The Biggest Winner in the Dell Settlement Was Hoping to Lose

Here’s how it went down: A Delaware court ruled on Tuesday that Dell founder Michael Dell and private equity firm Silver Lake Partners paid too little for Dell when they bought the computer company for $25 billion three years ago, or $13.75 a share. The court ruled that the fair price was actually $17.62 a share for Dell. But the only shareholders who can collect the rest of the money that the court deemed their shares were worth are those who voted against the deal, and Magnetar is the largest of just a few investors who did, according to The Wall Street Journal.

This was likely Magnetar’s strategy all along, and indeed its reason for investing in Dell in the first place—it bought Dell stock after the buyout was already announced, intending to go to court to sue for extra compensation. Of course, Magnetar could only protest the acquisition price in court if the deal was approved despite its objections. In other words, while the hedge fund voted to reject the deal, it was banking on losing that vote—it must have expected other shareholders to approve the deal anyway. Had a majority of shareholders voted with Magnetar and blocked the deal, the hedge fund’s whole strategy would have been moot.

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If that game plan seems backwards and counterintuitive, consider that Magnetar, which manages more than $13 billion, has made a killing literally betting against itself in the past. The hedge fund famously profited during the financial crisis by investing in risky mortgage securities known as collateralized debt obligations (CDOs) while also shorting them, a maneuver highlighted in Michael Lewis’s book “The Big Short.” Magnetar was the focus of a Pulitzer Prize-winning investigation by journalism non-profit ProPublica into the deals that caused the housing bust. Magnetar has maintained that it was implementing a “market neutral” strategy that would make money no matter what happened in the housing market; while the Securities and Exchange Commission investigated the hedge fund’s actions, it eventually closed the investigation without pressing charges. The SEC has levied fines on Merrill Lynch and other firms for their roles in the Magnetar deals.

Magnetar’s tactic of filing lawsuits challenging takeover valuations in order to make money, also known as appraisal arbitrage, has become increasing popular with hedge funds in recent years, especially in the merger litigation hotbed of Delaware. In 2015, 54 such cases were filed in Delaware, and so far this year, 29 have been filed through the end of May alone, according to the Delaware Court of Chancery, which handles appraisals in that state (including the Dell case). That’s up from fewer than 10 cases filed in 2010, according to a recent study published in the Washington University Law Review.

In the M&A appraisal game, Magnetar is one of the most active players. A new study by Columbia Business School professor Wei Jiang found that the hedge fund filed appraisal petitions on five M&A transactions between 2010 and 2014. Magnetar has long specialized in merger arbitrage, a strategy that involves trading around deals and occasionally engaging in litigation.

For example, besides the Dell case, Magnetar was one of several hedge funds to share in a $127 million payment from Safeway in June 2015 to settle the investors’ claims that the grocery chain sold itself to Albertson’s for too low a price. The sum amounted to a 26% premium over what the funds originally received for their Safeway stock in the deal.

And in December 2015, Magnetar again split the proceeds, estimated at more than $300 million, of a settlement of its lawsuit claiming that the 2013 buyout of Dole had undervalued the fruit company. More recently, in late January of this year, Magnetar received another settlement of about $11 million, according to regulatory filings, from CEC Entertainment—the operator of Chuck E. Cheese kid-friendly restaurants—which it had sued seeking additional shareholder compensation in CEC’s 2014 buyout by private equity firm Apollo Global Management (APO).

As with Magnetar’s mortgage bet, investing in M&A deals with the primary purpose of challenging them is also controversial. Some critics argue the lawsuits are frivolous and an abuse of the legal system. Others complain that the litigation may benefit a few institutional investors like hedge funds with pockets deep enough to go to court, but it does more harm than good for most shareholders by levying extra expenses on companies and squeezing them for settlements. Delaware itself has recently introduced amendments that could limit such lawsuits.

Magnetar defended the practice. “Decades ago, shareholders in Delaware corporations were granted the right to seek appraisal in mergers where they believe they are not receiving fair value for their shares,” a spokesperson for the firm told Coins2Day. “The appraisal process—which is exercised multiple times a year by shareholders—allows a court to determine fair value through a judicial process.”

Of course, when takeover appraisal cases do make it all the way to court, there’s no guarantee that the hedge fund will reap a return on its efforts. Sometimes, the court decides that the acquiring company paid the right price—or even too much compared to the target’s fair value. In 2013, for example, Magnetar and several other hedge funds sued over the acquisition by 3M (MMM) of biometrics company Cogent, seeking about 55% more money for their shares in the target, which they claimed were priced too low. But the judge said the shares had only been undervalued by $0.37 apiece, and that Cogent was worth less than 4% more than what 3M paid.

The Dell deal may have had just the right combination of factors to make it a winning candidate for appraisal litigation, but Magnetar and other investors may not always be so lucky.

This story has been updated with new statistics on appraisal cases from the Delaware Court of Chancery.