Court Opinion

ID: 4172178
Source: CourtListenerOpinion
Date Created: 2017-05-26 17:08:30.270235+00
Date Added: 2024-06-11T14:39:24.085087
License: Public Domain

EFiled: May 26 2017 11:52AM EDT
                                                    Transaction ID 60650885
                                                    Case No. 10782-VCS

   IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE

                                  :
IN RE APPRAISAL OF PETSMART, INC. :              CONSOLIDATED
                                  :              C.A. No. 10782-VCS

                         MEMORANDUM OPINION

                       Date Submitted: February 27, 2017
                         Date Decided: May 26, 2017

Stuart M. Grant, Esquire, Nathan A. Cook, Esquire, Kimberly A. Evans, Esquire,
and Joseph L. Christensen, Esquire of Grant & Eisenhofer P.A., Wilmington,
Delaware, Attorneys for Petitioners.

Gregory P. Williams, Esquire, Brock E. Czeschin, Esquire, John D. Hendershot,
Esquire, Robert L. Burns, Esquire, Sarah A. Clark, Esquire, and Matthew D. Perri,
Esquire of Richards, Layton & Finger, P.A., Wilmington, Delaware, and
Theodore N. Mirvis, Esquire, Rachelle Silverberg, Esquire, Adam M. Gogolak,
Esquire, Adam D. Gold, Esquire, and Joshua J. Card, Esquire of Wachtell, Lipton,
Rosen & Katz, New York, New York, Attorneys for Respondent PetSmart, Inc.

SLIGHTS, Vice Chancellor
       I would not be the first to observe that the trial of an appraisal case under the

Delaware General Corporation Law presents unique challenges to the judicial

factfinder.1 The petitioner bears a burden of proving the “fair value” of his shares;

the respondent bears a burden of proving the “fair value” of the petitioner’s shares;

and then the judge, as factfinder, assumes, in effect, a third burden to assign a

particular value “as the most reasonable [] in light of all of the relevant evidence and

based on considerations of fairness.”2 The role assigned to the trial judge in this

process independently to review “all relevant factors” that may inform the

determination of fair value, if not unique, is certainly unusual.3 It is unusual in the

sense that the judge is not bound by the positions on fair value espoused by either of

1
 See In re Appraisal of Ancestry.com, Inc., 2015 WL 399726, at *2 (Del. Ch. Jan. 30,
2015); Albert H. Choi & Eric L. Talley, Appraising the “Merger Price” Appraisal Rule
(Virginia Law and Economics, Working Paper No. 2017-01, Jan. 18, 2017).
2
  Cede & Co. v. Technicolor, Inc., 2003 WL 23700218, at *2 (Del. Ch. July 9, 2004), aff’d
in part, rev’d on other grounds, 884 A.2d 26 (Del. 2005).
3
  8 Del. C. § 262(h). See Ancestry.com, 2015 WL 399726, at *1 (noting that the burdens
of proof imposed by Section 262 makes the job of the judge “particularly difficult” and
that the litigation structure imposed by the statute is “unusual”); Choi & Eric Talley, supra,
at 2 (noting that the appraisal statute presents a “particularly vexing challenge” for the trial
judge, inter alia, because it “allocates no explicit burden of proof and requires the court to
deliver a single number at the end of the process”) (emphasis in original).

                                               1
the parties. Indeed, the trial court commits error if it simply chooses one party’s

position over the other without first assessing the relevant factors on its own.4

         Yet it cannot be overlooked that the judge’s decision in an appraisal case

follows a trial––an honest-to-goodness, adversarial trial––where the parties are

incented to present their best case, grounded in competent evidence, and to subject

their adversary’s evidence to the discerning filter of cross-examination. The trial

court then reviews the evidence the parties have placed in the trial record and does

its best to “distill the truth.”5 In this regard, at least, the appraisal trial is no different

from any other trial. The court’s determination of “fair value,” while based on “all

relevant factors,” must still be tethered to the evidence presented at trial. The

appraisal statute is not a license for judicial freestyling beyond the trial record.

         This appraisal action follows a going-private merger in which the public

stockholders of PetSmart, Inc. (“PetSmart,” the “Company” or the “Respondent”)

received $83 per share in cash from a private equity acquiror, BC Partners, Inc. (the

“Merger”). The Merger closed on March 11, 2015. Petitioners declined the Merger

consideration and demanded appraisal.

4
    See Gonsalves v. Straight Arrow Publ’rs, Inc., 701 A.2d 357, 362 (Del. 1997) (holding
that the trial court’s decision to adopt one of the parties’ valuations of the company “hook-
line-and-sinker” without considering all relevant factors was “fatally flawed”).
5
 See Finkelstein v. Liberty Digital, Inc., 2005 WL 1074364, at *24 n.56 (Del. Ch. Apr. 25,
2005).

                                              2
      The battle lines staked here rest on positions that are well-known to Delaware

courts, the academy and those who otherwise follow the evolving state of Delaware

appraisal litigation. The Respondent would have me determine fair value by

deferring to the price paid by a third-party purchaser in an arm’s-length transaction

after an allegedly robust pre-signing auction process. The Petitioners insist that

“deal price” is unreliable in this case for a variety of reasons and urge me to

determine fair value by employing a tried and true valuation methodology,

discounted cash flow (“DCF”). The experts engaged by the parties, both well

credentialed, sponsor these differing views with unwavering commitment. Indeed,

the parties are so certain of their respective positions on the fair value of PetSmart

at the time of the Merger that they insist I disregard the other’s proffered

methodology entirely. The result: Respondent values PetSmart at $83 per share;

Petitioners value the same firm at $128.78 per share.

      In this post-trial opinion, I conclude that the evidence presented during trial

points in only one direction––Petitioners have failed to carry their burden of

persuasion that a DCF analysis provides a reliable measure of fair value in this case.

The management projections upon which Petitioners rely as the bedrock for their

DCF analysis are, at best, fanciful and I find no basis in the evidence to conclude

that a DCF analysis based on other projections of expected cash flows would yield

a result more reliable than the Merger consideration. Nor is there a foundation in

                                          3
the evidence for concluding that some other valuation methodology might lead to a

reliable determination of fair value. On the other hand, I am satisfied Respondent

has carried its burden of demonstrating that the process leading to the Merger was

reasonably designed and properly implemented to attain the fair value of the

Company. Moreover, the evidence does not reveal any confounding factors that

would have caused the massive market failure, to the tune of $4.5 billion (a 45%

discrepancy), that Petitioners allege occurred here. Based on my review of all

relevant factors, as found in the evidence, I am satisfied that the deal price of $83

per share, “forged in the crucible of objective market reality,”6 is the best indicator

of the fair value of PetSmart as of the closing of the Merger.7

                                 I.   BACKGROUND

         I recite the facts as I find them by a preponderance of the evidence after a

four-day trial beginning in October 2016. That evidence consisted of testimony from

seventeen witnesses (thirteen fact witnesses, some presented live and some by

deposition, and four live expert witnesses) along with over 2300 exhibits. To the

6
    Van de Walle v. Unimation, Inc., 1991 WL 29303, at *17 (Del. Ch. Mar. 7, 1991).
7
  To preserve its record, Respondent has asked me to decline to follow the now-settled
precedent of this Court that establishes the right of a petitioner to seek appraisal of shares
acquired after the record date by demonstrating that the number of shares held by the record
holder and not voted in favor of the merger exceeds the number of shares upon which
appraisal is sought. See In re Transkaryotic Ther., Inc., 2007 WL 1378345 (Del. Ch.
May 2, 2007). The issue is preserved but I decline to revisit this precedent.

                                              4
extent I have relied upon evidence to which an objection was raised but not resolved

at trial, I will explain the bases for my decision to admit the evidence at the time I

first discuss it.

      A. Parties and Relevant Non-Parties

           Respondent, PetSmart, Inc., is a Delaware corporation with headquarters in

Phoenix, Arizona.8 It is one of the largest retailers of pet products and services in

North America.9 Prior to the Merger, PetSmart’s stock traded on NASDAQ.10 On

March 11, 2015, PetSmart was acquired by a consortium of funds advised by BC

Partners, Inc. and certain other investment firms for $83.00 cash per share

(the “Merger Price”) in a merger.11 In connection with this transaction, PetSmart

merged into Argos Merger Sub Inc., with PetSmart surviving as a wholly owned

subsidiary of Argos Holdings Inc.12

           Petitioners are CF Skylos I LLC, CF Skylos II LLC, Third Point Reinsurance

(USA) Ltd., Third Point Reinsurance Company Ltd., Third Point Partners Qualified

L.P., Third Point Offshore Master Fund L.P., Third Point Partners L.P., Third Point

8
    Stipulated Joint Pre-Trial Order ¶ 77 (“PTO”).
9
    PTO ¶¶ 78, 116; JX 1336 at 23.
10
     PTO ¶ 79.
11
     PTO ¶ 1.
12
     Id.

                                              5
Ultra Master Fund L.P., Farallon Capital Partners, L.P., Farallon Capital AA

Investors, L.P., Farallon Capital (AM) Investors, L.P., Farallon Capital Institutional

Partners, L.P., Farallon Capital Institutional Partners II, L.P., Farallon Capital

Institutional Partners III, L.P., Farallon Capital Offshore Investors II, L.P., Noonday

Offshore, Inc., Muirfield Value Partners LP, HCN L.P., CAZ Halcyon Strategic

Opportunities Fund L.P., Halcyon Mount Bonnell Fund L.P., Merlin Partners, LP,

and AAMAF, LP (collectively, “Petitioners”).13 Petitioners were stockholders of

PetSmart as of the Merger date and collectively held 10,713,225 shares of PetSmart

common stock.14

      B. The Company

         Founded in 1987, PetSmart is a pet specialty retailer.15 Its business consists

of providing pet products, including consumables and hardgoods,16 as well as pet

services such as pet grooming and boarding.17 At the time of the Merger, PetSmart

operated 1,404 stores in the United States, Canada, and Puerto Rico and had annual

13
     PTO ¶¶ 15–16, 19, 24–30, 36–44, 51, 55, 60–62, 64, 69–72.
14
  PTO ¶¶ 15–16, 19, 24–30, 36–44, 51, 55, 60–62, 64, 69–72. Most of these shares were
acquired after the record date of January 29, 2015. See PTO ¶¶ 18, 31, 45, 53, 63, 71.
15
     PTO ¶ 117.
16
   Pet “consumables” include “pet food, pet treats and snacks, and pet litter products.”
JX 2307 (Weinsten-Opening) at 12. Pet “hardgoods” include “pet toys, apparel, collars,
leashes, grooming equipment, food bowls and pet beds.” Id.
17
     PTO ¶ 78; JX 1336 at 23; JX 1477.

                                            6
revenues of approximately $7 billion.18 The only other company in North America

that does what PetSmart does on the same scale is Petco Animal Supplies, Inc.

(“Petco”).19 PetSmart also faces competition from big box stores like Target and

WalMart, grocery stores like Kroger, smaller chain and independent pet stores and

online retailers like Amazon.20

      C. PetSmart Experiences Strong Growth from 2000–2012

         PetSmart experienced significant positive growth each year from 2000 to

2012.21 From 2000 to the onset of the financial crisis in 2007, PetSmart achieved

annual revenue growth of 8–13%, significantly outperforming the retail industry as

a whole.22 PetSmart’s annual revenue growth rate declined in 2008 and 2009 (falling

to 5% in 2009) during the peak of the financial crisis but soon rebounded, reaching

11% in 2012.23

         PetSmart’s growth was driven in significant part by favorable dynamics in the

pet industry from 2000 to 2008 coupled with PetSmart’s rapid increase in new store

18
     JX 1336 at 23.
19
     PTO ¶ 118.
20
     Trial Tr. 181:13–182:24 (Teffner).
21
     JX 1697 (Metrick-Opening) at 15–16, Ex. 1A, Ex. 3; see Trial Tr. 177:1–7 (Teffner).
22
  JX 1697 (Metrick-Opening) at 15–16, Ex. 1A, Ex. 3; see JX 1698 (Dages-Opening) at 3–
6; Trial Tr. 177:1–7 (Teffner).
23
     JX 1697 (Metrick-Opening) at 15–16, Ex. 1A, Ex. 3.

                                              7
openings.24 From 2000 to 2008, the pet industry benefitted from the convergence of

two industry-favorable trends: an increasing pet population in North America and

increasing spending per pet by North American pet owners due to the trend described

as pet “humanization.”25 The period from 2000 to 2008 also saw PetSmart more

than double the number of its stores, from 484 stores in 2000 to 1,004 stores at the

start of 2008.26 PetSmart’s store expansion was particularly rapid from 2004 to

2008, when PetSmart opened 518 new stores.27 As these new stores grew to their

full sales potential, PetSmart experienced a strong increase in its comparable store

sales growth from 2009 to 2012.28

24
     JX 1698 (Dages-Opening) at 6–7; see Trial Tr. 177:8–178:11 (Teffner).
25
  JX 1697 (Metrick-Opening) at 11–14; JX 1698 (Dages-Opening) at 3–4; Trial Tr. 177:8–
178:11 (Teffner); PTO ¶ 121. Pet “humanization” describes owners treating their pets as
members of the family. Id. This, in turn, prompts owners to seek out premium pet foods
and products of a quality they might buy for themselves or other family members.
PTO ¶ 122.
26
     JX 1697 (Metrick-Opening) at Ex. 4.
27
     Id.
28
   JX 1697 (Metrick-Opening) at 16, 19; JX 2307 (Weinsten-Opening) at 56, Ex. 18;
JX 1698 (Dages-Opening) at 6. “Comparable stores sales growth” (or “comp”) is the
percentage growth in sales revenue period-over-period (e.g., year-over-year or quarter-
over-quarter) for a retailer’s existing stores, “excluding new [stores] during their first year,
remodeled [stores] and [stores] that have since closed.” JX 2307 (Weinsten-Opening)
at 15. Comparable store sales growth (as between two different time periods of equal
duration) is calculated by multiplying (1) the change period-over-period in the total number
of customer purchase transactions for existing stores by (2) the change period-over-period
in average dollars per consumer purchase transaction for those existing stores. Id. at 15–
                                               8
      D. PetSmart’s Performance Declines

          PetSmart’s growth began to stall in 2012.29 Between Q1 2012 and Q4 2013,

PetSmart’s comparable store sales growth declined from 7.4% (in Q1 2012) to 1.4%

(in Q4 2013), and PetSmart’s overall sales growth exhibited a general downward

trend.30       During this same period, PetSmart found itself facing increasing

competition and other headwinds on multiple fronts.31 Along with this decline,

PetSmart struggled accurately to project its future performance, even quarter-by-

quarter. Indeed, management’s forecasts were often off by large margins.32

          PetSmart also experienced substantial management turnover in 2013 and early

2014. In June 2013, PetSmart’s CEO and CFO both resigned.33 David Lenhardt,

who had previously served as PetSmart’s President and COO, became PetSmart’s

16. Comparable store sales growth is a metric that features prominently in the discussion
of PetSmart’s fair value.
29
     JX 1697 (Metrick-Opening) at Ex. 1A.
30
     Id. at 20, Fig. 4, Ex. 2.
31
     Trial Tr. 183:5–186:17 (Teffner); Trial Tr. 396:23–397:18 (Gangwal).
32
   See JX 1697 (Metrick-Opening) at 64–65, Fig. 11. See also Trial Tr. 1172:22–1178:4
(Weinsten) (describing PetSmart’s historical difficulties in meeting its near-term forecasts,
and how this affected his view of the reliability of the Management Projections because
“[i]t’s easier to forecast in the near term. It’s even easier forecasting in the near term when
you have actual results available that factor into the calculation. So projecting out over a
five-year period is significantly more difficult”).
33
     JX 153 at 2; JX 137 at 4; PTO ¶¶ 101, 103.

                                              9
new CEO, and Carrie Teffner joined PetSmart as its new CFO.34 PetSmart’s then-

President and COO, Joseph O’Leary, left the Company in April 2014.35

         New management pushed initiatives that precipitated additional difficulties

for PetSmart. In particular, under Lenhardt’s direction, PetSmart implemented a

major “consumables reset” in early 2014 through which it increased store space for

exclusively distributed premium pet foods while reducing space for widely

distributed value pet foods.36 This consumables reset was intended to drive growth

in PetSmart’s sales and margins.37 As reflected in PetSmart’s disappointing Q1 2014

34
     PTO ¶¶ 99–101, 103.
35
     PTO ¶ 169.
36
     PTO ¶ 135.
37
   See Trial Tr. 246:20–23 (Teffner); JX 1684 (Lenhardt Dep.) 50:14–16, 51:20–52:7;
PTO ¶ 171. Petitioners object to the admission of Lenhardt’s deposition on hearsay and
related grounds. Pursuant to Court of Chancery Rule 32(a)(3)(B), deposition transcripts
may be used “by any party for any purpose” in lieu of live witness testimony when “that
witness is out of the State of Delaware, unless it appears that the absence of the witness
was procured by the party offering the deposition.” When Rule 32 applies to permit the
use of deposition testimony, “the Rules of Evidence are ‘applied as though the witness
were then present and testifying[,]’ . . . [such that] a party cannot raise evidentiary
objections to admissibility based on the fact that the testimony takes the form of a
deposition.” ACP Master, Ltd. v. Sprint Corp., 2017 WL 75851, at *3 (Del. Ch. Jan. 9,
2017). Rule 32 allows Respondents to offer Lenhardt’s deposition testimony as he is “out
of the state of Delaware” and there is no evidence that the Respondent procured his
absence. Importantly, procuring the absence of a witness from trial is different from “doing
nothing to facilitate presence,” even where potential witnesses are employed by one of the
parties to the trial. Carey v. Bahama Cruise Lines, 864 F.2d 201, 204 (1st Cir. 1998)
(quoting Houser v. Snap-On Tools Corp., 202 F. Supp. 181, 189 (D. Md. 1962)). To have
procured the absence for the purposes of Rule 32, the party must have “actively [taken]
steps to keep the deponent[] from setting foot in the court-room.” Carey, 864 F.2d at 204.
Respondent also demonstrated that the witness is “unavailable” pursuant to DRE 804(a)(5)
                                            10
results, announced on May 21, 2014, the consumables reset failed.38 PetSmart’s

comparable store sales growth for Q1 2014 had declined to -0.6%, and its Q1 2014

net sales growth was only 1.1%.39

           Following PetSmart’s announcement of its Q1 2014 results, PetSmart’s stock

price dropped 8% to $57.02.40 PetSmart’s Q1 2014 results, combined with the sharp

decline in its stock price, drew the ire of shareholders, including Longview Asset

Management LLC (“Longview”), then PetSmart’s largest stockholder. Longview

was not bashful in communicating its frustration with PetSmart’s lackluster

performance to both members of management and PetSmart’s board of directors (the

“Board”).41

      E. PetSmart’s Board Begins to Explore Strategic Alternatives

           At a meeting on June 18, 2014, the Board received reports on Longview’s

most recent communications and PetSmart’s poor results in Q1 2014.42 Morgan

& 804(b)(1). This reasoning applies with equal force to the use of the deposition testimony
of Christina Vance, Kim Smith and Michael Chang, all of whom were “out of the State of
Delaware” at the time of trial through no active involvement of the Respondent.
38
     PTO ¶ 171.
39
     Id.
40
     Id.; JX 1623.
41
     E.g., Trial Tr. 193:10–195:18 (Teffner); PTO ¶ 170.
42
     PTO ¶¶ 176–78.

                                             11
Stanley had been engaged to advise the Board regarding its options in the wake of

recent events and, at the June 18 meeting, it gave a presentation on PetSmart’s

valuation, capital structure and potential strategic alternatives.43

         In anticipation of the June 2014 meeting, PetSmart had provided Morgan

Stanley with PetSmart’s strategic plan and a set of financial projections prepared by

PetSmart’s management (the “June 2014 Projections”). The June 2014 Projections

were “very high level,”44 created “specifically for Morgan Stanley,”45 and prepared

in “[r]elatively short order, in a matter of maybe not even a week”46 using

management’s general financial planning framework (the “fishbone” or “financial

framework”).47 These projections had not been approved by PetSmart’s Board and

43
     PTO ¶¶ 176–80.
44
     Trial Tr. 198:12 (Teffner).
45
     Trial Tr. 197:17–18 (Teffner).
46
     Trial Tr. 198:18–19 (Teffner).
47
    Trial Tr. 197:21–198:9 (Teffner). Teffner testified that PetSmart’s management used
the financial framework to outline its expectations with respect to “revenue growth, how
much of that was comp, how much of that was new store growth . . . margin, profit, CAPX,
those type of things.” Trial Tr. 198:3–6 (Teffner); Trial Tr. 208:20–22, 209:20–210:12
(Teffner). See also JX 1674 (Vance Dep.) 42:2–12, 43:15–20 (“The format of [the
fishbone was] a single piece of paper that has some boxes on it that have little numbers on
it that say sales should grow three to four percent, margins should be flat, expenses should
grow, you know . . . three to four percent, something like that.”), 46:1–4 (“The [fishbone]
itself is not a plan. It’s a piece of paper that says here’s what we aspire to achieve, but it’s
not an individual plan.”).

                                              12
were not intended to inform PetSmart’s business operations going forward.48 Rather,

the June 2014 Projections were prepared “to be in line with what the board would

have expected from the financial framework, but [also] to give them directional

guidance in terms of what the impact of leveraging up to do a significant share

buyback would do.”49

         Having reviewed PetSmart’s strategic plan and the June 2014 Projections,

Morgan Stanley presented the following “preliminary conclusions” to PetSmart’s

Board at the June 2014 meeting: (1) “Based on management’s forecasts and

[PetSmart’s] recent share price decline, [PetSmart’s] stock appeared to be

undervalued”;50 (2) “PetSmart could optimize its capital structure and lower its cost

of capital by raising debt to accelerate its return of capital while still maintaining

strategic flexibility”;51 and (3) “Given [PetSmart’s] compelling cash flow and return

characteristics . . . , Morgan Stanley expected financial sponsors to be interested in

a take-private transaction [i.e., a leveraged buyout (“LBO”)].”52 Morgan Stanley’s

presentation to the Board also included a preliminary assessment of PetSmart’s value

48
     Trial Tr. 198:20–199:1 (Teffner).
49
     Trial Tr. 199:5–9 (Teffner).
50
     PTO ¶ 179(c)(i).
51
     PTO ¶ 179(c)(ii).
52
     PTO ¶ 179(c)(iii).

                                         13
based on a DCF analysis, which yielded a range of valuations for PetSmart of $100

per share (upside), $88 per share (base), and $77 per share (downside).53

         Following Morgan Stanley’s presentation, the Board discussed a range of

possible strategic options, including: (1) adhering to management’s current strategic

and operating plans; (2) engaging in a significant leveraged recapitalization

(as described by Morgan Stanley); (3) pursuing an acquisition of Pet360, Inc.

(“Pet360”), an online pet business; (4) pursuing a strategic combination with Petco;

or (5) pursuing a sale of the Company to a financial buyer.54 At the end of the June

2014 meeting, the Board established an Ad Hoc Advisory Committee of non-

executive, independent directors: Gregory Josefowicz, Rakesh Gangwal, and

Thomas Stemberg.55 The Board established the Ad Hoc Committee to work with

management and PetSmart’s advisors to evaluate options that would increase

shareholder value (including a leveraged recapitalization) and to develop one or

more related proposals for consideration by the Board.56 One of the goals in forming

53
     PTO ¶ 180.
54
     PTO ¶ 178; Trial Tr. 400:12–16 (Gangwal).
55
  PTO ¶ 181. The three members of the Ad Hoc Committee were each experienced board
members and former CEOs (Josefowicz was the former CEO of Borders, Gangwal was the
former CEO of US Airways, and Stemberg was the former CEO of Staples). JX 276 at
15–16.
56
     PTO ¶ 182.

                                           14
the Ad Hoc Committee was to relieve some of the pressure from PetSmart’s “young

management team” during the Company’s exploration of strategic alternatives since

management “was already under a lot of pressure to perform.”57

      F. Activist Investor JANA Partners Discloses Stake in the Company and
         Urges Sale

      On July 3, 2014, JANA Partners LLC (“JANA”), an activist hedge fund,

disclosed in a Schedule 13D filing that it had acquired a 9.9% stake in PetSmart.58

JANA stated its view that PetSmart’s stock was undervalued and disclosed its

intention to push PetSmart to pursue strategic alternatives including a possible sale.59

Four days later, on July 7, 2014, Longview publicly disclosed a letter it had sent to

the Board in response to JANA’s filing that also encouraged the Board to pursue a

possible sale of the Company in addition to examining other strategic alternatives.60

         On July 10, 2014, JANA representatives met in person with Lenhardt, Teffner,

and Josefowicz.61 At that meeting, JANA’s representatives criticized PetSmart’s

Board and management for pricing missteps, ineffective cost management, failure

57
     Trial Tr. 402:16–403:9 (Gangwal).
58
     PTO ¶ 188; JX 386.
59
     PTO ¶ 188; JX 386 at 2–3.
60
     PTO ¶ 190; JX 427; JX 403; Trial Tr. 462:14–15 (Gangwal).
61
     PTO ¶ 192.

                                           15
to capitalize on growth opportunities and failure to respond adequately to

competitors.62 In light of these failures, JANA’s view was that PetSmart’s only

solution was to sell the Company.63 That same day, Longview reiterated to PetSmart

its support for a possible sale of the Company.64

         On July 11, 2014, the Board held a special meeting via telephone.65 During

the meeting, the Board received a report on recent shareholder communications from

JANA and Longview and, with management’s recommendation, authorized the

retention of J.P. Morgan Securities LLC (“JPM”) as PetSmart’s new financial

advisor.66 A team from JPM led by Anu Aiyengar presented JPM’s preliminary

analysis of PetSmart’s current situation and possible strategic alternatives.67 This

presentation included an overview of preliminary valuation perspectives, selected

capital alternatives and selected strategic alternatives such as a possible going-

62
  See Trial Tr. 201:24–202:9 (Teffner); Trial Tr. 404:9–19 (Gangwal); JX 427 at 1–2;
JX 433.
63
     See Trial Tr. 201:24–202:9 (Teffner); JX 427 at 2; JX 433.
64
     PTO ¶ 193; JX 427 at 2; Trial Tr. 462:14–15 (Gangwal).
65
     PTO ¶ 194.
66
  PTO ¶¶ 191, 194–95; JX 427 at 4–5. According to the July 2014 meeting minutes, the
Board resolution authorizing JPM’s retention as PetSmart’s financial advisor provided that
the Ad Hoc Committee (1) was to determine the scope and terms of that retention; and
(2) then negotiate with JPM to reach the final terms of its engagement. JX 427 at 4–5.
67
     JX 427 at PETS_APP00000314–315; Trial Tr. 882:20–22 (Aiyengar).

                                              16
private transaction or the acquisition of Petco.68 JPM also discussed certain steps

that it would undertake to assist the Board in evaluating alternatives and making a

decision, which included: (1) reviewing and performing due diligence on PetSmart’s

business plan, which management had provided to JPM; (2) assessing trends in the

pet sector; (3) asking strategic questions about possible changes to PetSmart’s

business plan; (4) evaluating capital and structural changes that could be considered

in connection with that plan, as alternatives to a sale of the business; (5) considering

acquisition scenarios; (6) comparing the potential value to shareholders of executing

PetSmart’s business plan (including recommending possible modifications and

capital and structural changes) with the potential value to stockholders of a sale of

PetSmart, and (7) assessing which of these or other alternatives was more likely to

maximize shareholder value.69         While JANA had threatened a proxy fight if

PetSmart decided not to sell, the Board indicated to JPM that it was prepared to take

on that fight if it decided that a sale was not in the best interests of the Company. 70

68
     PTO ¶ 196; Trial Tr. 204:17–21 (Teffner).
69
     PTO ¶ 197; Trial Tr. 882:20–22 (Aiyengar); JX 372; JX 427 at 3.
70
     Trial Tr. 405:8–406:1, 467:5–6 (Gangwal).

                                             17
      G. PetSmart’s Management Prepares Long-Term Projections

         Following the July 11 meeting, PetSmart’s management began to prepare a

set of long-term projections at the direction of the Board (the “Base Case”).71 This

project was led principally by PetSmart CFO Carrie Teffner, Christina Vance,

PetSmart’s director of financial planning, and Kim Smith, PetSmart’s director of

treasury operations—with input from Lenhardt and several other executives.72

         PetSmart did not prepare long-term projections in the ordinary course to

operate its business.73 Instead, PetSmart’s management would create a one-year

budget (or operating plan) which forecasted PetSmart’s quarterly performance for

the upcoming year.74 The budget formulation process began each summer with a

series of meetings over several days referred to within the Company as “Summer

Strategy.”75 During these meetings, PetSmart’s management discussed financial and

strategic priorities for the next fiscal year.76 Prior to each Summer Strategy, the

71
     Trial Tr. 217:10–17, 229:2–6 (Teffner); JX 1674 (Vance Dep.) 105:18–112:8.
72
     Trial Tr. 220:1–18, 221:22–222:1 (Teffner).
73
  See Trial Tr. 209:4–6 (Teffner) (Q: “Did PetSmart senior management prepare long-term
projections to operate its business?” A: “No.”); Trial Tr. 211:8–14, 211:21–23 (Teffner).
74
     PTO ¶ 433; Trial Tr. 206:21–209:3 (Teffner).
75
     Trial Tr. 205:14–209:3 (Teffner); PTO ¶ 424.
76
  Id. See also JX 149 (presentation slides from 2013 Summer Strategy “Lead Meeting 4”);
JX 150 (presentation slides from 2013 Summer Strategy business case prioritization
                                             18
leaders of PetSmart’s different business segments would identify potential initiatives

for the upcoming fiscal year and, working with members of PetSmart’s finance

department, develop “business cases” around those initiatives.77 Each business case

for a proposed initiative would include certain financial forecasts.78 The business

segment leaders would then present their proposed business initiatives

(and business cases) to the Company’s senior management during the Summer

Strategy meetings.79 Management, in turn, would select (and approve) specific

initiatives for advancement in the upcoming fiscal year.80

         Following Summer Strategy, PetSmart’s management would continue to

evaluate the approved initiatives through the fall and early winter to determine their

expected impact on PetSmart’s revenue and expenses.81 Typically, management

would then complete the one-year budget in February of the following calendar year,

meeting); JX 156 (presentation slides from 2013 Summer Strategy business case
prioritization review meeting).
77
     Trial Tr. 205:16–206:5 (Teffner); PTO ¶ 425–27.
78
   PTO ¶ 431. “While business cases [used] multiyear looks [i.e., projections] . . . , the
focus was really on Year 1 and what we were going to wind up putting in the budget for
the following year.” Trial Tr. 206:12–14 (Teffner).
79
     Trial Tr. 206:6–10 (Teffner).
80
     Trial Tr. 206:23–207:12 (Teffner).
81
  Trial Tr. 206:23–207:17 (Teffner); PTO ¶ 434. PetSmart’s fiscal year runs from
February 1 to January 31. PTO ¶ 80.

                                            19
present it to the Board in March of that year and the Board would approve it that

same month.82 Thereafter, before Q2, Q3 and Q4 of the fiscal year, management

would prepare reforecasts of PetSmart’s projected performance for the remaining

quarters.83 PetSmart used the one-year budgets and reforecasts “to run the business

and incentivize management.”84

         Over time, Vance had developed a model to extrapolate the business cases

presented at Summer Strategy.85 She used her model to evaluate whether PetSmart

“would stay within [its] financial framework.”86 The model was not, however,

“presented to the board for approval . . . [and was not] considered a multiyear

projection that the business relied upon.”87 Rather, it “was more of an inherent

working tool for the planning department . . . .”88

         PetSmart management confronted several challenges when the Board tasked

them with developing the long-term projections to be used by JPM and the Board in

82
     PTO ¶¶ 434–35; Trial Tr. 207:18–208:3 (Teffner).
83
     PTO ¶ 440.
84
     Trial Tr. 211:18–19 (Teffner); PTO ¶¶ 438–42.
85
     Trial Tr. 213:7–19 (Teffner); JX 1674 (Vance Dep.) 38:12–41:24.
86
     Trial Tr. 213:12–13 (Teffner). See also JX 1674 (Vance Dep.) 38:12–42:12.
87
     Trial Tr. 213:15–19 (Teffner).
88
     Trial Tr. 213:16–17 (Teffner).

                                            20
their evaluation of strategic alternatives. First and foremost, they had never prepared

long-term projections and the process of doing so was vastly different than the

process employed to prepare budgets for Summer Strategy.89 The business units

were unable to provide much input because they had never prepared and had never

been accountable for long-term projections.90 And then there was the time pressure.

The Board rushed management to prepare the Base Case “in the span of a few days”

after the Board meeting on July 11, 2014, so that the results could be presented at

the next Board meeting in August.91

         During PetSmart’s 2014 Summer Strategy, management had “identified a

variety of initiatives that [management] thought would be go-forward initiatives to

help drive growth going forward.”92 Thus, in creating the Base Case, management

first sought “to build a base of what [they] believe[d] the comp would be for the

existing business before layering in [those] initiatives.”93 The finance team then

89
     Trial Tr. 220:19–222:1 (Teffner).
90
   Trial Tr. 220:22–221:19 (Teffner) (noting that in her past experience before joining
PetSmart the business units “really owned their own forecasts” but at PetSmart the
management in place did not “have experience putting multiyear projections together”
leaving “a small group of [senior management] to “try[] to validate with the business
instead of the other way around.”).
91
     Trial Tr. 219:7–22 (Teffner); JX 426; JX 430; JX 448; JX 458; JX 583.
92
     Trial Tr. 217:24–218:3 (Teffner).
93
     Trial Tr. 218:4–16 (Teffner).

                                             21
“layered onto [the “base” comp projections] what it thought the value of each of

the[] initiatives would be.”94 As part of this “layering” process, the finance team

sent its value assumptions to the relevant business segment leaders “to get an

affirmation that yes, that looks right . . . .”95 And, as Teffner explained, “that’s

essentially what drove the top line.”96

         The Base Case forecast estimated revenues using three primary yardsticks:

(1) new store openings; (2) comparable stores sales growth; and (3) four initiatives

selected from the Summer Strategy.97 The Base Case is summarized below:98

94
     Trial Tr. 218:20–22 (Teffner).
95
     Trial Tr. 220:1–18 (Teffner).
96
     Trial Tr. 218:22–23 (Teffner).
97
     JX 586 at 7; JX 598.
98
     JX 586 at 8.

                                          22
         The comparable store sales forecasts were ambitious and well above the

performance management had projected at Summer Strategy, including comparable

store sales growth.99 Specifically, the Base Case assumed the success of each of the

new revenue initiatives developed at Summer Strategy and projected comparable

store sales growth of 1.3% in 2015, 3.2% in 2016 and 3.3% increases each year

thereafter.100

         The Base Case was not well received by the Board. Specifically, “when

[management] reviewed the base case comp assumptions with the ad hoc committee

of the board, [the committee], specifically . . . Stemberg, indicated that the comp

assumptions that [management] had put in the plan were not aggressive enough and

[management] needed to be far more aggressive, recognizing that potential buyers

looking at [PetSmart would] discount [management’s] plans themselves.”101

Accordingly, management went back to the drawing board and prepared the Base-

Plus Case, which is summarized below:102

99
  Trial Tr. 233:22–234:19 (Teffner). Estimates coming out of Summer Strategy had shown
that, including the acquisition of Pet360 that was under consideration but excluding any
new initiatives, PetSmart’s comparable store sales growth for 2015 to 2017 would range
from 0.1% to 0.5%. JX 842 at 139.
100
      JX 586 at 6; JX 842.
101
      Trial Tr. 234:23–235:6 (Teffner).
102
      JX 586 at 9.

                                          23
         The Base-Plus Case “assumed more aggressive delivery of performance

against the exact same initiatives that [management] had looked at in the Base

Case.”103      These projections also assumed comparable store sales growth that

exceeded similar projections in the Base Case.104 The take away from the Base-Plus

Case was that it depicted an even sharper turnaround of PetSmart’s recent

downward-trends than had been forecast previously.105

103
      Trial Tr. 235:9–14 (Teffner).
104
      Compare JX 586 at 8 (Base Case projections) with id. at 9 (Base-Plus Case projections).
105
    See JX 1684 (Lenhardt Dep.) 275:14–21 (describing the projections as “a hockey stick
from negative to slightly positive to much more positive,” meaning that “there was a lot of
risk going forward to hitting these things”).

                                              24
            As with the Base Case, management prepared the Base-Plus Case “extremely

quickly.”106 During this same time frame, PetSmart’s management also prepared a

third set of projections—the “Growth Case.”107 The Growth Case started with the

Base-Plus Case projections and “assumed yet even [better] performance of the exact

same initiatives.”108 Unlike the Base Case and Base Plus Case, however, the Growth

Case was not prepared at the request of the Ad Hoc Committee.109 Rather, PetSmart

management prepared the Growth Case on its own initiative because it was not “sure

how far the ad hoc committee wanted [them] to go in terms of comp assumptions.”110

Management kept the Growth Case in their “back pocket” in case the Ad Hoc

Committee once again was displeased with their work on the Base Plus Case.111

      H. The PetSmart Board Decides to Commence a Public Sale Process

            PetSmart’s Board next met on August 13, 2014.112 At this meeting, JPM

presented a preliminary valuation summary for PetSmart and reviewed several

106
      Trial Tr. 219:9–14 (Teffner).
107
      Trial Tr. at 236:11–16 (Teffner).
108
      Trial Tr. 236:15–16 (Teffner).
109
      See Trial Tr. 237:5–12 (Teffner).
110
      Trial Tr. 237:9–12 (Teffner).
111
      Id.
112
      PTO ¶¶ 198, 204–05.

                                            25
strategic alternatives for the Company, including (1) continuing on a standalone

basis while engaging in a significant leveraged recapitalization; (2) exploring a sale

of the Company; and (3) exploring a strategic merger with another industry

participant.113 In connection with the third alternative, the Board focused on the

potential benefits and risks associated with inviting Petco to participate in an

exploratory sales process.114          The Board identified two “overwhelming,

overriding”115 risks associated with such an overture: (1) that Petco would not be

serious about acquiring PetSmart, but would feign interest in order to gain access to

confidential information about PetSmart’s business model, strengths and

weaknesses;116 and (2) that a Petco-PetSmart merger “would face pretty strong

[antitrust] headwinds . . . [so that] approval of th[e] transaction would be quite

difficult.”117 Given these concerns, the Board “was not very keen on engaging with

Petco” at that time.118

113
      PTO ¶ 206.
114
      Trial Tr. 414:12–416:24 (Gangwal).
115
      Trial Tr. 415:14 (Gangwal).
116
      Trial Tr. 415:9–10 (Gangwal).
117
      Trial Tr. 415:15–17, 414:21–23 (Gangwal).
118
      Trial Tr. 415:17–18 (Gangwal).

                                            26
         During the August 2014 meeting, PetSmart management and JPM provided

the Board with an overview of management’s standalone plan and the Base Case and

Base-Plus Case financial projections.119 The Board admonished management that

that Base Case and the Base-Plus Case were not aggressive enough because

PetSmart “needed to put [its] best foot forward in terms of the projections [it was]

putting forward to . . . potential buyers.”120 Teffner’s “take-away from the [August

2014 Meeting] was very much one that [management] needed to put [their] best foot

forward because potential buyers were going to discount [management’s]

assumptions and assume that [the Company was] putting more aggressive

assumptions forward.”121

         At the conclusion of the August meeting, the Board determined that it would

publicly announce that PetSmart was exploring strategic alternatives including a

possible sale of the Company.122 Accordingly, on August 19, 2014, PetSmart issued

a press release to that effect, announcing that, based on a thorough, year-long

business review, the Board had determined to explore strategic alternatives for the

119
  Trial Tr. 237:17–238:13 (Teffner). Management did not present the Growth Case at the
August 2014 Meeting. See Trial Tr. 237:5–12 (Teffner).
120
      Trial Tr. 241:10–13 (Teffner).
121
      Trial Tr. 242:22–243:2 (Teffner).
122
      Trial Tr. 418:12–419:8 (Gangwal).

                                          27
Company to maximize value for shareholders, including a possible sale of the

Company.123

            Also on August 19, 2014, PetSmart issued a second press release announcing

PetSmart’s Q2 2014 results.124 Here, PetSmart announced that its comparable store

sales for Q2 2014 had declined to -0.5%, with comparable transactions declining to

2.6%.125 This press release also announced that the Company had entered into a

definitive merger agreement to acquire online retailer Pet360 for $130 million and

that the Company would be launching a broad cost reduction program and certain

other growth initiatives.126

      I. PetSmart Management Formulates the Profit Improvement Plan and
         Finalizes its Projections

            Prior to the August 13, 2014 Board meeting, PetSmart had engaged two

consulting firms to analyze certain aspects of PetSmart’s business and identify cost-

savings opportunities.127 In May 2014, PetSmart engaged The Hackett Group to

identify cost cutting initiatives with respect to PetSmart’s Selling, General, and

123
      PTO ¶ 213.
124
      PTO ¶ 211.
125
      Id.
126
   PTO ¶ 212. The PetSmart-Pet360 merger closed on September 29, 2014, with a
purchase price of $131.5 million and a potential earnout of $30 million. PTO ¶ 221.
127
      See PTO ¶¶ 366–70, 378; Trial Tr. 247:22–248:23 (Teffner).

                                            28
Administrative expenses (specifically, a headcount reduction).128 And in May/June

2014, PetSmart engaged A.T. Kearny, Inc. to focus on cost cutting initiatives with

respect to certain of PetSmart’s indirect expenses.129

         Shortly after the August 2014 Board meeting, with the assistance of its

consultants, PetSmart’s management undertook to formulate a large-scale cost-

savings plan at the Board’s direction.130 This plan came to be known as the “Profit

Improvement Plan” (or “PIP”).131           The PIP consisted of: (1) implementing a

headcount reduction;132 (2) engaging A.T. Kearny to develop a cost-savings plan

with respect to PetSmart’s cost of goods sold (“COGS”) expenses and certain of

PetSmart’s other indirect expenses such as spending on transportation, marketing,

supplies, real estate, packaging, and real estate services;133 and (3) engaging the

Peppers & Rogers Group to develop a cost-savings plan with respect to PetSmart’s

enterprise costs.134 Two weeks after the August 2014 Board meeting, Teffner sent

128
      PTO ¶ 378; Trial Tr. 247:22–24 (Teffner).
129
   Trial Tr. 248:5–7 (Teffner); PTO ¶ 370. PetSmart had previously entered into a Master
Provider Agreement with A.T. Kearney in August 2013. Id.
130
      Trial Tr. 247:14–19 (Teffner); see PTO ¶ 366.
131
      Trial Tr. 247:14–19 (Teffner); PTO ¶ 366.
132
      Trial Tr. 248:14–17 (Teffner).
133
      Trial Tr. 248:17–23 (Teffner); PTO ¶¶ 371–73.
134
   PTO ¶ 375; Trial Tr. 248:24–249:7 (Teffner) (“We also brought in Peppers & Rogers[,]
and their work was [focused] around a Lean Six Sigma operational efficiency process, . . .
                                             29
an email to the Board stating that management’s target for PIP cost savings was

“[approximately] $160M–$200M+ EBITDA improvement.”135                   The final PIP

savings developed by the consultants, together with management, and presented to

the Board showed an expected range of $183–$283 million in EBITDA savings

annually.136

         While management worked on developing the PIP, they also worked to

prepare an updated set of financial projections that would integrate the PIP

savings.137 Specifically, between August and October 2014, PetSmart management

prepared what would be their final revised set of financial projections for

presentation to the Board (the “Management Projections”).138 The Management

Projections started with the Base-Plus Case projections and layered on (1) greater

sales growth assumptions for the same proposed business initiatives, (2) new sales

growth expected from the Pet360 acquisition, and (3) cost savings associated with

to see if [PetSmart] had opportunity to reduce labor costs by operating more efficiently
than [it was] currently operating at the time.”). PetSmart engaged Peppers & Rogers to
perform this work on September 12, 2014. PTO ¶ 375.
135
      JX 668 at 1.
136
      JX 2021 at 375; Trial Tr. 338:22–339:1 (Teffner); PTO ¶ 232.
137
      See Trial Tr. 247:22–249:8 (Teffner); PTO ¶¶ 223, 231.
138
      PTO ¶¶ 223, 231.

                                             30
the PIP.139 The forecasts for comparable store sales growth were significantly higher

than those set forth in both the Base and Base-Plus Cases. These new projections

also included more aggressive Net Sales, EBITDA, Earnings Per Share and Capex

numbers.140 They estimated that, through the PIP, PetSmart would achieve cost

savings totaling $120 million in 2015 and then $200 million for each of the

subsequent years laid out in the forecast.141 The Management Projections are

summarized below:142

                           Management Projections (FY2014-2019)

                            2014E     2015E         2016E    2017E 2018E 2019E
         ($ in millions)
                            Jan-15    Jan-16        Jan-17   Jan-18 Jan-19 Jan-20

       Revenue               $7,088    $7,456       $7,869   $8,331   $8,822   $9,329
       EBITDA                 $958     $1,060       $1,223   $1,326   $1,422   $1,515
       Net Income             $432      $490         $588      $646   $700     $748
       Capital
       Expenditure            $152      $150         $157      $167   $176     $187
       FCF Before
       Distributions          $465      $571         $667      $684   $736     $786

139
      PTO ¶ 223; Trial Tr. 254:16–255:6, 259:1–14 (Teffner).
140
      Compare JX 807 at PETS_APP00000694 with JX 586 at PETS_APP00000438–39.
141
      JX 1136 at 8; Trial Tr. 339:7–10 (Teffner).
142
      PTO ¶ 231.

                                               31
            Once again, management designed its latest projections to be aggressive—

“bordering on being too aggressive.”143 Indeed, Vance went so far as to characterize

the Management Projections as approaching “insan[ity].”144 With that said, these

projections reflected an inexperienced management team’s best effort at estimating

how PetSmart would perform in the future if all of its performance and cost

initiatives paid off.145 And management made a point of “being very clear with

respect to the assumptions that they were making.”146

            The record is clear that the Board exerted substantial pressure upon

management to prepare increasingly more aggressive and ultimately unrealistic

long-term projections. In this regard, Lenhardt and Teffner were told that their jobs

“depended” on it.147 And management heard the Board “loud and clear.”148 For its

part, JPM told PetSmart management that prospective buyers would likely view the

143
      Trial Tr. 258:13–14, 258:18–20 (Teffner).
144
      JX 758.
145
      Trial Tr. 368:19–369:16 (Teffner). See also JX 1674 (Vance Dep.) 136:25–137:3.
146
      Id.
147
      JX 671 at PETS_APP00215455. See also JX 608; JX 668.
148
      JX 673.

                                             32
overly aggressive Management Projections skeptically,149 and that management best

be prepared to defend them when the sales process got underway.150

      J. The Auction for PetSmart

            While PetSmart management continued the back-and-forth with the Board

over its projections, JPM opened the auction process for PetSmart in earnest. JPM

spoke with 27 potential bidders following the announcement that PetSmart was

exploring a sale in August through early October.151 As among the potential bidders,

three were potential strategic partners that had been targeted by JPM and the

Board—Wal-Mart, Target, and Tractor Supply––and the rest were financial

sponsors.152 Ultimately, none of the strategics elected to participate in the process.153

Of the 24 private equity funds with whom JPM spoke, 15 signed nondisclosure

agreements and moved forward with the bidding process.154

149
      Trial Tr. 256:11–13, 257:10–11 (Teffner).
150
      JX 758; JX 753.
151
      JX 1336 at 23; Trial Tr. 884:10–885:4, 886:10–18 (Aiyengar).
152
      Trial Tr. 919:4–921:21 (Aiyengar).
153
      Id.
154
      JX 1336 at 23; JX 811 at PETS_APP00000578; Trial Tr. 887:18–888:5 (Aiyengar).

                                             33
            The Board held additional meetings with JPM on October 2 and 3, 2014, to

discuss, among other things, the risks and benefits of formally inviting Petco to bid

for the Company.155 Citing the risks it and JPM had previously identified, the Board

again decided that it was not in the Company’s best interests to pursue a transaction

with Petco.156 Of course, the Board was open to engaging with Petco if Petco

expressed a serious indication of interest.157

            During the Board meetings on October 2 and 3, PetSmart’s management

updated the Board on their progress with the PIP, including their expectation that the

Company would achieve cost savings of $120 million in 2015 and $200 million in

2016.158 Management also presented the Management Projections to the Board.159

JPM’s reaction to this presentation was to reiterate that buyers would likely be

skeptical of PetSmart’s ability to achieve those results as potential bidders had

expressed concerns to JPM that well-documented trends in PetSmart’s performance

did not bode well for the future.160         Even so, the Board decided to use the

155
      JX 803; JX 811.
156
      JX 803 at PETS_APP00000557–58.
157
      See Trial Tr. 417:13–418:1 (Gangwal); Trial Tr. 923:1–16 (Aiyengar).
158
      JX 805 at PETS_APP00000609.
159
      Id.
160
      JX 803 at PETS_APP00000556.

                                             34
Management Projections for the auction process,161 with the expectation that bidders

would give a “haircut” to the projections in any event.162

         PetSmart’s electronic data room was opened to bidders after the October 3

Board meeting. It was well-stocked with comprehensive, nonpublic information

about PetSmart, including information about PetSmart’s financials, performance and

the PIP.163 PetSmart’s management also made presentations to the various potential

bidders who had signed nondisclosure agreements.164          Around this time, JPM

informed potential bidders that Longview would consider rolling over up to

7.5 million of its approximately 9 million shares in a sale of the Company.165

         PetSmart received five preliminary bids by October 31, 2014: (1) $80–$85 per

share from Clayton, Dubilier & Rice (“CD&R”); (2) $81–$84 per share from Apollo

Global Management L.P. (“Apollo”); (3) $81–$83 per share from BC Partners;

(4) $70–$75 per share from KKR & Co. L.P. (“KKR”); and (5) $65 per share from

161
      See PTO ¶¶ 315–17.
162
    See Trial Tr. 234:23–235:8, 242:22–243:2, 256:11–17, 258:8–14 (Teffner); Trial
Tr. 421:4–422:3 (Gangwal); Trial Tr. 892:1–20 (Aiyengar).
163
   Trial Tr. 263:3–265:13 (Teffner); JX 811 at PETS_APP00000580; JX 913 at
PETS_APP00000748; JX 1054 at PETS_APP00000907.
164
      JX 913 at PETS_APP00000747; Trial Tr. 262:1–263:2 (Teffner).
165
      JX 861.

                                           35
Ares Management, L.P. and Canada Pension Plan Investment Board.166 The stock

price as of October 31 was $72.35, while the unaffected price, which JPM set as of

July 2, 2014, was $59.81.167 Some members of the Board were “surprised that the

numbers had come in that high.”168

            As the auction progressed, the Board continued to consider alternatives to a

sale.169 In this regard, the Board pressed management to create a stronger standalone

plan for the Company.170 And the Ad Hoc Committee asked JPM to report on the

financing that would be available for a leveraged recapitalization of the Company

should the Board decide against a sale.171

            The Board next reviewed the progress of the auction for PetSmart with its

advisors at a meeting on November 3.172 JPM reported on the initial indications of

interest it had received as well as feedback from parties who chose not bid. This

feedback largely reflected a view that PetSmart’s business had “significant execution

166
      JX 913 at PETS_APP00000749.
167
      Id.
168
      Trial Tr. 430:3–4 (Gangwal).
169
      See JX 666; JX 915; Trial Tr. 427:22–428:15 (Gangwal).
170
      JX 666.
171
      JX 915 at PETS_APP00000741–42.
172
      JX 913.

                                             36
risk” and that there was inadequate potential for upside growth.173 The Board

decided to allow the four bidders who bid $80 per share or higher (CD&R, Apollo,

BC Partners and KKR) to continue in the process.174 These remaining bidders

performed further due diligence, which included access to more detailed information

about PetSmart’s financials, the Management Projections and the PIP, and additional

meetings with management.175

            PetSmart released its Q3 results on November 18, 2014.176 Comparable store

sales growth was stagnant and comparable transactions were down 2.4%.177

PetSmart also announced its progress on the PIP and its expectation that the plan

would be fully implemented by the end of fiscal year 2015, and reiterated its

expectation that the plan would result in a pre-tax cost savings of $120 million in

2015 and $200 million per year starting in 2016.178

173
      JX 913 at PETS_APP00000752; Trial Tr. 898:11–899:11 (Aiyengar).
174
   JX 1336 at 24. The Board later determined to allow CD&R and KKR to work together
based on the understanding that this would allow them to make a stronger bid. Id.; JX 953.
175
      JX 1054 at PETS_APP0000903.
176
      JX 984.
177
      Id.
178
      Id.

                                            37
         The Board met again on December 2 and 3 to consider whether to sell the

Company, remain independent or pursue a leveraged recapitalization.179 The Board

also reexamined the Management Projections, noting that it believed the PIP savings

were achievable but that it was skeptical about the Company’s ability to achieve the

projected top-line revenue and comparable store sales growth.180 The feedback

delivered to management was that the Board had a low level of confidence in

PetSmart’s ability to achieve the results forecasted in the Management

Projections.181

         The Board’s skepticism centered largely around the projections of comparable

stores sales growth; “many in the board really did not believe” that these projections

were realistic.182 To understand PetSmart’s standalone value better, the Board

determined that it needed to “see additional sensitivity analyses, particularly around

top-line and same-store sales growth.”183 Accordingly, the Board directed JPM to

prepare sensitivities assuming a 2% comparable store sales growth.184 The requested

179
      JX 1336 at 24; JX 1121; JX 1081 at PETS_APP00000759–61.
180
      JX 1081 at PETS_APP00000760.
181
   Trial Tr. 440:7–9 (Gangwal). See also Trial Tr. 432:13–433:14, 434:1–8, 436:13–19,
440:2–4 (Gangwal).
182
      Trial Tr. 433:9–14 (Gangwal). See also Trial Tr. 433:12–13, 434:3, 436:14 (Gangwal).
183
      JX 1081 at PETS_APP00000760.
184
    Trial Tr. 434:4–8 (Gangwal); Trial Tr. 910:24–911:8 (Aiyengar). I will hereafter refer
to these adjustments to the Management Projections as the “JPM sensitivities.” This should
                                             38
sensitivities were set at 2% because the Board had “a great amount of discomfort . . .

[about whether the 4% comparable store sales used in the Management Projections]

would be achievable, attainable or not.”185          Instead, the Board believed that

“2 percent looked more reasonable, and something that the management team more

than likely should be able to get to, if they executed a plan.”186

            In the weeks leading up to the final bids, questions arose about whether the

financial sponsors would be able to obtain deal financing based on reports that the

Office of the Comptroller of the Currency (“OCC”) and Federal Reserve would

engage in “increased scrutiny . . . over LBO loans.”187 The OCC and Federal

Reserve had implemented restrictions on the amount of leverage that would be

allowed in deal financing and, in the days leading up to Thanksgiving 2014 (in the

not be interpreted, however, as a finding that the JPM sensitivities were undertaken on
JPM’s own initiative. As noted above, I am satisfied that the Board came up with the idea
of the 2% sensitivities and then directed its financial advisor to run the analysis. The JPM
sensitivities began with the Management Projections and then: (1) for Sensitivity #1
applied a higher discount rate; (2) for Sensitivity #2 made no changes to the new store
assumptions through FY19 but eliminated new stores thereafter; (3) for Sensitivity #3
assumed half the new stores through FY19 and eliminated new stores thereafter; and (4) for
Sensitivity #4 assumed no new stores after FY14. See JX 1336 at 35. Sensitivity #1 was
the only sensitivity not to make adjustments based on 2% comparable store sales growth.
Id. This sensitivity was not featured at trial, not addressed by the experts and will not be
included herein when referencing the JPM sensitivities.
185
      Trial Tr. 436:14–19 (Gangwal).
186
      Id.
187
      JX 2044. See also JX 1414; JX 1618.

                                             39
midst of the PetSmart auction), regulators indicated they would begin to enforce

these regulations more strictly than before.188 This led bidders to perceive that the

quantum of debt available to finance an acquisition of PetSmart had tightened.189

While there were initial concerns that this increased regulatory scrutiny may affect

the bids for PetSmart, the evidence reveals that those concerns abated after

Thanksgiving when it became clear that all of the bidders would have no difficulty

securing debt financing at the levels necessary to fund their bids for PetSmart at the

values they deemed appropriate.190

188
      JX 1414 at 3; JX 2044.
189
    See Trial Tr. 859:15–860:24 (Svider); JX 1104; JX 1084 (Svider characterizing the
financing restrictions as “[w]orse than during Lehman in some ways”). See also JX 1103;
JX 1109 at 5–6 (discussing BC Partners’ issues with debt financing); Trial Tr. 995:4–6
(Aiyengar) (discussing Apollo’s struggles to get its debt financing in order); JX 1296 at 182
(stating that KKR’s financing for the PetSmart deal had “apparently” collapsed).
190
    See Trial Tr. 861:18–862:3 (Svider) (testifying that BC Partners was able to get all the
financing that it needed); Trial Tr. 916:16–918:3, 994:13–995:6 (Aiyengar) (testifying that
all other bidders were able to secure deal financing and that none were prevented from
reaching the levels needed to bid their desired price). The ability of the bidders to secure
adequate financing in spite of the enhanced regulation appears to be attributable, at least in
part, to PetSmart’s strong cash flow profile. See JX 1109 at BC00146204 (noting that BC
Partners was able to get seven “viable” financing proposals notwithstanding the increased
regulatory scrutiny due to the “high quality of the credit” of PetSmart); Trial Tr. 917:7–
918:10 (Aiyengar) (testifying that she had no reason to believe that any regulation of the
U.S. debt market negatively impacted the bidding for PetSmart, likely because of
PetSmart’s “pretty strong cash flow profile,” as she saw U.S. regulated banks participating
in diligence calls, whereas U.S. regulated banks typically will not participate in financing
when leverage levels are too high).

                                             40
            On December 10, PetSmart received new offers from the remaining

bidders.191 BC Partners made a binding offer of $80.70 per share.192 Apollo made

a binding offer of $80.35 per share.193 KKR and CD&R, working together, verbally

indicated they would not offer more than PetSmart’s current stock price, which was

approximately $78 per share.194 When JPM presented these offers to the Ad Hoc

Committee, the committee directed JPM to engage further with Apollo and

BC Partners to see if they would increase their bids.195 The Ad Hoc Committee also

decided on December 12 that it would allow Longview to join with BC Partners after

BC Partners “indicated that they may be able to offer [] a higher price with

Longview.”196

            JPM returned to the bidders and directed them to submit their best and final

offers because the Board would soon be meeting to make a final decision whether to

sell the Company or go in a different direction. Specifically, JPM told bidders “if

191
      JX 1336 at 25.
192
      JX 1144.
193
      JX 1134.
194
      JX 1336 at 25.
195
      Id.
196
   JX 1142 at 1. See also PTO ¶¶ 288–89. Apollo had indicated that it was not interested
in partnering with Longview and that its price would be the same with or without
Longview’s participation. JX 1142 at 1; JX 1153 at PETS_APP00000944.

                                             41
[they] had anything more in [their] pocket, now [was] the time to put it [in].”197

Apollo responded with an offer of $81.50 per share; BC Partners, with its

commitment from Longview in hand, offered $82.50 per share.198 With some

prodding, JPM was able to get BC Partners to increase its offer to $83 per share.199

Both parties made clear that these were their best and final offers.200

      K. The Auction Concludes and the Board Recommends the BC Partners
         Offer to Shareholders

            The PetSmart Board met on December 13 to discuss the final offers from BC

Partners and Apollo and to consider strategic alternatives to a sale of the

Company.201 JPM made presentations to the Board on each of these alternatives,

including the possibility that the Board may have to engage in a proxy contest with

JANA.202         JPM also presented its valuation analysis under various scenarios

including a standalone valuation of PetSmart if the Board determined to terminate

197
      Trial Tr. 907:5–12 (Aiyengar).
198
      JX 1336 at 26.
199
      Id.
200
      JX 1153 at PETS_APP00000945; Trial Tr. 906:7–908:9 (Aiyengar).
201
   JX 1156; JX 1157; JX 1153 at PETS_APP00000944–45. In fact, the night before this
meeting, PetSmart management worked to put together a press release that would announce
that the Company had decided to end the sales process. JX 1138.
202
      JX 1149; JX 1153; JX 1155; JX 1158.

                                            42
the auction.203 This standalone valuation focused on a DCF analysis based on the

Management Projections that resulted in a valuation for the Company of $78.25–

$106.25 per share.204          Understanding that the Board had little faith in the

Management Projections, JPM also presented the Board with the results of the

sensitivity analyses the Board had requested which resulted in a valuation range of

$65–$95.25 per share.205

            As a part of its presentation, JPM delivered its fairness opinion with respect

to the BC Partners offer concluding that, as of that date, the Merger Price of $83 per

share in cash was fair from a financial point of view to the stockholders of the

Company.206 Petitioners point to several aspects of JPM’s fairness opinion they

contend reveal that JPM “manipulated [its] financial analysis” in order to get to a

place where it could recommend the BC Partners proposal.207 At the core of the

criticism is the contention that JPM “stretched” to reach a high weighted average

cost of capital (“WACC”) for PetSmart in order to deflate the DCF results.208 In this

203
      JX 1158 at PETS_APP00001265–73; JX 1156 at PETS_APP00001129–31.
204
      Id.
205
    JX 1158 at PETS_APP00001265–68; Trial Tr. 432:13–436:19 (Gangwal); Trial
Tr. 908:14–912:20 (Aiyengar).
206
      JX 1153 at PETS_APP000945; PTO ¶ 293.
207
      Pet’rs’ Post-Trial Br. 72.
208
      Id. at 73.

                                              43
regard, Petitioners select certain of JPM’s internal communications they contend

demonstrate that Aiyengar pushed her team to inflate PetSmart’s WACC into double

digits even though her team had determined that a much lower WACC was

appropriate.209

            To be sure, there were discussions among the JPM deal team regarding

whether a double digit WACC could be defended.210                   But the evidence also

demonstrates that JPM approached its work without preconceptions or designs to

reach a desired result.211 JPM made no secret of its approach to calculating WACC

and walked the Board through that analysis in detail.212 Petitioners may not agree

209
      Id.
210
      JX 847.
211
    See JX 1680 (Gold Dep.) 47:24–48:2, 49:7–50:11; JX 1679 (Aiyengar Dep. Day 1)
327:16–330:6. I note that Aiyengar’s deposition testimony, proffered by Respondents,
along with the deposition testimony of other witnesses who testified at trial on
Respondent’s behalf, is admissible over Petitioners’ objection under either Court of
Chancery Rule 32(a)(4) or DRE 106. Court of Chancery Rule 32(a)(4) provides that “[i]f
only part of a deposition is offered in evidence by a party, an adverse party may require the
offeror to introduce any other part which ought in fairness to be considered with the part
introduced, and any party may introduce any other parts.” Delaware Rule of Evidence 106
provides that where a party introduces “a writing or recorded statement or part thereof . . . ,
an adverse party may require him at that time to introduce any other part or any other
writing or recorded statement which ought in fairness to be considered contemporaneously
with it.” After an analysis of the deposition testimony proffered by the Respondents in
response to Petitioners’ Post-Trial Brief, I find that each instance where Respondent cites
to the deposition testimony of Teffner, Svider, Aiyengar and Weinstein fits under the
“completeness” doctrine codified in Court of Chancery Rule 32(a)(3)(B) and DRE 106,
and is therefore admissible.
212
      JX 1086 at JPM00000203; JX 1158 at PETS_APP00001282.

                                              44
with that approach but there is simply no credible evidence that JPM set out to

manipulate its analysis to support a fairness opinion.213

         Petitioners also criticize JPM for utilizing the so-called “Barra beta,” which

Petitioners (and others) describe as a “‘black box’ form of forward-looking beta”

that is difficult, if not impossible, to verify.214             Contrary to Petitioners’

characterization of JPM’s process, however, the evidence reveals that, in addition to

considering Barra’s forward-looking beta, JPM considered “Barra predicted, Barra

historical, as well as relevered beta.”215

         Petitioners next criticize JPM for “artificially inflat[ing]” the betas it applied

by “arbitrarily” selecting PetSmart’s peer group and then selecting the betas of

companies in the lowest quartile of that group even though PetSmart had historically

213
      JX 605; JX 1086; JX 1158.
214
     JX 1679 (Aiyengar Dep. Day 1) 253:5–8; JX 79. “Barra is a company owned by MSCI,
Inc., that provides investment decision-making tools, including market indices and a beta
service.” In re Appraisal of DFC Global Corp., 2016 WL 3753123, at *8 n.89 (Del. Ch.
July 8, 2016). See JX 1698 (Dages-Opening) 40–42 (“Barra betas are rarely used by
academics to justify their beta estimates. I am unaware of any academic evidence that
Barra beta estimates are superior predictors of a stock’s future beta than are historical
estimates such as Bloomberg. Another problem with Barra betas is that they cannot be
unlevered and relevered to reflect the appropriate target capital structure. Therefore, a
peer-based beta derived from Barra betas can potentially reflect the risk of a capital
structure that is different than the operative capital structure of the company being valued.
. . . In addition, a commonly referenced valuation textbook cautions the use of Barra betas
because they are not replicable. I understand that, for those same reasons, Barra betas have
yet to be accepted by the Delaware Chancery Court.”) (citations omitted).

  See JX 1158 (JPM’s slide deck reflecting its WACC analysis relied upon Barra predicted
215

and historical betas); Trial Tr. 947:23–948:1 (Aiyengar).

                                             45
traded at a premium to its peers.216 Here again, Petitioners’ criticism recounts only

a portion of the evidence. First, the criticism glosses over the fact that PetSmart was

a niche retailer with only one true peer (Petco). Moreover, the complete evidentiary

picture reveals that, after conducting a “very detailed benchmarking analysis,” JPM

looked to the betas of companies that had “operating and financial statistics” that it

could meaningfully correlate with PetSmart’s operations, “numbers and

projections.”217

         While one can debate the results JPM reached, and can speculate whether JPM

would have arrived at the same place had it utilized different inputs in its valuation

analysis,218 there is no credible basis to debate whether JPM skewed its analysis to

push the Board to accept the BC Partners offer. The JPM analysis was thorough and

the results were objectively rendered.219

216
      Pet’rs’ Post-Trial Br. 72.
217
   JX 1682 (Aiyengar Dep. Day 2) at 412:9–413:15. See also JX 1682 (Aiyengar Dep.
Day 2) at 122:15–24, 243:8–245:1, 288:7–24, 320:3–10, 341:21–342:21, 673:24–675:10;
JX 534; JX 538.
218
   Trial Tr. 958:21–959:10 (Aiyengar) (agreeing that had JPM utilized a lower WACC it
could not have rendered its fairness opinion).
219
   I also find no basis to accept Petitioners’ contention that JPM labored under disabling
conflicts. Pet’rs’ Post-Trial Br. 74. JPM’s previous work with Petco was disclosed to the
PetSmart Board and, if anything, it was deemed as a benefit not a conflict. Trial Tr.
203:21–204:6 (Teffner). JPM’s prior relationships with potential private equity buyers,
including those that actively participated in the process, was correctly deemed by the Board
to be a “fact of business life.” See In re Dollar Thrifty S’holder Litig., 14 A.3d 573, 582
(Del. Ch. 2010) (noting that it is “one of the facts of business life that most of the top, if
not all, banks have relationships with the major private equity firms.”); Trial Tr. 484:22–
                                             46
         Aiyengar shared her view during the December 13 Board meeting that the

PetSmart auction had been “a robust auction process, where anybody who had an

interest in this company had the opportunity to engage with the company and see

whether they wanted to buy the company.”220 The Board then weighed the $83 per

share offered by BC Partners generated by this process against the Company’s

prospects if it remained standalone.221 In its deliberations, the Board considered the

aggressiveness of the Management Projections, which it felt were heavily dependent

on a number of factors breaking the Company’s way all of which were subject to

much speculation and volatility.222 After weighing all options, the Board decided to

take the $83 per share offered by BC Partners, as this was a “certainty,” rather than

confront the “risk of trying to get something more than $83 if [PetSmart] were a

23 (Gangwal) (testifying that he “knew that [JPM] would have many, many” relationships
with private equity firms). Nor is there a basis in the evidence to find that JPM misled the
Board regarding potential conflicts. See Pet’rs’ Post-Trial Br. 75. The evidence to which
Petitioners refer in support of this contention, JX 1251, upon careful reading, says no such
thing.
220
      Trial Tr. 925:12–15.
221
      See JX 1336 at 27; Trial Tr. 439:4–441:9 (Gangwal).
222
   JX 1336 at 27 (In considering the achievability of the Management Projections, the
Board considered, inter alia, “the risks associated with executing on [PetSmart’s] business
plans, including that [PetSmart’s] business plans and Profit Improvement Plan [were]
based, in part, on projections . . . dependent on a number of variables, including economic
growth, same-store-sales growth, ability to execute on store expansion plans, and overall
business performance that are difficult to project and are subject to a high level of
uncertainty and volatility.”).

                                             47
stand-alone.”223 This decision reflected the Board’s pessimism that management

would be able to deliver on their plans and its view that such efforts likely would not

yield more than the $83 per share that had been achieved through the sales process.224

The Board unanimously voted to approve and recommend the Merger with

BC Partners at the conclusion of the December 13 meeting.225 It announced the

transaction and signed the Merger Agreement the following day.226

            The $83 per share was $1.50 higher than what the next highest bidder, Apollo,

had offered. Indeed, Apollo told JPM after the process concluded that it “never

would have paid that price” for PetSmart.227 Several financial analysts also were

surprised and impressed by the price achieved in the auction.228 While PetSmart was

covered by more than a dozen securities analysts, the consensus price target for

223
   Trial Tr. 440:23–441:2 (Gangwal). See also JX 1336 at 26–27 (proxy statement
summarizing the Board’s reasons for recommending the merger to stockholders).
224
      Trial Tr. 439:16–441:9 (Gangwal).
225
      JX 1336 at 26.
226
      Id.
227
    Trial Tr. 908:9 (Aiyengar). I have considered this hearsay testimony only as evidence
of the state of mind of the declarants, not for the truth of the matter asserted. DRE 803(3).
228
    JX 1188; JX 1187; JX 1185. In addition to DRE 803(3), these analyst reports are
admissible under DRE 703 as they were relied upon by Professor Metrick in formulating
his opinion and are “of a type” of information “reasonably relied upon by experts” in the
valuation field. They have “help[ed] the [Court] understand [the] expert’s thought process
and determine what weight to give [the] expert’s opinion.” Towerview LLC v. Cox Radio,
Inc., 2013 WL 3316186, at *2 (Del. Ch. June 28, 2013) (applying DRE 703).

                                              48
PetSmart in the year preceding the Merger, even after the PIP was disclosed, never

exceeded $75 per share.229

         PetSmart’s definitive proxy statement, filed with the SEC on February 2, 2015

(the “Proxy”), disclosed the Management Projections as well as the JPM

sensitivities.230 When introducing the projections, the Proxy disclosed that the

Company had not historically prepared long-term projections in the ordinary course

of its business and that it was “wary” of doing so.231 The Board wanted stockholders

to have the Management Projections because they had been utilized by the Board,

JPM, and the bidders.232 But the Proxy made clear that the Board was cautioning

stockholders not to place undue reliance on the projections.233 With regard to the

JPM sensitivities, the Proxy disclosed that these had been prepared by JPM “to assist

229
   See JX 1703 (Metrick-Rebuttal) at 71. See also JX 1697 (Metrick-Opening) at Ex. 8
(providing monthly summary of analyst price targets for PetSmart stock from January 2012
to March 2015).
230
      JX 1336 at 35–36, 38–39.
231
      Id. at 37–38.
232
    Id. The Proxy “included a summary of [the Management Projections] . . . to give
stockholders access to certain nonpublic information provided to [the PetSmart Board] and
J.P. Morgan for purposes of considering and evaluating the Company’s strategic and
financial alternatives, including the merger.” Id.
233
    Id. at 38 (“Readers . . . are cautioned not to place undue reliance on the [projections
found in the Proxy].”). See also Trial Tr. 324:7–15 (Teffner) (“The proxy had disclaimer
statements in there with respect to projections . . . to explain that these are projections” and
therefore speculative.).

                                              49
the board in assessing the potential downside risks that could arise from reasonable

deviations in the assumptions underlying the [Management] Projections.”234

         After the announcement of the transaction, and the disclosure of the

Management Projections in the Proxy, no topping bids emerged and no further

inquiries about PetSmart surfaced before the Merger closed.235 The stockholder vote

on March 6, 2015, overwhelmingly favored the Merger; 99.3% of voting shares of

PetSmart voted in favor of the transaction, representing 77.4% of the 99,455,151

outstanding common shares.236 The Merger closed on March 11, 2015.237

      L. BC Partners Creates its Plan for PetSmart

         As one would expect, BC Partners formulated a plan to turnaround PetSmart

throughout the auction process so it could hit the ground running should it win the

bid. It engaged Michael Massey, the former CEO of Collective Brands, former

President of Payless, Inc. and current director of Office Depot, to provide counsel as

it pursued its goal (as reported to investors) of making a significant retail

234
      JX 1336 at 39.
235
   See Trial Tr. 926:5–7 (Aiyengar) (“[T]here was nobody who called after the deal was
announced really, other than to say congratulations for getting such a good price.”).
236
      PTO ¶¶ 3–4; JX 1496.
237
      PTO ¶ 5.

                                         50
acquisition.238 When looking at PetSmart, Massey believed the Company lacked a

clear strategy or understanding of its customers, meaning it was ripe for a

turnaround.239 BC Partners also believed that PetSmart had been “undermanaged,”

but that these management problems had been masked historically by “the strength

of underlying market growth” in the pet specialty industry.240 BC Partners’ strategic

hypothesis was that PetSmart’s performance slowed when the underlying growth

trends in the pet specialty industry slowed. It posited that PetSmart could be revived

with a new management team, headed by Massey, who would implement a series of

new revenue and cost initiatives.241

         In performing its due diligence, BC Partners engaged Boston Consulting

Group to speak to PetSmart’s vendors on its behalf.242 It also spoke directly to

several former PetSmart executives and consultants.243 With this information in

hand, BC Partners was confident that the Management Projections were not

238
      See JX 779; JX 931.
239
      JX 779; Trial Tr. 1011:6–23 (Massey).
240
      JX 1060 at BC00105547.
241
      JX 1060 at BC00105547–49, 560, 617–21; Trial Tr. 739:9–742:1 (Svider).
242
      Trial. Tr. 833:15–838:16 (Svider).
243
      Trial Tr. 827:4–833:4, 838:21–841:2 (Svider).

                                              51
achievable, at least not with PetSmart’s current management in place.244 Therefore,

when evaluating PetSmart, BC Partners developed its own “BCP Case.”245 The BCP

Case projected lower total revenues, year-over-year total sales growth and fewer new

store openings from 2014 to 2019.246 These projections were included in the equity

syndication memo that BC Partners sent to potential investors.247 BC Partners told

its potential investors that its case was conservative, with room for significant

upside.248

            Massey also created his own set of projections based on his plans for running

PetSmart (the “Massey Case”), which included the implementation of his proposed

cost and revenue initiatives which he hoped would help drive up EBITDA.249

Massey told BC Partners’ equity investors that these projections were conservative

and that he was very confident they could be achieved.250 The projected cash flows

244
      Trial Tr. 746:9–15 (Svider).
245
      Id.
246
      Compare JX 1060 at BC0010552 with JX 807 at PETS_APP00000692–94.
247
      JX 1065 at 80.
248
      JX 1065 at 83.
249
      JX 1060 at BC00105546; JX 1132; Trial Tr. 739:9–740:11 (Svider).
250
      JX 1238 at 29, 48; Trial Tr. 1125:8–1127:23 (Massey).

                                              52
from the Massey Case were higher than those in the Management Projections by

$192 million.251

         BC Partners also prepared the “Bank Case” with the help of PetSmart’s

management after the signing of the Merger Agreement252 in order to solicit debt

financing for the transaction253 and present to ratings agencies so they could rate the

bonds BC Partners would issue in connection with the transaction.254 The Bank Case

was designed to be conservative; it assumed, for instance, that PetSmart would have

no new store openings in later years.255

      M. PetSmart’s Performance in the Period Leading Up To The Stockholder
         Vote and Post-Closing

         Beginning in December of 2014, preliminary estimates suggested that

PetSmart was outperforming the forecasts in the Management Projections for items

such as comparable store sales, comparable transactions and earnings per share.256

251
      Trial Tr. 526:14–19 (Dages).
252
      PTO ¶ 309; Trial Tr. 360:22–361:15 (Teffner).
253
      PTO ¶ 311; Trial Tr. 362:9–16 (Teffner).
254
   PTO ¶ 309; Trial Tr. 363:17–20 (Teffner). “Bank Case” is a term of art in the LBO
industry to describe projections meant to reflect a company’s post-acquisition capacity to
service its debt. They are heavy on cash flows and light on growth. Trial Tr. 692:3–15
(Dages).
255
      Trial Tr. 639:2–8 (Dages); Trial Tr. 373:14–18 (Teffner).
256
      JX 1280; JX 1411 at 17.

                                              53
When PetSmart released its Q4 2014 results on March 4, 2015––seven days before

the close of the transaction––it revealed that its operating income EBIT beat its

projections by 5.4%.257 PetSmart also adjusted its non-GAAP adjusted diluted

earnings per share estimate up to $1.43, exceeding its guidance and the $1.28 per

share achieved for the prior year period.258 PetSmart’s comparable store sales grew

from -.05% in Q2 2014, to flat in Q3 2014, to +2.6% in Q4 2014.259 Revenue

similarly grew from 1.4% in Q2 2014, to 2.6% in Q3 2014, to 6% in Q4 2014.260

            The Merger Agreement was signed in the middle of Q4 2014, and Lenhardt,

Teffner and Gangwal all testified that PetSmart’s favorable Q4 performance did not

change their views about the long-term prospects of the Company.261 Indeed, in

Q1 2015 (the quarter in which the Merger closed), PetSmart’s comparable store sales

growth dropped to 1.7%,262 and remained below 2% throughout 2015.263

257
      JX 1350 at 12.
258
      JX 1447; Trial Tr. 1385:21–23 (Metrick).
259
      JX 630; JX 983; JX 1476.
260
      Id.
261
  Trial Tr. 272:18–274:19 (Teffner); Trial Tr. 447:4–11 (Gangwal); JX 1684 (Lenhardt
Dep.) 63:10–65:19, 331:21–332:25.
262
      JX 1598 at PETS_APP00842050.
263
   Id.; JX 1619 at PETS_APP00820988; JX 1656 at PETS_APP00821452. See also Trial
Tr. 1057:6–9 (Massey).

                                             54
         After the closing of the Merger, Lenhardt resigned and Massey became

PetSmart’s new President and CEO.264 Massey quickly installed a new management

team, changed PetSmart’s organizational structure and created a new strategy for

PetSmart based on his own revenue and cost initiatives.265 While Massey used the

Management Projections solely for purposes of management compensation,266 his

team created a new set of multi-year projections in July 2015.267

         In 2015, PetSmart achieved $7.2 billion in total sales and $982.1 million in

EBITDA.268 PetSmart’s comparable store sales growth, however, came in at 0.9%,

missing the projected 1.5% growth forecast in the Management Projections by

264
      JX 1508.
265
    Trial Tr. 741:19–742:19 (Svider); Trial Tr. 1051:15–1055:13 (Massey). These new
initiatives were informed by updated reports from PetSmart’s consultants who identified
for Massey additional savings they believed could be achieved. See Trial Tr. 348:16–350:6
(Teffner); JX 2022 at 5; JX 1286 at 18; PTO ¶ 388–393. See also JX 1286 at 7; Trial Tr.
342:24–346:16 (Teffner); JX 1684 (Lenhardt Dep.) 324:14–23.
266
      Trial Tr. 750:2–5, 750:14–22 (Svider).
267
      JX 1590 at PETS_APP00821375.
268
    JX 1656 at PETS_APP00821450–51, 57. I appreciate that PetSmart’s post-closing
performance is not relevant when assessing the Company’s operational reality at the point
of valuation––the date the merger closed. Cede & Co. v. Technicolor, Inc., 758 A.2d 485,
499 (Del. 2000). Petitioners argue, however, that PetSmart’s post-closing performance is
probative of the reliability of the management projections. I have considered this post-
merger evidence for this limited purpose. See id. (holding that a court may consider post-
merger evidence to the extent it relates to the validity of projections prepared prior to the
merger).

                                               55
40%.269 According to Massey, in 2016 year-to-date, the comparable store sales

growth was -0.2%, in comparison to the projected growth in the Management

Projections.270 The Company’s EBITDA, however, exceeded the 2015 Management

Projections by $200 million by the end of FY 2015.271 In February 2016, PetSmart

was able to issue a dividend of $800 million which constituted a 38% return on

invested capital.272

      N. Procedural Posture

            Petitioners seek appraisal for 10,713,225 shares of common stock of

PetSmart, 9,541,372 of which were acquired after the record date of the Merger.273

Six appraisal petitions were filed on March 12 and 13, 2015, and all were

consolidated by order dated April 30, 2015.274 A trial was held October 31 to

November 3, 2016. I heard post-trial oral argument on February 28, 2017, following

post-trial briefing.

269
      Id.
270
      Trial Tr. 1057:6–9 (Massey).
271
      Trial Tr. 1119:16–20 (Massey); JX 1643 at 4; JX 1637 at 2.
272
      JX 1637 at 2; PTO ¶ 352; JX 1627 at 6.
273
      PTO ¶¶ 15–16, 18, 24–29, 31, 36–43, 45, 51, 53, 60–61, 63, 69–71.
274
      PTO ¶¶ 6–7.

                                               56
         Petitioners and Respondent both presented two experts at trial: one to address

the reliability of the Management Projections and the other to address the fair value

of PetSmart at the time of the Merger. I summarize their opinions briefly below.

         1. The “Projections” Experts

         Mark A. Cohen served as Petitioners’ retail expert.275 He focused on the

credibility of the Management Projections and the outlook of PetSmart’s business

going forward.276 Based on his analysis of the pet retail industry and PetSmart’s

prior performance, Cohen believes that PetSmart hit a “speed bump” just prior to the

initiation of the sales process from which the Company would have rebounded.

According to Cohen, PetSmart was not facing long-term growth issues.277 He also

opined that the Management Projections were created in line with industry standards

and were reliable estimates of the Company’s future cash flows.278

275
      JX 1692 (Cohen-Opening) at 1–3, App. 8–9.
276
    Cohen holds a B.S. in Electrical Engineering as well as a M.B.A. from Columbia
University. He has an extensive history working in the retail industry, having worked for
Abraham & Strauss, Gap Stores, Lord & Taylor, Mervyns Stores, Federated Department
Stores, Bradlees Inc. and Sears Roebuck & Co. He served as Chairman and CEO of Sears
Canada Inc. from 2001 to 2004. Since 2005, he has served as the Director of Retail Studies
and Adjunct Professor of Retailing at Columbia University’s Business School, maintains
an independent consulting practice, and serves as a contributor for several news outlets.
JX 1692 (Cohen-Opening) at 1–3.
277
      See JX 1692 (Cohen-Opening) at 28, 30, 33, 35–37.
278
   Id. at 38 (“PetSmart’s 5-year financial projections were reasonably and reliably prepared
in a manner consistent with industry standards.”).

                                            57
            Mark Weinsten was retained by Respondent to provide an expert opinion on

the Management Projections and related business plans created by the PetSmart

management during the sales process.279 Weinstein opined that the Management

Projections were overly aggressive, overly optimistic and wholly unreliable.280 In

support of this opinion, he pointed to the facts that PetSmart’s management was

newly installed when they were directed to create the projections, they had no

experience in creating long-term projections of future cash flows and they could not

look to past examples of projections within PetSmart for guidance since PetSmart

historically did not create long-term projections.281        In those instances where

management attempted to forecast future performance, even for quarterly forecasts,

the Company regularly would underperform.282

279
    Weinsten holds a B.S. in economics from Carnegie-Mellon University and an M.B.A.
from the Wharton School at the University of Pennsylvania. He is a Managing Director in
the Corporate Finance Group at Berkeley Research Group, a global strategic advisory firm.
His practice focuses on turnarounds and restructurings, and he specializes in serving in
interim executive positions during transition phases. Prior to joining Berkeley Research
Group, Weinsten served as Senior Managing Director in the Corporate Finance &
Restructuring practice of FTI Consulting, Inc. JX 2307 (Weinsten-Opening) at 1–6,
App. A.
280
      See id. at 6–7.
281
      Id.
282
    Id. at 42 (“Starting in 2013 through first half of 2014, Management had underperformed
its quarterly forecasts––even short-term forecasts). See also id. at 43, Ex. 15.

                                            58
      According to Weinsten, the Management Projections were all the more

sketchy given that they were prepared largely as top down forecasts, an approach

not consistent with industry best practices, and were prepared specifically for a sales

process with Board pressure to be more and more aggressive.283 He also found

specific areas of concern regarding the achievability of the forecasts, which included

the comparable store sales growth projections and the ability of management

successfully to execute on its overall business plans.284

      2. The Valuation Experts

      Petitioners’ valuation expert was Kevin Dages.285 Dages determined that a

DCF analysis based on the Management Projections is the most reliable indicator of

283
   Id. “Top down is driven by management and starts with overarching goals, such as 3%
revenue growth and 10% gross margin expansion, which are then pushed down to targets
and quotas that are assigned down to employees. Bottoms up planning starts with teams
of employees who develop plans for initiatives to improve the business, which are then
passed on to management for review and approval and the aggregate result of all initiatives
drives the overall company goals and targets. . . . [B]ottoms up planning typically yields
more realistic and reliable results as it involves detailed planning by the people who will
be responsible for executing on the initiatives.” Id. at 45.
284
   Id. at 53 (“[I]t would have been difficult for Management to achieve the turnaround in
comparable store sales growth reflected in the [Management Projections.]”); id. at 84 (“The
ability to execute a plan hinges upon three critical components—people, processes and
tools. At the time of development of the [Management Projections], PetSmart faced
challenges with respect to all three components.”).
285
   Dages is well-known to this Court. He holds a B.B.A. in accounting from the University
of Notre Dame and is a Certified Public Accountant. He is an Executive Vice President of
Compass Lexecon, a consulting firm specializing in the application of economics to legal
and regulatory issues. JX 1698 (Dages-Opening) at 1.

                                            59
the fair value of the Company. Based on his DCF analysis, Dages concluded that

the fair value of PetSmart’s common stock as of the date of the Merger was $128.78

per share.286 Dages relied upon the Management Projections in all respects for his

DCF analysis based upon Cohen’s opinion that the projections “were reasonably and

reliably prepared in a manner consistent with industry standards,” as well as his own

opinion that the Management Projections “represent the most reasonable set of

projections [available] as to PetSmart’s future performance.”287                   Dages also

acknowledged, however, that “once [he] signed onto the opinion of where the fair

value is . . . based on these projections,” he was, “at the end of the day,” tied to the

projections.288 On the other hand, Dages recognized that if the Court finds that the

Management Projections are not reliable, then it should not rely on his DCF

286
    In his DCF analysis, Dages used a perpetual growth rate of 2.25%, a WACC of 7.75%
and a required investment in the terminal period of $47 million. JX 1698 (Dages-Opening)
at 32–33; JX 1704 (Dages-Rebuttal) at Ex. 6D.
287
   JX 1698 (Dages-Opening) at 25–26. Dages noted, however, that “I’m not a retail guy
so I didn’t start with this is absolutely the right set of projections to go with, because I—
you know, that’s not my expertise.” JX 1712 (Dages Dep.) 157:6–11.
288
    JX 1712 (Dages Dep.) 155:20–157:22 (Dages further explained that the Management
Projections were “the best set of projections for me to start with and to examine
sensitivities, and to then . . . reach an opinion about fair value, and since the opinion on fair
value is based on this set of projections, then yes, I believe I’m wed to [the] answer [that
the Management Projections are the best estimate of PetSmart’s future performance]. . . .
If my opinion was based on the 80 percent PIP scenario, then I think I would be telling you
that the 80 percent PIP scenario is the best estimate of performance.”).

                                               60
valuation because that analysis assumed the accuracy of those projections.289 Stated

differently, “[g]arbage in, garbage out.”290

         Dages performed a WACC-based DCF analysis in which he discounted the

Company’s free cash flows back to present value using the Company’s weighted

average cost of capital and then subtracted the value of the Company’s debt to

determine the value of its equity.291 He also ran the BCP Case, Massey Case and

Bank Case through his DCF model—which, notably, all produced higher values than

the DCF based on the Management Projections.292 In Petitioners’ rebuttal case at

trial, Dages presented a new DCF analysis he ran during trial based on the JPM

sensitivities.293 This exercise yielded a value ranging from $102.82 to $112.90 per

share.294

289
      Trial T7r. 624:14–19 (Dages).
290
      Trial Tr. 624:6–13 (Dages).
291
      JX 1697 (Metrick-Opening) at 107.
292
   See Trial Tr. 554:6–556:21 (Dages). Using the BCP Case, Dages came up with a value
of $137.00 per share. Pet’rs’ DX1 at 66. With the Massey Case, Dages arrived at a value
of $138.87 per share. Id. The Bank Case produced a value of $138.04 per share. Id.
293
      Trial Tr. 1412:9–17 (Dages).
294
      Trial Tr. 1413:7–1420:12 (Dages); Pet’rs’ DX2 at 1; Pet’rs’ DX3 at 1; Pet’rs’ DX4 at 1.

                                              61
          Dages rejected the $83 per share deal price as a reliable indicator of fair value

for three main reasons.295 First, he believed the Merger Price was stale due to the

three-month lag between the signing and closing of the deal.296 Second, he believed

“the Board did not receive accurate or reliable valuation advice from J.P. Morgan”

because JPM’s DCF analysis was “results-driven” and biased.297 Finally, he found

that the Merger Price was depressed due to the exclusion of Petco, the most logical

strategic buyer, from the PetSmart auction, resulting in the participation of only

financial bidders.298

          Respondent’s valuation expert was Andrew Metrick.299              According to

Metrick, the Merger Price of $83 per share, achieved after a well-run active auction,

is the most reliable indicator of PetSmart’s fair value at the time of the Merger.300

While he acknowledged that DCF is considered by many to be the “gold standard”

295
      See JX 1704 (Dages-Rebuttal) at 3.
296
      Id. at 6.
297
      Id. at 10.
298
      Id. at 14–23.
299
   Metrick is also no stranger to this Court. He holds a Ph.D. and A.M. from Harvard
University and a M.A. and B.A. from Yale University. He is currently the Michael H.
Jordan Professor of Finance and Management at the Yale School of Management. Prior to
that, he was on the faculty at the Wharton School at the University of Pennsylvania and at
Harvard University, and served as Senior Economist and Chief Economist for the Council
of Economic Advisers in Washington, D.C. JX 1697 (Metrick-Opening) at 2.
300
      Trial Tr. 1244:14–1245:23 (Metrick).

                                              62
of valuation tools, Metrick found that DCF was misleading here since the primary

data input, the Management Projections, were entirely unreliable.301 He explained

that, for the purposes of a DCF analysis, “one must use the ‘expected’ (as opposed

to ‘hoped for’) future cash flows of the business.”302 Based on his review of the

evidence, Metrick opined that the Management Projections were unreliable because

they were prepared specifically for the sale process (not in the ordinary course of

business) by inexperienced management who were pushed to be overly optimistic.303

          Nevertheless, for the sake of completeness, Metrick did perform a DCF

analysis, but not with the Management Projections. Instead, he utilized his own

adjustments to the revenue forecasts, starting with the JPM sensitivities.304 He did

not believe that PetSmart could achieve the $200 million in cost savings from the

PIP indefinitely into the future, as projected by management, so he adjusted the

projected PIP savings to decline linearly beginning three years after the savings are

assumed to be fully realized, with only $59 million remaining in the terminal

period.305

301
      Trial Tr. 1241:3–17, 1244:14–1245:8 (Metrick).
302
      JX 1697 (Metrick-Opening) at 60.
303
      Id. at 101–02.
304
      Id. at 102.
305
      Id. at 103.

                                            63
          After adjusting the Management Projections, Metrick created an APV-based

DCF model that discounts the Company’s free cash flows by the Company’s

unlevered cost of equity, adds the benefits of a tax shield obtained from the

Company’s debt, and then subtracts the value of the debt to determine the

Company’s equity value.306 Metrick’s DCF analysis resulted in a fair value of

$81.44 per share. According to Metrick, his DCF valuation simply corroborates the

most reliable indicator of PetSmart’s fair value—the $83 per share Merger Price that

followed a “deal process where (1) the sale [was] well publicized, (2) there [were]

multiple bidders and a large number of interested parties, and (3) the incentives of

the Board and management [were] aligned with those of the stockholders.”307

          Metrick asserts that his opinion regarding the fair value of PetSmart at the

Merger Price is bolstered by the following confirmatory analyses: (1) his DCF

analysis resulting in a value of $81.44 per share; (2) the fact that “[a]t no point prior

to PetSmart’s acquisition did its shares trade at or above $83 per share”; (3) the fact

that “[a]t no point prior to the consummation of the transaction did analysts’ average

price target of PetSmart exceed $83 per share”; (4) a “valuation of PetSmart based

on the trading multiples of comparable companies ranges from $70 to $112, with a

306
   Id. at 107–08. In his DCF analysis, Metrick used a 2% terminal growth rate, a WACC
of 6.35% and a required investment in the terminal period of $222 million. Id. at 117–18,
Ex. 21, Ex. 23.
307
      Id. at 142.

                                           64
value below $91 (the median) [being] more appropriate based on PetSmart’s

operating metrics relative to the peers”; (5) a “valuation of PetSmart based on the

recent acquisition of Petco is $69”; and (6) a “valuation of PetSmart based on prior

transactions involving retailers ranges from $59 to $74.”308

            After trial, Metrick submitted a supplemental report to respond to Dages’s

DCF analysis based on the JPM sensitivities.309          He determined that Dages’s

valuations corresponding to the sensitivities “are inflated significantly due to (i) an

assumption that PetSmart has no fixed costs, meaning margins are unchanged as

revenue declines in moving from the [Management Projections] to [the JPM

sensitivities], and (ii) [the] failure to adjust the discount rate to reflect the lease

treatment embedded in the cash flows.”310 Correcting for these errors, Metrick

derived valuations from the JPM sensitivities ranging from $82.79 to $86.96.311

            The driving difference in the valuations produced by Dages and Metrick can

be traced most directly to the different projections of expected cash flows on which

they rely.312 Unlike many appraisal cases litigated in this court, the inputs utilized

308
      Id.
309
      JX 2315 (Metrick-Supplemental).
310
      Id. at 2.
311
      Id.
312
    See Trial Tr. 1272:2–5 (Metrick) (“In this particular case, Mr. Dages and I approached
it in a broadly similar way and ended up with discount rates that were fairly similar.”);
                                            65
by the valuation experts involved here are relatively close. But there are differences.

Metrick capitalized all of PetSmart’s current leases, 313 while Dages maintained the

characterization of the leases from PetSmart’s financial statements.314 The experts

agreed, however, that as long as the leases are treated consistently throughout the

valuation analysis, the manner in which the leases are characterized should not affect

the valuation substantially.315 The other large difference between the two models is

the terminal investment required.316 Metrick used a model out of a McKinsey & Co.

JX 1704 (Dages-Rebuttal) at 4 (“Assuming the Court agrees that PetSmart’s Management
Projections are the appropriate basis for a fair value calculation, the range of expert
opinions of fair value based on a DCF analysis would be $128.78 to $133.94 per share,
with the $133.84 per share DCF value resulting from Professor Metrick’s WACC and
terminal period growth assumptions and the lower $128.78 per share DCF value coming
from [Dages’s] analysis.”); JX 2028 (Metrick Dep.) 639:11–14 (“Q. But if I put the
[Management Projections] through your model and his model, if we use the same models,
we are going to come very, very close; correct? A. That is correct.”). See also JX 1704
(Dages-Rebuttal) at 23 (“The heart of any free cash flow-based valuation analysis—either
a WACC-based DCF or an APV-based DCF model – is the underlying financial forecast.”).
I note that while Dages uses a WACC-based DCF and Metrick uses an APV-based DCF,
if the analyses are performed correctly, both models should yield substantially the same
result. Trial Tr. 1274:9–15 (Metrick); JX 1704 (Dages-Rebuttal) at App. A ¶ 1. The two
experts are also “in general agreement regarding the appropriate levered beta,” though
Dages derives his beta estimate from PetSmart’s historical data and peer betas while
Metrick combined the historical beta for PetSmart with an industry average. JX 1703
(Metrick-Rebuttal) at 34.
313
      Trial Tr. 1303:8–1304:3 (Metrick); Trial Tr. 636:6–15 (Dages).
314
      Trial Tr. 1371:24–1372:5 (Metrick); Trial Tr. 636:6–15 (Dages).
315
      See JX 2028 (Metrick Dep.) 639:5–10.
316
    See Trial Tr. 1302:16–20 (Metrick) (“But that essentially—this boils down the
difference. On the DCF, we have a lot of things that are the same, but ultimately we
                                             66
textbook to calculate the amount of investment necessary at the terminal period to

support the projected growth during the terminal period, arriving at an investment

rate of 28.6% in the terminal period.317 This results in a required investment of $222

million.318      Dages adopted the required terminal investment found in the

Management Projections of $47 million.319

                                     II.     ANALYSIS

         Petitioners and Respondent present two vastly different valuations of

PetSmart as of the date of the Merger based on two binary views of the most reliable

means by which to determine fair value––deal price versus a discounted cash flow

analysis. The vast delta between the valuations generated by the parties’ proffered

methodologies raises red flags and suggests, perhaps, that neither is truly reflective

of PetSmart’s fair value. As the Court undertakes to discharge its duty (or burden)

independently to determine fair value, therefore, the temptation to strike a balance

between the competing positions is undeniable. The $4.5 billion that separates the

parties certainly leaves much room for compromise. But the unique structure of the

disagree about what the right model is for this company in the long-run and what will
happen to their returns.”).
317
      Trial Tr. 1305:20–1307:21 (Metrick).
318
      Trial Tr. 1367:15–1369:4 (Metrick).
319
      Trial Tr. 572:22–574:10 (Dages); JX 1704 (Dages-Rebuttal) at Ex. 6D.

                                              67
appraisal proceeding should not obscure the reality that the process is adversarial;

the parties have presented evidence; and the Court’s fact-finding and decision-

making must be evidence based. Nor should the Court jump to the conclusion that

both parties’ valuations are off the mark simply because their positions on fair value

are so incredibly divergent. Rather, the Court’s first task, as I see it, is to drill down

on the parties’ positions to see if they are grounded in the evidence and in sound

methodology. That assessment will take the Court a long way down the road of

fulfilling its function to appraise the fair value of the shares of PetSmart. Only then

can the Court discern the extent to which further valuation analyses may be required.

      A proper examination of the parties’ competing positions reduces to the

following questions: (1) was the transactional process leading to the Merger fair,

well-functioning and free of structural impediments to achieving fair value for the

Company; (2) are the requisite foundations for the proper performance of a DCF

analysis sufficiently reliable to produce a trustworthy indicator of fair value; and

(3) is there an evidentiary basis in the trial record for the Court to depart from the

two proffered methodologies for determining fair value by constructing its own

valuation structure? I take up these questions below. But first I address the statutory

framework within which the Court must operate.

                                           68
      A. The Legal Standard for Appraisal

            This action for appraisal is governed by the Delaware appraisal statute, which

directs that the Court

            Appraise the shares, determining their fair value exclusive of any
            element of value arising from the accomplishment or expectation of the
            merger or consolidation, together with a fair rate of interest, if any, to
            be paid upon the amount determined to be the fair value. In determining
            such fair value, the Court shall take into account all relevant factors.320

The purpose of an appraisal action is to “provide equitable relief for shareholders

dissenting from a merger on grounds of inadequacy of the offering price.”321 The

court’s prescribed task is to determine the fair value of the dissenters’ shareholdings

as of the date of the merger.322

            Appraisal is not subject to “structured and mechanistic procedure.”323 It is

“by design, a flexible process.”324 Accordingly, there are no presumptions in

320
      8 Del. C. § 262(h).
321
      Cede & Co. v. Technicolor, Inc., 684 A.2d 289, 296 (Del. 1996).
322
      Id.
323
      Weinberger v. UOP, Inc., 457 A.2d 701, 713 (Del. 1983).
324
   Golden Telecom, Inc. v. Global GT LP, 11 A.3d 214, 218 (Del. 2010) (declining to
adopt a rule requiring this Court to defer to the deal price in appraisal proceedings). See
also id. (reiterating that appraisal is designed to be a flexible process and “declin[ing] to
adopt a rule that binds public companies to previously prepared company specific data in
appraisal proceedings,” noting that the statute provides this Court with “significant
discretion”).

                                                69
Delaware appraisal law that favor one valuation approach over another.325 Instead,

the fair value determination, by statutory design and mandate, must take into account

“all relevant factors.”326 Every company is different; every merger is different.327

These differences are enriched with “relevant factors” that must be accounted for in

the search for fair value.

         In the unique design of statutory appraisal, “[b]oth parties ‘have the burden of

proving their respective valuation positions by a preponderance of the evidence.’”328

325
     See Union Ill. 1995 Inv. Ltd. P’ship v. Union Fin. Gp., Ltd., 847 A.2d 340, 356–57 (Del.
Ch. 2003) (“As I perceive it, I am free to consider all non-speculative elements of value,
provided that I honor the fair value definition articulated by the Delaware Supreme Court.
. . . I am empowered to come up with a valuation, drawing on what I reasonably conclude
is the most reliable evidence of value in the record.”).
326
      8 Del. C. § 262(h).
327
    See Merion Capital L.P. v. Lender Processing Servs., Inc., 2016 WL 7324170, at *16
(Del. Ch. Dec. 16, 2016) (recognizing that “[t]he relevant factors can vary from case to
case depending on the nature of the company, the overarching market dynamics, and the
areas on which the parties focus. . . . An argument may carry the day in a particular case
if counsel advance it skillfully and present persuasive evidence to support it. The same
argument may not prevail in another case if the proponents fail to generate a similarly
persuasive level of probative evidence or if the opponents respond effectively.”).
328
    Highfields Capital, Ltd. v. AXA Fin., Inc., 939 A.2d 34, 42 (Del. Ch. 2007) (quoting
M.G. Bancorp., Inc. v. Le Beau, 737 A.2d 513, 520 (Del. 1999)). See also Lender
Processing, 2016 WL 7324170, at *12 (“Each party also bears the burden of proving the
constituent elements of its valuation position by a preponderance of the evidence, including
the propriety of a particular method, modification, discount, or premium. If both parties
fail to meet the preponderance standard on the ultimate question of fair value, the Court is
required under the statute to make its own determination.”) (quoting Jesse A. Finkelstein
& John D. Hendershot, Appraisal Rights in Mergers & Consolidations, 38–5th C.P.S.
§§ IV(H)(3), at A-89 to A-90 (BNA)).

                                             70
If neither party carries this burden, however, “the court must then use its own

independent judgment to determine fair value.”329

      B. Did the Auction for PetSmart Yield Fair Value?

         “The concept of fair value under Delaware law is not equivalent to the

economic concept of fair market value.”330 It is, rather, “a jurisprudential concept

that draws more from judicial writings than from the appraisal statute itself.”331 The

focus of the fair value calculation is on “the value of the company as a going concern,

rather than its value to a third party as an acquisition.”332 Even so, in certain cases,

based on the evidence presented, the fair market value for a company may be the

best and most reliable indicator of fair value.333 But this will only be so where the

evidence reveals a market value “forged in the crucible of objective market

329
Taylor v. American Specialty Retailing Gp., Inc., 2003 WL 21753752, at *2 (Del. Ch.
July 25, 2003).
330
   Lender Processing, 2016 WL 7324170, at *13 (quoting Finkelstein, 2005 WL 1074364,
at *12).
331
      Del. Open MRI Radiology Assoc., P.A. v. Kessler, 898 A.2d 290, 310 (Del. Ch. 2006).
332
      M.P.M. Enters., Inc. v. Gilbert, 731 A.2d 790, 795 (Del. 1999).
333
     See, e.g., Lender Processing, 2016 WL 7324170, at *33; Merion Capital LP v. BMC
Software, Inc., 2015 WL 6164771, at *18 (Del. Ch. Oct. 21, 2015); LongPath Capital, LLC
v. Ramtron Intern. Corp., 2015 WL 4540443, at *24 (Del. Ch. June 30, 2015); Merlin P’rs
LP v. AutoInfo, Inc., 2015 WL 2069417, at *11 (Del. Ch. Apr. 30, 2015); Ancestry.com,
2015 WL 399726, at *24; Huff Fund Inv. P’ship v. CKx, Inc., 2013 WL 5878807, at *15
(Del. Ch. Nov. 1, 2013), aff’d, 2015 WL 631586 (Del. Feb. 12, 2015) (TABLE); Union
Ill., 847 A.2d at 364.

                                              71
reality,”334 meaning that it was the “the product of not only a fair sales process, but

also of a well-functioning market.”335

         After years of striving for it, Vince Lombardi finally arrived at the

understanding that perfection in human endeavors is not attainable.336 Even in the

best case, a process to facilitate the sale of a company, constructed as it must be by

the humans that manage the company and their human advisors, will not be

perfect.337 For the reasons I explain below, I am satisfied that the process employed

to facilitate the sale of PetSmart, while not perfect, came close enough to perfection

to produce a reliable indicator of PetSmart’s fair value.338

334
      Unimation, Inc., 1991 WL 29303, at *17.
335
   DFC, 2016 WL 3753123, at *21. See also Lender Processing, 2016 WL 7324170, at
*16 (collecting cases).
336
   Chuck Carlson, Game of My Life: 25 Stories of Packer Football (Sports Pub. 2004)
(quoting Coach Lombardi as opening his first Packers team meeting in 1959, after twenty
years of coaching, by saying: “Gentleman, we are going to relentlessly chase perfection,
knowing full well we will not catch it, because nothing is perfect”).
337
   See AutoInfo, 2015 WL 2069417, at *14 (observing that no “real-world sales process”
will live up to “a perfect, theoretical model”).
338
    Lender Processing identifies a number of structural factors that may be relevant when
determining whether the merger consideration was a reliable indicator of the company’s
fair value including “meaningful competition among multiple bidders during the pre-
signing phase,” the availability of “adequate and reliable information” to participants in the
auction, the “absence of any explicit or implicit collusion,” and “the lack of a topping bid.”
2016 WL 7324170, at *16–26. Of course, the court also recognized that the relevant
considerations will be deal and company specific and that the court’s focus will be
sharpened by the arguments offered by counsel. Id. at *16. My analysis of the reliability
                                             72
         With guidance from Morgan Stanley, PetSmart’s Board began the process of

exploring strategic alternatives because the Company’s “stock had taken [a] very

significant decline from historical levels,” the Company “was unhappy,” and

“[s]hareholders were speaking up. . . .”339 When the Board ultimately decided to

pursue a sale, it engaged another reputable investment bank, JPM, and created an Ad

Hoc Committee of experienced independent directors to oversee the process. From

the outset, the Board’s orientation was to view a sale of the Company not as an

inevitable outcome, but rather as one of several strategic alternatives that also

included remaining standalone while pursuing new revenue and cost saving

initiatives or pursuing a significant leveraged recapitalization.340         If the price

achieved in the auction was unsatisfactory, the Board was prepared to walk away

from that process and pursue other alternatives.341 And if the more active among the

Company’s stockholders were unhappy with the decision the Board ultimately made,

the Board was ready to deal with the consequences of that reaction, including to take

of deal price as a product of the efficacy of the sales process necessarily has been shaped
by the arguments of counsel and the evidence they chose to present at trial.
339
      Trial Tr. 398:22–399:7 (Gangwal).
340
      JX 337; JX 339; Trial Tr. 400:7–16 (Gangwal).
341
      Trial Tr. 427:7–430:12, 439:11 (Gangwal).

                                            73
on a proxy fight if necessary.342 It was in this environment that the auction for

PetSmart was conducted.

         In August of 2014, PetSmart announced to the world that it was pursuing

strategic alternatives including a sale, so the whole universe of potential bidders was

put on notice.343 The Board did not rush the sale; it did not receive final bids and

make its final decision to sell the Company until December 2014. By the time the

gavel fell, JPM had contacted 27 potential bidders, including the three potential

strategic partners it considered most likely to be interested in acquiring PetSmart’s

niche business. In this regard, I note that the Board considered inviting the most

likely strategic partner, Petco, into the process, but made the reasoned decision that,

without a firm indication of interest from Petco, the risks of providing PetSmart’s

most direct competitor with unfettered access to PetSmart’s well-stocked data room

outweighed any potential reward. Nevertheless, the evidence revealed that the

Board held the door open for Petco to join the auction if it expressed serious interest

in making a bid. It never did.

         Fifteen parties signed nondisclosure agreements and engaged in due diligence.

PetSmart management made in-person presentations to thirteen suitors. Thereafter,

342
      See Trial Tr. 405:8–406:2 (Gangwal).
343
      Trial Tr. 418:24–419:8 (Gangwal). See also PTO ¶ 219.

                                             74
JPM received indications of interest from five bid groups. Two of those bidders

joined forces so that three bid groups proceeded into the next round of bidding.

Those three bid groups then engaged in further due diligence, receiving constant

updates regarding PetSmart’s financials and operations (including the progress of

the PIP) and further presentations from PetSmart management.344 There was no

credible evidence presented that management, the Ad Hoc Committee, the Board or

JPM colluded with or otherwise favored any bidder during the entirety of the

process.345

         When JPM directed the final-round bidders to submit “their best and final”

offers, KKR/CD&R advised JPM they could not offer more than PetSmart’s then-

current trading price of approximately $78 per share.346 Apollo then submitted a

final bid of $81.50 per share. BC Partners submitted a bid of $83 per share, after

JPM prodded it to bid against its own initial final bid of $82.50 per share.

BC Partners’ offer of $83 per share was higher than PetSmart stock had ever traded

and reflected a premium of 39% over its unaffected stock price. With this bid in

hand, the Board met on December 13, 2014, and carefully considered its strategic

344
      JX 984; JX 910 at PETS_APP00177993; JX 936; JX 934; JX 1200.
345
      See Global GT LP v. Golden Telecom, Inc. (Golden Telecom I), 993 A.2d 497, 507
(Del. Ch.), aff’d, 11 A.3d 214 (Del. 2010) (“an arms-length merger price resulting from an
effective market check is entitled to great weight in an appraisal.”).
346
      Trial Tr. 907:5–12 (Aiyengar).

                                           75
options with the assistance of its financial and legal advisors. Only after engaging

in an analysis of all options did the Board conclude that accepting the $83 per share

offer provided the best opportunity to maximize value for PetSmart stockholders.347

         The Proxy issued by PetSmart in advance of the stockholder vote on the

Merger included the Management Projections. Even though the Board cautioned

stockholders against relying too heavily upon these projections,348 they were there

nonetheless for any stockholder to run its own DCF analysis, just as Petitioners have

done.349 PetSmart also announced its Q4 2014 results which revealed at least some

positive recent trends in PetSmart’s performance.               Despite these disclosures,

between the announcement that BC Partners would acquire PetSmart and the

closing, no topping bidder stepped forward. When the time came to vote, PetSmart’s

fully-informed stockholders overwhelmingly approved the Merger.

         In the wake of this well-constructed and fairly implemented auction process,

Petitioners are left to nitpick at the details and to invent certain prevailing market

dynamics that they now claim acted as impediments to PetSmart realizing fair value

in the Merger. Specifically, Petitioners point to the following confounders that

347
   Trial Tr. 439:11 (Gangwal) (The Board, in determining whether to accept BC Partners’
offer of $83 per share “[was] looking at greater value if [it] could [get it].”). See also Trial
Tr. 439:4–441:9 (Gangwal).
348
      JX 1336 at 38; Trial Tr. 324:7–15 (Teffner).
349
      See Pet’rs’ Post-Trial Br. 53–54.

                                              76
render deal price unreliable in this case: (1) restrictions on financing impeded the

ability of bidders to bid as much as they might have otherwise been willing to pay;

(2) the lack of strategic bidders left PetSmart at the mercy of financial sponsors and

their “LBO models”; (3) PetSmart was forced into the sales process at a low point

in its performance by the agitations of JANA; (4) the Board was ill-informed,

(5) JPM was conflicted; and (6) the transaction price was stale by the valuation date.

I address each in turn.

         First, as for the contention that a seized credit market restricted the bids, the

credible evidence says otherwise. While JPM had concerns in the late fall of 2014

that the credit markets may not allow the private equity bidders to attain the

financing necessary to fully fund their bids, these concerns abated soon after

Thanksgiving and prior to the submission of final bids. The record is devoid of any

evidence that unavailable credit actually affected the amount any bidder was willing

to offer for PetSmart. Both Aiyengar and Svider confirmed that in their testimony

and I believe them.350

         Second, while it is true that only financial sponsors submitted bids for the

Company, the evidence is clear that JPM made every effort to entice potential

strategic bidders and none were interested. Indeed, the Board would have been

350
      Trial Tr. 755:6–757:6 (Svider); Trial Tr. 917:4–918:10 (Aiyengar).

                                              77
receptive to a deal with Petco if only it would have expressed a serious indication of

interest. Importantly, the evidence reveals that the private equity bidders did not

know who they were bidding against and whether or not they were competing with

strategic bidders.351 They had every incentive to put their best offer on the table.

       Petitioners advance the argument that the “LBO model” will rarely if ever

produce fair value because the model is built to allow the funds to realize a certain

internal rate of return that will always leave some portion of the company’s going

concern value unrealized. Taken to its logical conclusion, of course, Petitioners’

position would suggest that all private equity bidders employing the same model

(assuming they strive for the same IRR as Petitioners contend they do) should have

bid the same amount for PetSmart. This, of course, did not happen––as shown by

the spread between KKR and CD&R’s final verbal bid at $78 per share and

BC Partners’ winning bid at $83 per share. And while it is true that private equity

firms construct their bids with desired returns in mind, it does not follow that a

private equity firm’s final offer at the end of a robust and competitive auction cannot

ultimately be the best indicator of fair value for the company.352

351
    Cf. Lender Processing, 2016 WL 7324170, at *18 (observing that “if bidders perceive
a sale process to be relatively open, then a credible threat of competition can be as effective
as actual competition”).
352
   See, e.g., Lender Processing, 2016 WL 7324170, at *26–29 (relying on the merger price
in a sale to a private equity buyer); BMC, 2015 WL 6164771, at *18 (determining that the
deal price was the most reliable indicator of fair value in case involving sale to a group of
private equity buyers); AutoInfo, 2015 WL 2069417, at *12 (same); Ancestry.com, 2015
                                              78
       Third, the notion that the Board was forced to sell after the emergence of an

activist shareholder finds no credible support in the evidence. By the time JANA

arrived on the scene in July 2014, PetSmart’s Board had already begun the process

of reviewing strategic alternatives with Morgan Stanley. Thereafter, PetSmart took

its time with the sales process, not signing the Merger Agreement with BC Partners

until December 2014. Indeed, the evidence reveals that all strategic alternatives

were on the table in December 2014 and that the Board did not decide to sell until

JPM was able to coax the final offer of $83 per share from BC Partners (actually

causing it to bid against itself). Had the auction not generated an offer that the Board

deemed too good to pass up, I am satisfied that the Board was ready to pursue other

WL 399726, at *23–24 (same); CKx, 2013 WL 5878807, at *13 (same). I note that the
LBO model and DCF model both rely upon the same expected cash flows. The LBO
model, however, is risk adjusted to account for post-transaction leverage. It follows, then,
that the higher rate of return sought by bidders employing an LBO model will be offset by
the fact that most of the purchase price is financed with debt which, in turn, creates a higher
return on equity. Moreover, companies with a history of lagging performance may be
valued more by financial bidders with a plan to turn around the company than strategic
bidders who might be less inclined to take on that risk. Stated more simply, there are two
sides to the “LBO model” argument. JX 1697 (Metrick-Opening) at 49–56; Trial
Tr. 1277:4–1281:22 (Metrick). While there may be some intuitive appeal to Petitioners’
argument that the requisite IRR embedded in the LBO model will drive lower valuations,
the evidence in this trial record did not support that argument or demonstrate that this
dynamic was in play during the auction for PetSmart. Accord Alexander S. Gorbenko &
Andrey Malenko, Strategic and Financial Bidders in Takeover Auctions, 69 J. Fin. 2513,
2514–16, 2532 (2014) (conducting an analysis of values paid by strategic and financial
bidders and concluding that both, on average, pay more than the company’s value under
current management and that, in the case of 22.4% of the targets within the sample, those
targets, all “mature, poorly performing companies,” were “valued more by an average
financial bidder than by an average strategic bidder”).

                                              79
initiatives as a standalone company and to defend itself in a proxy contest against

JANA and others if necessary.353

         Fourth, Petitioners’ argument that the Board was ill-informed is premised

largely on the exploitation of director Gangwal’s inability to recall at trial (nearly

three years after the fact) certain details regarding PetSmart’s PIP initiative. It is a

stretch to point to a witnesses’ lack of recall at trial regarding the details of a cost-

savings initiative as evidence that the entire PetSmart Board was ill-informed

regarding the sales process. This is especially so given that Gangwal was able to

testify extensively regarding the Board’s consideration of strategic alternatives, the

sales process and the Board’s deliberations during this period.354 Petitioners also

argue that the Board was ill-informed because it did not receive advice regarding the

valuation of the Company if it remained standalone, but this is contradicted by the

353
    See Trial Tr. 405:8–406:2, 427:7–430:12, 439:11 (Gangwal). Nor does the evidence
suggest that PetSmart was sold at a time of market or internal uncertainty. The market
trends confronting PetSmart had been in place for some time and the Company’s struggles
were not of recent origin. See, e.g., Resp’t’s RX-6 (displaying PetSmart’s historical
comparative store sales growth beginning Q1 2011, showing that comparable store sales
growth declined continually from Q1 2012 through Q1 2014 and then continued to slide in
2015 after a minor uptick Q4 2014). See also JX 2307 (Weinsten-Opening) at 16–26
(describing the challenges facing PetSmart in the period leading up to the Merger). This
is not a case like DFC, where the company was confronting acute regulatory uncertainty
at the time it was sold. 2016 WL 3753123, at *22. PetSmart’s Board was able to weigh
the Company’s options on a clear day and make the decision it believed was in the best
interest of the Company and its stockholders.
354
      See, e.g., Trial Tr. 410:10–20, 418:20–419:8, 437:2–441:9 (Gangwal).

                                             80
evidence adduced at trial, including (but not limited to) JPM’s presentation at the

December 13 Board meeting.355

       Fifth, as previously noted, the “conflicts” Petitioners rely upon to impugn the

results of the sales process are hardly striking and, in any event, were fully disclosed

to the Board and the Ad Hoc Committee. For example, Petitioners argue that JPM

did not adequately disclose its previous relationships with potential private equity

bidders. As Gangwal testified, however, as a large institutional bank, the Board

knew and was not at all surprised that JPM naturally had ties to the large private

equity funds interested in bidding on the Company. 356 While Petitioners contend

that JPM did not disclose, and was hindered by, conflicts due to its involvement with

the initial public offering that Petco pursued in the fall of 2015, the only record

355
   See Trial Tr. 908:14–910:23 (Aiyengar) (“[V]aluation was presented to the board at
multiple different times here. I don’t remember all the dates. But starting from—from the
time the plan was finalized in September, I think most of the other board presentations . . .
had some sort of valuation discussion.”). See also JX 1158.
356
    See In re Inergy LP, 2010 WL 4273197, at *14 (Del. Ch. Oct. 29, 2010) (holding that
financial advisor’s “prior dealings” with counterparty to the proposed transaction “d[id]
not show that [the transaction committee’s] decision to retain [that advisor] . . . was
unreasonable”); Emerald P’rs v. Berlin, 2001 WL 115340, at *7 n.17 (Del. Ch. Feb. 7)
(rejecting argument that target banker’s work for the buyer created a conflict of interest),
vacated on other grounds, 787 A.2d 85 (Del. 2001); Maric Capital Master Fund, Ltd. v.
Plato Learning, Inc., C.A. No. 5402-VCS, at *87–88 (Del. Ch. May 13, 2010)
(TRANSCRIPT) (noting that the presence of a conflict “doesn’t mean that [the advisor]
can’t be the banker. . . . I’d rather have some of the best bankers with their conflicts
disclosed than some of the worst bankers who don’t have any conflicts”); Dollar Thrifty,
14 A.3d at 582 (noting that a company’s investment bankers working with private equity
bidders prior to a sales process was “one of the facts of business life”).

                                             81
evidence on this conflict shows that JPM did not pitch this project, much less get

retained to work on it, until months after the PetSmart Merger closed.357 Petitioners

also point to JPM’s prior relationship with Gangwal due to its involvement in taking

his airline public, but I can discern no basis to characterize this relationship as a

conflict or to conclude that it would have affected the advice JPM rendered to the

PetSmart Board or its work in running the PetSmart auction.

         Finally, the argument that the Merger Price was stale by the time of closing is

at best speculative. Mergers are consummated after the consideration is set. That

temporal separation, however, does not in and of itself suggest that the merger

consideration does not accurately reflect the company’s going concern value as of

the closing date.358 Here, Petitioners would have me conclude that the Merger Price

was stale because, in the gap between signing and closing, PetSmart’s fortunes took

a miraculous turn for the better. While the record indicates that the Company did

enjoy some favorable results in Q4 2014, such as an uptick in comparable store sales

growth, I am not convinced that these short-term improvements were indicative of a

long-term trend. In fact, all testimony at trial was to the contrary—the Board, as

well as Teffner, believed that the Q4 results were temporary and provided no basis

357
      JX 1679 (Aiyengar Dep. Day 1) 29:5–9.
358
      See Union Ill., 847 A.2d at 358.

                                              82
to alter their view of the Company’s long-term prospects.359 These perceptions were

born out in Q1 2015 (when the Merger closed) during which PetSmart’s comparable

store sales dropped to 1.7%.360 At year end, PetSmart reported comparable store

sales growth of 0.9%, a 40% miss from the Management Projections in just the first

projection year.361

         Respondent has carried its burden of demonstrating that the Merger Price of

$83 per share was the result of a “proper transactional process”362 comprised of a

robust pre-signing auction in which adequately informed bidders were given every

incentive to make their best offer in the midst of a “well-functioning market.”363

359
   See, e.g., Trial Tr. 447:4–7 (Gangwal) (Q. “And did [PetSmart’s] performance in the
fourth quarter [of 2014], did that in any way affect your view of the long-term value of the
company?” A. “No.”); Trial Tr. 273:24–24 (Teffner) (Q. “Did [PetSmart’s Q4 2014] results
change your view of the long-term prospects of the company?” A. “No.” Q. “Why not?”
A. “Because it was one quarter.”). Petitioners contend that PetSmart’s Q4 2014 results
were released too close to the closing of the Merger for potential bidders to digest them.
This ignores the fact that bidders were constantly updated regarding PetSmart’s
performance, so they received information about PetSmart’s Q4 performance in real time
well before the market. See, e.g., JX 1090; Trial Tr. 263:7–20 (Teffner); Trial Tr. 735:17–
737:21 (Svider).
360
      JX 1598 at PETS_APP00842050.
361
      JX 1656 at PETS_APP00821450–51, 57.
362
      Ramtron, 2015 WL 4540443, at *21.
363
      DFC, 2016 WL 3753123, at *21.

                                            83
Under these circumstances, I am satisfied that the deal price is a reliable indicator of

fair value.364

      C. Can a DCF Analysis that Relies Upon the Any of the Projections In the
         Record Produce a Reliable Indicator of Fair Value?

          My determination that the $83 per share Merger Price is a reliable indicator

of fair value does not end the inquiry. To discharge my statutory obligation to

consider “all relevant factors,” it is necessary that I consider the reliability of the

other valuations of PetSmart in the trial record.365

          Petitioners peg DCF as the “gold standard” of valuation tools.366 To be sure,

that is precisely how Metrick has described it.367 This court, likewise, has turned to

a DCF analysis in the appraisal context to determine fair value and, in certain

circumstances, has deemed the results of a DCF analysis to be the only reliable

364
    BMC, 2015 WL 6164771, at *11 (observing that the court may rely upon “the merger
price itself as evidence of fair value, so long as the process leading to the transaction is
reliable indicator of value and any merger-specific value in that price is excluded.”). I note
that there is no need or basis to adjust the Merger Price in recognition of either positive or
negative synergies associated with the combination of PetSmart and BC Partners since the
buyer here “was a financial buyer rather than a strategic acquirer,” DFC, 2016
WL 3753123, at *20 n.230, and there was no evidence presented that synergies unique to
private equity sponsors were present here. See Lawrence A. Hamermesh & Michael L.
Wachter, Rationalizing Appraisal Standards in Compulsory Buyouts, 50 B.C. L. Rev.
1021, 1050 (2009) (discussing synergies financial buyers may have with target firms
arising from other companies in their portfolio and reduced agency costs).
365
      Gonsalves, 701 A.2d at 362.
366
      Pet’rs’ Post-Trial Br. at 14.
367
      JX 1714 (Metrick Dep.) 245:17-19; Trial Tr. 1317:10–21 (Metrick); JX 63 at 14.

                                             84
indicator of fair value.368 Even though I am confident that the deal price in this case

is a reliable indicator of fair value, I have approached the DCF valuations performed

by the parties’ experts with an open mind.369

      A proper DCF analysis follows a well-defined sequence:

      First, one estimates the values of future cash flows for a discrete period,
      based, where possible, on contemporaneous management projections.
      Then, the value of the entity attributable to cash flows expected after
      the end of the discrete period must be estimated to produce a so-called
      terminal value, preferably [by] using a perpetual growth model.
      Finally, the value of the cash flows for the discrete period and the
      terminal value must be discounted back using the capital asset pricing
      model or ‘CAPM.’370

The first key to a reliable DCF analysis is the availability of reliable projections of

future expected cash flows, preferably derived from contemporaneous management

projections prepared in the ordinary course of business.371          As this court has

determined time and again, if the “data inputs used in the model are not reliable,”

368
   See, e.g., Owen v. Cannon, 2015 WL 3819204, at *29 (Del. Ch. June 17, 2015); Golden
Telecom I, 993 A.2d at 499.
369
   I note that both valuation experts agree that no other valuation methodology (e.g.,
comparable company or comparable transaction analyses) would make sense here,
particularly given the rather unique nature of PetSmart’s retail business. See JX 1698
(Dages-Opening) at 73; JX 1697 (Metrick-Opening) at 142. I agree and will not discuss
these methodologies further.
370
    Andaloro v. PFPC Worldwide, Inc., 2005 WL 2045640, at *9 (Del. Ch. Aug. 19, 2005)
(citation omitted).
371
   See Merion Capital, L.P. v. 3M Cogent, Inc., 2013 WL 3793896, at *11 (Del. Ch. July 8,
2013); Ramtron, 2015 WL 4540443, at *10. See also JX 1697 (Metrick-Opening) at 106–
07; JX 1698 (Dages-Opening) at 23–24.

                                           85
then the results of the analysis likewise will lack reliability.372 And, as the experts

in this case both agree, to be reliable, management’s projections should reflect the

“expected cash flows” of the company, not merely results that are “hoped for.”373

         1. The Projections

         Petitioners like the Management Projections and maintain they are reliable

indicators of PetSmart’s future performance. Respondent, on the other hand, finds

itself in the presumably uncomfortable position of having to argue that its own

projections cannot be trusted as a basis for predicting expected cash flows and,

therefore, cannot provide a sound foundation for a DCF analysis. While I appreciate

that the parties’ disagreement with respect to the reliability of the Management

Projections presents a question of fact that must be answered by the evidence in this

case, I take guidance from other instances where this court has examined the

reliability of projections used for the purposes of appraisal. Specifically, this court

has deemed projections unreliable where “the company’s use of such projections

was unprecedented, where the projections were created in anticipation of litigation,

372
   Ramtron, 2015 WL 4540443, at *10. See also id. at *18 (stating that where there are
no “reliable five-year projections, any values generated by a DCF analysis are
meaningless”); CKx, 2013 WL 5878807, at *11 (noting that “methods of valuation,
including a discounted cash flow analysis, are only as good as the inputs to the model”);
Andaloro, 2005 WL 2045640, at *9 (noting that this court may give a DCF analysis great
weight in an appraisal proceeding “when it may be used responsibly”). Dages agrees. Trial
Tr. 624:6–13 (Dages) (“Garbage in; garbage out.”).
373
      See Trial Tr. 621:2–8 (Dages); Trial Tr. 1240:18–23 (Metrick).

                                              86
where the projections were created for the purpose of obtaining benefits outside the

company’s ordinary course of business,”374 where the projections were inconsistent

with a corporation’s recent performance,375 or where the company had a poor history

of meeting its projections.376

         The Management Projections upon which Petitioners rely are saddled with

nearly all of these telltale indicators of unreliability: (1) PetSmart management did

not have a history of creating and, therefore, had virtually no experience with, long-

term projections; (2) even management’s short term projections frequently missed

the mark; (3) the Management Projections were not created in the ordinary course

of business but rather for use in the auction process; and (4) management engaged

in the process of creating all of the auction-related projections in the midst of intense

pressure from the Board to be aggressive, with the expectation that the projections

would be discounted by potential bidders. As explained below, each of these factors

undermine the credibility of Dages’s DCF results.

         First, PetSmart had not historically created five-year projections prior to the

creation of the auction-related projections (including the Management Projections).

374
      CKx, 2013 WL 5878807, at *9.

  See In re Nine Sys. Corp. S’holders Litig., 2014 WL 4383127, at *41 (Del. Ch. Sept. 4,
375

2014) (citing Kahn v. Household Acq. Corp., 591 A.2d 166, 175 (Del. 1991)).
376
      Nine Sys., 2014 WL 4383127, at *42.

                                            87
PetSmart’s forecasting practice was limited to the creation of annual budgets in

connection with the Summer Strategy meetings. These budgets were nothing like

the five-year projections management was directed to prepare when the Board

decided to explore a sale of the Company. The Summer Strategy budgets were one-

year forecasts prepared to support particular proposed initiatives with the

anticipation that they would be revised throughout the year as events unfolded.377

While Vance made her own long-term projections based on the annual budgets

created as a part of Summer Strategy, her model was never presented to or relied

upon by PetSmart’s management or Board.378

      The Board’s request that management shift from preparing one-year budgets

to five-year cash flow projections was made all the more difficult by the fact that

PetSmart’s senior management were new to their jobs. Teffner, who was leading

the effort, had only been in her job for about a year; Lenhardt had only taken on the

role of CEO in June 2013. And, of course, the projections were rush jobs; the Board

377
   Trial Tr. 208:4–209:3 (Teffner). See also Trial Tr. 34:1–23 (Cohen) (Petitioners’ retail
expert testifying that retail operates on a one-year cycle, so that creating detailed
projections beyond one-year made little sense).
378
   Trial Tr. 213:7–19 (Teffner) (explaining that Vance’s model “was not presented to
management, was not presented to the board for approval; [instead it] was more of an
inherent working tool for the planning department, but it wasn’t considered a multiyear
projection that the business relied upon”).

                                            88
wanted the work product in a matter of weeks to ready the Company for the sales

process.379

         Second, while management had no history of preparing long-term projections,

it did have a history of preparing short-term forecasts that did not accurately predict

Company performance.380 As demonstrated in the following chart produced in

Metrick’s opening expert report, even PetSmart’s reforecasts were often off by large

margins:381

                                             FY13                           FY14
                          Q1      Q2       Q3       Q4       FY        Q1          Q2
           F1            3.80%    3.90%    4.10%    4.30%     4.00%    1.50%       2.90%
           F2                     3.70%    4.00%    4.90%     4.10%                0.80%
           F3                              4.00%    4.90%     4.00%
           F4                                       3.50%
           Actual        3.50%    3.40%    2.70%    1.20%     2.70%    -0.60%      -0.50%
           Actual - F1   -0.30%   -0.50%   -1.40%   -3.10%    -1.30%   -2.10%      -3.40%
           Actual – F2            -0.30%   -1.30%   -3.70%    -1.40%               -1.30%

         Third, the evidence reveals that management did not believe that the

projections they were preparing actually offered reliable predictions of future

379
      Trial Tr. 219:9–22, 229:2–13, 236:8–16 (Teffner).
380
    See Ramtron, 2015 WL 4540443, at *11 (discounting the reliability of management
projections since their ability to be accurate forecasters “more than two quarters out was
quite poor” and noting that “management’s lack of success in accurately projecting future
revenue in the past provides another reason to doubt the reliability of the Management
Projections”); AutoInfo, 2015 WL 2069417, at *8 (finding it significant in its assessment
of the reliability of management projections that “[m]anagement itself had no confidence
in its ability to forecast”).
381
      JX 1697 (Metrick-Opening) at 65, Fig. 11.

                                                    89
performance. They were told to “put their best foot forward” and that is precisely

what they did.382 This, of course, is no surprise since they were told by the Board

that their jobs depended on it.383

         Finally, the evidence makes clear that the Management Projections were

created specifically to aid PetSmart in its pursuit of strategic alternatives, including

a sale of the Company. To fulfill this purpose, the projections were created to be

aggressive and extra-optimistic about the future of the Company.384 In fact, the

Management Projections projected a reversal of several downward trends, including

with regard to the important metric of comparable store sales growth estimates.385

As Teffner, Gangwal and Aiyengar testified at trial, the projections were designed

to be aggressive because the Board (and JPM) were convinced that potential bidders

would discount whatever projections were put in front of them. This makes perfect

382
    Trial Tr. 368:14–16 (Teffner) (“[The Management Projections were] our best foot
forward to potential buyers around the performance of the company, given the
initiatives.”). See also Trial Tr. 242:10–243:2, 256:7–17, 260:5–261:10, 268:9–269:5,
270:1–11, 370:19–23 (Teffner).
383
      JX 671 at PETS_APP00215455.
384
      JX 1674 (Vance Dep.) 135:5–137:3.
385
   JX 1684 (Lenhardt Dep.) 275:14–21. See also JX 2307 (Weinsten-Opening) at Ex. 8
n.52.

                                          90
sense when projections are being prepared not in the ordinary course but to facilitate

a sale of the Company.386

         Petitioners argue that management knew where to draw the line between

reliable and unreliable projections as evidenced by management’s decision not to

share the super-aggressive “Growth Case” with the Board. According to Petitioners,

the fact that management was willing to provide the Management Projections to the

Board reveals that management stood behind them and that they can trusted as a

reliable input for a DCF analysis. I disagree. The Management Projections were the

product of aggressive prodding by the Board for more optimistic forecasts and

everyone involved in their creation knew that. Indeed, when the time came for the

Board to look to JPM for valuation guidance, the Board directed JPM to run only

downside sensitivities on the Management Projections.387

         Petitioners next argue that the reliability of the Management Projections is

bolstered by the Company’s performance after the Merger Agreement was signed

and post-closing. Here again, I disagree. To hear Petitioners tell it, PetSmart’s post-

signing performance was nothing short of a turnaround miracle.388 The trial record

386
    It should also be noted that management’s projections were “top down” rather than
“bottom up” projections, which is contrary to best practices. JX 2307 (Weinsten-Opening)
at 6–7.
387
      Trial Tr. 434:16–436:19 (Gangwal).
388
   Specifically, Petitioners contend, “PetSmart outperformed the projections immediately,
with that outperformance accelerating from signing through, and well after, closing.”
                                           91
says otherwise. PetSmart’s success, both post-signing and post-closing was and has

been mixed.        It is true that PetSmart’s EBITDA exceeded the Management

Projections for 2015 and that PetSmart was able to issue a $800 million dividend by

year end. It is also true, however, that in both 2015 and 2016 (as of the date of trial),

PetSmart’s comparable store sales growth was massively underperforming the

numbers forecast in the Management Projections.389 Hardly a turnaround miracle.

         Petitioners point to the PIP and argue that no matter the “aggressiveness” of

the Management Projections, they must be considered in the context of the “cushion”

provided by the substantial estimated cost savings PetSmart would realize from this

initiative. In this regard, Petitioners point out that while PetSmart repeatedly

reported that it would achieve $200 million in cost savings annually from the PIP,

various internal documents set the actual estimates between $183–$283 million.390

Pet’rs’ Post-Trial Br. 44. See also id. at 47 (“PetSmart’s post-closing performance . . .
blew the Management Projections out of the water.”).
389
    Petitioners argue that Respondent is unduly “fixated” on the comparable store sales
growth. See id. at 48–53. However, the PetSmart financial model was premised largely
on this important growth metric. Indeed, management appeased the PetSmart Board’s
desire to make the projections for the sale process more aggressive by increasing the
comparable store sales growth from the Base to the Base-Plus Cases to the final
Management Projections. See JX 598 at PETS_APP00611653, 656; JX 798 (Comp_Trend
tab). Suffice it to say, I am satisfied that “comp” is an important metric to measure
performance and growth. In any event, whether or not the comparable store sales growth
is important for the long-term prospects of the Company, as the parties dispute, based upon
the evidence adduced at trial, this metric was indisputably central to the creation of the
Management Projections and therefore directly indicative of their reliability.
390
      Trial Tr. 338:22–339:10 (Teffner).

                                            92
The suggestion is that the extra $83 million was a cushion to offset any undue

optimism in the Management Projections. Petitioners make too much of the range

of PIP savings identified at various times by management. When the rubber hit the

road, and management was pressed to provide optimistic but arguably achievable

forecasts of PIP savings, management determined that, in their best estimate, $200

million was what was actually achievable.391            The PIP was layered into the

Management Projections and I see no basis in the evidence to conclude that some

additional phantom savings were ready to be mined out of PetSmart beyond those

already accounted for.392

         For all of these reasons, I find that the Management Projections are not reliable

statements of PetSmart’s expected cash flows. Any DCF analysis that relies upon

the Management Projections, therefore, would produce “meaningless” results.393

391
   Trial Tr. 339:23–340:11 (Teffner). Petitioners also point to other cost-savings proposals
created by consultants estimating even greater savings, arguing that the consultants found
an additional $473–$685 million in cost savings. Pet’rs’ Post-Trial Br. 32. There is no
evidence that PetSmart management ever thought these pitches from the paid consultants
were actually achievable. For his part, Massey explicitly rejected the consultants’ pitches
as providing any meaningful input for a valuation of PetSmart because they were nothing
more than “ideas.” Trial Tr. 1105:1–5, 1106:5–1107:1 (Massey).
392
      JX 807 at PETS_APP00000690; JX 728.
393
   CKx, 2013 WL 5878807, at *9 (“[W]ithout reliable five-year projections, any values
generated by a DCF analysis are meaningless.”). See also id. at *11 n.113 (“If I were to
apply a DCF analysis in this matter, by choosing between speculative revenue estimates . . .
I would simply lend a faux-mathematic precision to a patently speculative enterprise: I
would become, to use Twain’s memorable locution, no better than a hair-ball oracle.”);
Ramtron, 2015 WL 4540443, at *18 (determining that there were no reliable five-year
                                             93
      Even though I have determined that the Management Projections cannot

support a meaningful DCF analysis, I must consider the possibility that a reliable

valuation of PetSmart nevertheless can be constructed from other evidence in the

record. In addition to the Management Projections, Dages has looked to other

projections—namely the BCP Case, the Massey Case, and the Bank Case—as

foundations for alternative DCF analyses.394 And on the final day of trial, Dages

presented rebuttal testimony regarding a new DCF analysis he had performed based

on the JPM sensitivities.

      Metrick initially declined to run of any these projections through his DCF

model.    Instead, he created his own forecasts for PetSmart by adjusting the

Management Projections, based on the 2% comparable store sales growth

assumption adopted in the JPM sensitivities, and then further adjusting to account

for the eventual decline of the PIP savings he believed would be realized further into

the forecast.   As the last word from the valuation experts, however, Metrick

projections in the record, and therefore declining to rely upon a DCF analysis); Doft & Co.
v. Travelocity.com Inc., 2004 WL 1152338, at *7 (Del. Ch. May 20, 2004) (declining to
use a DCF analysis to value a company where the record did not contain any reasonably
reliable contemporaneous projections of the company’s future cash flows, rendering “a
DCF analysis of marginal utility as a valuation technique”).
394
   To be clear, Dages performed a DCF analysis with Management Projections and the
Bank Case in his initial report. JX 1698 (Dages-Opening) at 59, 65. He prepared his DCF
on the BCP Case and the Massey Case in advance of his direct testimony at trial. Trial Tr.
554:7–556:21, 603:1–4 (Dages).

                                            94
responded post-trial to Dages’ last-minute DCF analysis by pointing out its

shortcomings and running his own analysis on the unadjusted JPM sensitivities. The

questions remain whether any of these projections represent the expected future cash

flows of the Company and whether any DCF based on these projections can be

trusted as a reliable indicator of PetSmart’s fair value at the time of the Merger.

         When faced with unreliable contemporaneous management projections, this

court has adopted other contemporaneous projections as a basis for a DCF analysis

where it is satisfied that those projections provide a reliable estimate of the

company’s future cash flows.395 But the projections must be contemporaneous,

meaning they must reflect the “operative reality” of the Company at the time of the

Merger.396 A DCF analysis does not work in the appraisal context when the

projections reflect the “operative reality” of the company in the hands of the

acquirer.397 With this in mind, it is easy to see why none of the projections prepared

395
      See, e.g., AutoInfo, 2015 WL 2069417, at *15.
396
    Highfields Capital, 939 A.2d at 42 (“The corporation subject to valuation is viewed as
a going concern based upon the operative reality of the company at the time of the merger.
This value must be reached regardless of the synergies obtained from the consummation
of the merger, and cannot include speculative elements of value arising from the merger’s
accomplishment or expectation.”) (internal quotation marks and citations omitted).
397
   Id. See also Cede & Co. v. JRC Acq. Corp., 2004 WL 286963, at *7 (Del. Ch. Feb. 10,
2004) (rejecting one party’s valuation expert’s attempt to use the debt incurred in the
merger as a justification for his debt-to-equity ratio in his DCF analysis because nothing
relating to the merger itself “can be included as an element of value”).

                                             95
outside of PetSmart can produce a reliable DCF result.             Each reflect various

scenarios of how PetSmart would be run under BC Partners’ management with a

variety of different assumptions. The BCP Case and the Massey Case both were

designed with the idea that PetSmart would be run as a private, rather than a public

company, with new management, new initiatives and Massey at the helm.398 While

BC Partners believed that Massey might be able to turn PetSmart around, it had no

such confidence in PetSmart’s current management.399 Given BC Partners’ plan to

overhaul PetSmart management and its lack of faith in the current management, it

398
    Trial Tr. 741:19–742:22 (Svider) (describing the complete management turnover that
BC Partners believed was necessary at PetSmart, as “it was our view that in order to turn
this business around, you needed to implement very profound changes to the management
team” so that once the Merger closed, BC Partners “basically changed not only the whole
top management, but you know, pretty much the whole management of the company”).
See also JX 1236 at BC00043779–93 (detailing Massey’s loyalty, store associate behavior,
product optimization, product expansion, marketing and merchandising, net price, supply
chain and freight, consumable vendors negotiations, Asia sourcing, field payroll, overhead,
occupancy cost and other operating, general and administrative initiatives); Trial
Tr. 1027:7–11; 1030:8–1045:3 (Massey) (describing his proposed initiatives and how they
differed from current management’s initiatives); Trial Tr. 1041:23–1042:12 (Massey)
(stating that, after a meeting where they discussed current management’s progress on its
initiatives, “I had a lot of concern. Many of the initiatives didn’t seem to have much
backing them up. And what was really concerning were the—a number of the senior
managers really couldn’t articulate how they were going to execute these things. Some
could, and some did a very good job. But some of the most important ones in
merchandising and marketing, we had walked away with a lot of concerns”); Trial
Tr. 1048:3–22 (Massey) (describing his worries about the achievability of his plan leading
up to the consummation of the Merger because “I had serious doubts about relying on the
people, a number of the people. There were a lot of good people, but there [were] other
people I was very concerned about. And I knew I would have to make a tremendous
amount of change”).
399
      Id. See also JX 1676 (Svider Dep.) 38:6–9, 145:14–23.

                                            96
strains credulity to argue that the cases BC Partners created showed expected cash

flows if PetSmart were to continue operating as a going concern sans Merger.

            The Bank Case prepared by BC Partners fares no better. The assumptions

upon which those projections are based resemble nothing of PetSmart’s operative

reality. To reiterate, the Bank Case was created for BC Partners to present to

potential lenders, not in the ordinary course of business, with the purpose of showing

that “if things get tough . . . you can run the business for cash.”400 It assumed that

the Company would cut capital expenditures in its efforts to preserve cash with the

implicit understanding that this approach would stymie long-term growth.401 Simply

stated, the Bank Case did not reliably state expected cash flows because that was not

its purpose.

            Having determined that the Management Projections, the BCP Case, the

Massey Case and the Bank Case are not reliable statements of PetSmart’s expected

future cash flows, it should come as no surprise that I reject outright the DCF

analyses Dages performed using those projections as foundation.402 They are

patently not reliable indicators of fair value.

400
      Trial Tr. 743:21–746:4 (Svider) (describing the purpose of a bank case).
401
      Id.
402
   Ramtron, 2015 WL 4540443, at *18 (holding that a DCF analysis built on unreliable
projections is “meaningless”).

                                              97
         That leaves the possibility of undertaking some adjustments to the

Management Projections to bring them in line with the Company’s expected cash

flows as a means to supply reliable data for a DCF analysis. Both parties have

submitted a DCF analysis based on the JPM sensitivities.403 Metrick has gone a step

further by making further adjustments to the JPM sensitivities to account for his view

that the PIP savings will not be sustainable indefinitely. 404 Even though Dages

appears to have referred to the JPM sensitivities as an afterthought, his DCF based

on those projections is in the record and must be addressed.

         The Board requested that JPM run sensitivities based on 2% comparable store

sales growth because it had “a great amount of discomfort” with the 4% comparable

store sales growth utilized in the Management Projections, and thought that

“2 percent looked more achievable.” 405 Given the pressure the Board had placed

upon management to prepare increasingly aggressive projections, it is reasonable

that the Board would seek to gain a more realistic understanding of PetSmart’s

expected cash flows and its going concern value as the hour approached for the

Board to make impactful decisions about PetSmart’s future. While the evidence is

403
  Trial Tr. 1411:23–1429:18 (Dages); JX 1697 (Metrick-Opening) at 108–09; JX 2315
(Metrick-Supplemental) at 1.
404
      JX 1697 (Metrick-Opening) at 103.
405
      Trial Tr. 436:13–19 (Gangwal).

                                          98
a bit light with respect to the bases for the 2% adjustment in comparable store sales

growth selected by the Board, I take comfort that the adjustment was conceived by

an informed, experienced Board and then analyzed carefully by an informed,

experienced banker. It is also not lost on me that the JPM sensitivities are the only

projections utilized, in some form at least, by both of the valuation experts engaged

by the parties.       They bear sufficient indicia of reliability to justify further

consideration of the valuations based on the data contained therein.

         2. The Expert Valuations Based on the JPM Sensitivities

         Dages performed his rebuttal DCF on the JPM sensitivities to respond to

testimony from Aiyengar and Gangwal to the effect that the Board directed JPM to

make adjustments to the Management Projections that would cause them to reflect

more accurately PetSmart’s future performance.406 For this analysis, Dages took the

cash flows from the JPM sensitivities and ran them through a DCF analysis applying

the inputs derived from both his and Metrick’s prior DCF analyses––the discount

rate (or WACC), the perpetual growth rate and the terminal investment.407 First, he

applied his perpetual growth rate of 2.25%, WACC of 7.75% and terminal

406
      Trial Tr. 1412:9–1414:19 (Dages).
407
      Trial Tr. 1415:19–1416:5, 1416:15–21 (Dages).

                                            99
investment of $41 million.408 Across the three JPM sensitivities, this resulted in a

value ranging from $102.82 to $112.90 per share.409

            Dages then ran a DCF analysis using the inputs he attributed to Metrick “based

on [the] exhibits” Metrick utilized during his trial testimony––a perpetual growth

rate of 2.0% and WACC of 6.35%.410 Dages calculated the terminal investment for

each of the sensitivities using the same formula that Metrick had used for each

sensitivity during his testimony.411 Across the JPM sensitivities, this resulted in a

value ranging from $108.13 to $118.88 per share.412

            Metrick had already seized on the import of the JPM sensitivities in his initial

report.413 He adjusted the Management Projections to reflect the 2% comparable

store sales growth estimate for years after FY15.414              He further adjusted the

Management Projections, which assumed that PetSmart would achieve the cost

408
      Pet’rs’ DX 2 at 2; Pet’rs’ DX 3 at 2; Pet’rs’ DX 4 at 2.
409
      Id.
410
    Trial Tr. 1413:19–1414:3 (Dages); Pet’rs’ DX 2 at 3; Pet’rs’ DX 3 at 3; Pet’rs’ DX 4
at 3.
411
   Trial Tr. 1417:6–17, 1420:2–12 (Dages); Pet’rs DX 2 at 3; Pet’rs’ DX 3 at 3; Pet’rs’
DX 4 at 3. Dages used real rates in this method, whereas Metrick had used nominal rates.
Trial Tr. 1413:4–6.
412
      Pet’rs’ DX 2 at 3; Pet’rs’ DX 3 at 3; Pet’rs’ DX 4 at 3.
413
      JX 1697 (Metrick-Opening) at 102.
414
      Id. at 102–03.

                                               100
savings envisioned by the PIP infinitely, to account for his view “that the cost

savings EBITDA improvements will decline beginning in FY19, three years after

the savings are assumed to be fully realized in FY16.”415 He then incorporated his

assumption that “the annual savings will decline linearly to the Base Case Amount

($59 million) by the terminal period, which begins in FY25.”416

            The projected decreases in PIP savings represented Metrick’s best attempts to

estimate how long and to what extent PetSmart would retain the projected

benefits.417 He based his opinion that PetSmart would not realize the PIP savings

infinitely on “economic theory, market response to the PIP, and industry experience

related to cost reduction programs.”418 Of particular relevance was a McKinsey &

Co. study that found 90% of 230 S&P 500 firms that had engaged in cost-savings

strategies between 1999 and 2003 had failed to sustain the lower cost savings beyond

three years.419 Additionally, Metrick believed that increasingly strong competition

415
      Id. at 103.
416
      Id.
417
      Trial Tr. 1403:4–21 (Metrick).
418
      JX 1697 (Metrick-Opening) at 103.
419
   JX 24 at 108–11. This is also consistent with Weinsten’s experiences. Trial Tr. 1206:9–
19 (Weinsten).

                                             101
from other pet retailers––i.e., Petco––would cause the cost savings to erode over

time.420

          Metrick returned to the JPM sensitivities when he responded to Dages’s

rebuttal DCF valuations.421 He ran his own DCF analysis on the JPM sensitivities

(without adjustments) to reveal the errors in Dages’s DCF on those same

projections.422 Metrick found two principal faults with Dages’s rebuttal DCF. First,

he took Dages to task for using the improper discount rates. In this regard, he began

with the premise that “[t]o value the cash flows properly, the discount rate must

reflect the assumed capital structure, which in turn depends on how leases are treated

in the cash flows.”423 According to Metrick, the discount rates Dages utilized are

not consistent with the capital structure assumed in his analysis. Specifically, Dages

treated the leases as operating leases (as reflected in the JPM sensitivities), which

420
      JX 1697 (Metrick-Opening) at 94–95.
421
   JX 2315 (Metrick-Supplemental) at 1. I note for clarity that the JPM sensitivities are the
cash flows from JPM’s valuation model, and therefore distinct from the adjustments that
Metrick made to the Management Projections to reflect his view of the expected cash flows
for the DCF he performed in his initial report. See id. at 3.
422
    Id. at 2. Metrick focused on Sensitivity #2 “for simplicity” because, given the
assumptions in Sensitivity #3 and Sensitivity #4 regarding new store growth, his DCF
analysis on Sensitivity #2 would result in a higher valuation for PetSmart. Id. at 1. Since
the differences across the sensitivities are assumptions regarding new store growth,
Metrick’s criticisms of Dages’ DCF analysis would apply equally to all three sensitivities
he analyzed. Id.
423
      Id. at 5.

                                            102
results in a capital structure with no debt (and 100% equity).424 And yet the WACC

utilized by Dages, pulled from his initial report, is based on a capital structure of 8%

debt and 92% equity.425 Similarly, the WACC Dages attributed to Metrick in his

rebuttal DCF was based on Metrick’s assumption of a capital structure of 31% debt

and 69% equity.426 Given the very different capital structure assumed in the JPM

sensitivities, Metrick opines that Dages should have used a WACC of 8.17% based

on his own beta and equity risk premium, not 7.75%.427 The proper WACC based

on Metrick’s assumptions should have been 7.7%, not 6.35%.428

            Metrick’s second criticism of Dages focuses on his use of income projections

that “assume that all of PetSmart’s costs are completely variable, rising or falling in

proportion to sales, so profit margins do not change” even though the JPM

sensitivities (based on the Management Projections) include specific fixed expense

line items that will not vary with declining sales.429 To adjust for this, Metrick took

424
      Id. at 6.
425
   Id.; JX 1698 (Dages-Opening) at 58, Ex. 21. See also id. at 33 (noting that a company’s
WACC is “based on the company’s expected or target capital structure, that is, the relative
proportion of debt and equity ownership”).
426
      JX 2315 (Metrick-Supplemental) at 6.
427
      Id.
428
      Id.

  Id. at 6–7 (citing JX 1723 at row 128 of ‘Financial Build’ tab; JX 1697 (Metrick-
429

Opening) at 109).

                                             103
the fixed costs he found in the Management Projections and treated “all other costs

as variable in implementing the 2% comparable store sales growth assumption.”430

          Metrick then ran a DCF based upon JPM Sensitivity #2, which assumes that

PetSmart will open new stores according to current management plans through 2019

and will have no new store growth thereafter.431 In this DCF model, he used his

terminal investment formula to calculate the required investment in the terminal

period using a 2.0% perpetual growth rate.432 Applying his adjusted Dages WACC

of 8.17% (as adjusted to reflect the capital structure assumed by the cash flows),

Metrick then performed a DCF using the cash flows found in Sensitivity #2 resulting

in a valuation of $82.79 per share.433 Using his own adjusted WACC of 7.77%,

Metrick’s DCF analysis using Sensitivity #2 results in a valuation of $86.96 per

share.434

          As explained above, I have found the JPM sensitivities to be the most reliable

projections in the record before me – the question now is what to do with the various

430
      Id. at 7.
431
      Id. at 1; JX 1336 at 35.
432
   JX 2315 (Metrick-Supplemental) at 7–8, 8 n.18; JX 1697 (Metrick-Opening) at 115–
117. Both Dages and Metrick chose inflation for the perpetual growth rate; they just chose
two different rates of inflation. Trial Tr. 537:4–10 (Dages).
433
      JX 2315 (Metrick-Supplemental) at 8. See also id. at 6 n.14, Ex. 4.
434
      Id. at 8. See also id. at 6 n.15, Ex. 3.

                                                 104
DCF analyses constructed by the experts based upon these projections. While I

agree with Metrick’s criticism of any projection that extends the PIP cost savings

out indefinitely into the future, I find no support in the evidence for the specific

adjustments that he makes to the PIP cost savings in his initial report. The theory is

sound, and I agree that it is not reasonable to assume that the PIP savings will

continue at $200 million annually through the terminal period, but there is

insufficient evidence in the record to allow me to assess when the PIP cost savings

will begin to fade and at what levels. Therefore, I am not persuaded that Metrick’s

initial DCF valuation, based on his adjustments to the Management Projections,

offers a reliable indicator of fair value.435

       This leads me to the experts’ competing analyses based on the JPM

sensitivities. I agree with Metrick’s criticism of the rebuttal DCF analysis Dages

presented at trial—the WACC must accurately reflect the capital structure indicated

by the cash flows, and the costs should accurately reflect the fixed costs. I am also

convinced that Metrick’s formula for calculating the required amount of investment

to support the terminal growth rate is proper, as it is supported by economic theory,

finance literature and even testimony that Dages offered to this court in a prior

435
   To be fair, Metrick performed his DCF as a fallback. His showcase opinion is that the
Merger Price of $83 per share reflects fair value and that DCF is not a reliable indicator of
value in this case. Trial Tr. 1268:21–1269:8 (Metrick).

                                            105
case.436 Metrick’s formula demonstrates that PetSmart’s return on invested capital

will converge towards its cost of capital, a theory this court has repeatedly cited with

approval.437 In contrast, and in contrast to his past practice, Dages merely adopted

the terminal investment from the Management Projections, which would imply that

PetSmart would permanently see returns on capital far above its cost of capital.438

That premise is not credible, at least not to me.

         I also find Sensitivity #2 to be the most reliable of the three JPM sensitivities,

as this reflects the current management plan for new store sales growth.

Accordingly, I am satisfied that the DCF analysis performed by Metrick in his

supplemental report is the most reliable DCF that can be performed with the data

available. As noted, this analysis reveals a valuation of PetSmart ranging from

436
   JX 2315 (Metrick-Supplemental) at 7–8, 8 n.18; JX 1697 (Metrick-Opening) at 115–
117; JX 1233 at 29–31; JX 1691; Trial Tr. 714:10–21 (Dages).
437
   See, e.g., In re John Q. Hammons Hotels Inc. S’holder Litig., 2011 WL 227634, at *4
n.16 (Del. Ch. Jan. 14, 2011) (stating that the convergence model is “a reflection of the
widely-accepted assumption that for companies in highly competitive industries with no
competitive advantages, value-creating investment opportunities will be exhausted over a
discrete forecast period, and beyond that point, any additional growth will be value-
neutral” leading to the “return on new investment in perpetuity [converging] to the
company’s cost of capital”); Cede & Co. v. Technicolor, Inc., 1990 WL 161084, at *26
(Del. Ch. Oct. 19, 1990), consolidated with Cinerama, Inc. v. Technicolor, Inc., 1991
WL 111134 (Del. Ch. June 24, 1991), and aff’d in part and rev’d in part on other grounds,
634 A.2d 345 (Del. 1993) (discussing that “profits above the cost of capital in an industry
will attract competitors, who will over some time period drive returns down to the point at
which returns equal the cost of capital”).
438
      Trial Tr. 572:22–574:10 (Dages); Trial Tr. 1299:3–1302:24 (Metrick); JX 1691.

                                            106
$82.79 to $86.96 per share (depending upon whether one applies the adjusted Dages

WACC or the adjusted Metrick WACC). Given my lack of confidence in the

Management Projections underlying the JPM sensitivities, however, I am not

inclined to adjust my view that the fair value of PetSmart at the time of the Merger

is best reflected in the $83 per share Merger Price. The DCF analyses performed by

Metrick on the JPM Sensitivity #2 are, however, confirmatory.

   D. Does the Evidence Provide a Basis for Alternative DCF Analyses?

      As a final step in discharging my duty to consider “all relevant factors,” I have

looked to the record to determine if there is any basis to make further adjustments to

the projections or to alter the inputs used by the experts to arrive at a more reliable

DCF analysis. I am satisfied that no such basis exists. The JPM sensitivities

provided the most reliable evidence in the record of the actual, expected future cash

flows of the Company. And while they are not perfect, I find nothing in the evidence

that would allow me credibly to adjust these projections further. Nor do I find a

basis to alter the experts’ inputs. The DCF models they constructed were not that

dissimilar. Where they differed, I found Metrick’s explanations for his approach, in

this case, to be credible. I see no reason to alter the work he performed.

      I have considered all relevant factors. I state my final decision below.

                                         107
                                 III.    CONCLUSION

        Accepting Petitioners’ contention that the fair value of PetSmart was

$128.78 per share would be tantamount to declaring that a massive market failure

occurred here that caused PetSmart to leave nearly $4.5 billion on the table. In the

wake of a robust pre-signing auction among informed, motivated bidders, and in the

absence of any evidence that market conditions impeded the auction, I can find no

basis to accept Petitioners’ flawed, post-hoc valuation and ignore the deal price. Nor

can I find a path in the evidence to reach a fair value somewhere between the values

proffered by the parties. And so I “defer” to deal price, not to restore balance after

some perceived disruption in the doctrinal Force, but because that is what the

evidence presented in this case requires.439

439
    I cannot help but observe, however, that reliance upon the deal price as a reliable
indicator of fair value in this case, where the paid experts have offered such wildly different
opinions on the subject, does project a certain elegance that is very appealing. In an arm’s-
length transaction like the one here, the buyer and seller are both incented to value the
company as accurately as they can knowing that “they [will be] penalized in the
marketplace” for failing to do so. See Daniel R. Fischel, Market Evidence in Corporate
Law, 69 U. Chi. L. Rev. 941, 943 (2002). “Paid experts in litigation who testify about
values derived from analyzing comparables or discounting future cash flows to present
value, [on the other hand], have very different incentives.” Id. Given this dynamic,
Delaware courts must remain mindful that “the DCF method is [] subject to manipulation
and guesswork [and that] the valuation results that it generates in the setting of a litigation
[can be] volatile. . . .” William T. Allen, Securities Markets as Social Products: The Pretty
Efficient Capital Market Hypothesis, 28 J. Corp. L. 551, 560 (2003). The Merger Price,
negotiated at arm’s-length, in real time, after a well-run pre-signing auction that takes place
in the midst of a fully functioning market, is not burdened by such litigation-driven
confounding influences.
                                             108
      For the foregoing reasons, I have found the fair value of PetSmart shares at

the date of the closing of the Merger to be $83 per share. The legal rate of interest,

compounded quarterly, shall accrue from the date of closing to the date of payment.

The parties should confer and submit an implementing order within ten days.

                                         109