in favor of the proposal. Skelly and Mission were merged into Getty on January 31, 1977. On February 18, 1977, this class action was brought against Getty, challenging the fairness of the .5875 exchange ratio. After six and one-half years of discovery and twenty-three days of trial, the Chancellor held that the merger, and in particular the exchange ratio, were entirely fair to the Skelly minority.