Memtec (membrane technology) was to be the benchmark by which university research and commercial realities would find common ground.
The technology developed at the University of NSW was a way of purifying large-volume, low-value, fluid flows that had previously been achieved in the medical world for sterilising intravenous drips and other low-volume, large-value fluid flows.
The heart of the technology was a development in membrane Ultrafiltration. Following an initial public offering in 1983, the company started off purifying juices and then moved into waste water purification. It had the technology, but it needed a market. Unfortunately the waste water market was historically a civil engineering market, stringently and jealously guarded by the engineers of the large water authorities around Australia. Memtec fell victim to the ultimate Catch 22. Conservative and parochial engineers with little or no membrane purification experience were reluctant to test a home-grown technology until it had been proved overseas.
The Franklin River dam controversy had lifted the environmental consciousness and outfall pollution at Bondi Beach and other areas in Sydney during the early 1980s was making the environment a political issue. The Sydney Water Board (now Sydney Water) had more than 11,000 employees (it now has around 3000 to 4000) and the engineering-dominated water authority was under pressure to fix the problem. The solution was capital-intensive treatment plants and ocean outfalls. Memtec and its technology was left at the margin. Its loyal band of shareholders saw its share price continue to wither. Memtec CEO Denis Hanley saw the problem and decided to try and win market share offshore. The US was the obvious place. People there were anxious to protect the public drinking water systems against giardia and cryptosporidia, so Memtec moved its marketing focus to the US and to drinking water. It successfully listed on the NASDAQ and began to expand. Just before it was taken over, the company had grown substantially in the US and it had its own European operating subsidiaries in France, Italy, the UK and it was particularly large in Germany.
The company had an operation in Japan which today is in excess of $US100 million in turnover. Within South Asia it was fairly broadly represented either out of Australia or through distribution organised out of Singapore and a joint venture in China. Memtec however became a victim of its own success. As other Australian corporates such as Burns Philp, Leightons, BHP, NAB and others have discovered, the Americans are tough competitors and the Australian davids are often ill-prepared on many levels to fight the US goliaths. Denis Hanley provides an account of the battle.
I can't say I was awakened by a call at 7am. In those days I used to get up a little earlier - but I wasn't quite ready to receive it. I was in the bathroom and that probably was a reasonable portent of what was to come. I wasn't in the shower either. So having composed myself, the call was from one of our principal bankers, Oppenheimer in the US to say that US Filter had announced a hostile takeover of Memtec at the close of Wall Street. Our shares at the time were trading at about $US23. The offer was $US32. This gives you a bit of a sinking feeling, as it means they were pretty serious. At 7.05 I started getting calls from staff asking what's going on. The staff expressed a great deal of loyalty. The company culture and camaraderie was very deep, so girding the loins was the initial reaction. And we got ready to see what we could do about this interloper - a $US6 billion interloper. The offer price was $US32 per share - about $540 million in total. We had the honour of being the largest takeover offer that week on Wall Street. So we actually got into a few papers. It was a measly price earnings ratio of 44 times historic earnings.
The takeover was going to be conducted within the bounds of both the Australian and the US legal systems. I find it difficult to deal with any legal system, but when you try and put two of them together life gets to be very interesting. Along with the takeover announcement US Filter cheerfully indicated that they would be able to eliminate the entire head office staff of Memtec. So we at head office already knew that life was going to be interesting. The Part A takeover document was issued the next morning. If you've ever been through this, the Part A gives you 30 days to get a Part B back. And of course, the opposition has only been working on it for the past 6-12 months. The share price immediately moved to $US33 - the only good thing to happen in the first week of the takeover. My first response was to give the news to the Memtec directors. I called them personally, got them out of bed, and let them all know. We scheduled a meeting. We also broke our first US law in that we issued a statement saying the offer was unwelcome, inadequate and totally ridiculous.
The US Securities Control Commission quickly told us we shouldn't have said that. We pleaded ignorance, which was the truth. We then thought we'd better plan a defence, so I contacted the staff later that day and told them we were going to take it to the mattresses, we'd be defending it, don't worry. It was all going to be all right ... I didn't have a clue of course. In the first week of the preparation, our in-house US counsel went looking for a good Australian legal representative, and those of you who've met Mr Atanaskovic will know he's a very interesting and capable defender in matters such as this. He agreed to help and so we got our Australian legal counsel on board and pretty well straight away and received board approval for that. We then went looking for an Australian merchant banker. We were looking for people who knew the Australian shareholders. The key issue for the Australian banker was to try to help us with the Part B, which was the legal side, but also to focus on keeping the Australian shareholder base together. We chose our long-standing Australian banker, Ord Minnett as they knew most of the Australian register shareholders because they had put them there. That proved to be a good decision.
We then went after a US merchant bank. You could take three months just figuring out who you wanted there, as there's a lot of choices But we stayed with Oppenheimer, the people we knew there too because we had too little time to explain everything to somebody else. Oppenheimer introduced us to the US defence counsel in New York. He was one of those wonderful high-powered defence lawyers and the first person I have met who actually ran two sets of secretarial staff simultaneously. His appointments went all the way from 6.30am to 10pm, and you always got to see him but you weren't too sure about who was taking the dictation. In the second week, we negotiated the US bank fees and the legal fees, and believe me this was "fascinating". You don't have a terribly good position from which to negotiate but we were treated very fairly. We were able to organise a lot of payments for the bankers on a success basis. Of course it was different for the lawyers. I mean payments to the lawyers are not controllable only the quality of the advice can be managed. We were thus very careful about our selection.
Our Australian bank told us all the wonderful things they could do. Fundamentally they told us we could not defend the attack, but we could affect the price at which we would be sold. We had about as much leverage with Atanaskovic as we had with the US lawyers. So that precedent was set. We then appointed both Australian and US PR firms. If they had actually reported the paranoia and frustration we were experiencing with half our time gone and only the appointments of advisers made, I don't know what would have happened. But they did come on board early and they were therefore able to develop with us as we got up and going. The board again approved everything. Indeed it was not quite like that as I have to say the Memtec directors were intimately involved in all of this work. We realised that the senior management who were going to conduct the defence had been pre-emptively fired by the attacker so we thought we'd better put some sort of redundancy package together so that they didn't disappear down a plughole during our defence. Key head office staff were already being contacted by headhunters. For good corporate governance and board procedure reasons we appointed a consultant to advise a reasonable package in our circumstance.
At the end of two weeks, we had kept our people and we had some players lined up to help us with the defence. We had two weeks to go on the Part A. The Australian lawyers tried to buy time by nitpicking the documents. They were good at it. Buying time became their initial role, and if they didn't buy time we were dead in the water. The US lawyers started to think about winning. They came up with the normal defence mechanisms in the United States which are shareholder table of rights defences, designed to delay the offer. With such a delay we could actually find time to inform shareholders of our true value as a research based business. This US defence however is illegal in Australia and therefore it was a very frustrating process that they were going through. The laws exclude, not approve and so we were always facing the worst of both when trying to negotiate the treacherous waters of the corporations laws in both Australia and the US. The Australian lawyers actually were temporarily successful with their objections so we bought a little more time.
The decision to accept the takeover offer is always the shareholders'. That's the first thing anyone has to realise. Memtec was a research-based company and it was growing at the top line between 30 and 40 percent per annum. At the bottom line the earnings per share were 30 percent for the past three or four years. What the market didn't know because it was secret was that there were a lot of things in the research pipeline. The key to our defence was try to point out that there was a lot of continuing future earnings growth and the 44 times price/earnings this year was really 25 times next year. And within 18 months it was probably below anything that would be reasonable. So, having decided the defence, we then started to build within Australia, the Part B, which is to look for all sorts of value comparisons, ask for loyalty, present the plans and get value. The share price through this period had not dropped below the offer of $US32. We thought that things weren't going too bad in Australia. The US lawyers came back and again recommended the shareholder rights plan also known as a poison pill.
The object of the exercise was to delay the offer by up to 12 months because we were growing into their offer from an earnings point of view anyway. It also would enable us to present arguments to shareholders as to our true value before the long-term holders flipped their stock to the arbitrageurs and potentially also to look for the best alternative offers if the shareholders did indeed want to sell. We want to maximise shareholder benefits. This is when the interesting stuff also comes out. You employ private investigators to review the takeover company and the key people in the takeover company. You always hope you're going to find an Alan Bond so that you can point out certain problems and inaccuracies in the takeover promises. You then go out and get forensic accountants. I'd never heard of these folk until we got involved in this process. Now I have met a few. And aside from their hood and their dark glasses they seem like normal good accountants to me except they charge more. They set about by trying to figure out what US Filter had done from an acquisition strategy point of view over the years and from that to try to understand what real value had been created and how much of the growth in their earnings had come from the smoke and mirrors of acquisition accounting. Not that we expected this would produce a positive outcome for us but you really have to check.
The US banker then began looking for potential buyers or white knights on a global basis. With their help we prepared an offer pitch document that did show our potential future value. It had forecasts. It did also have restrictive US legal confidentiality provisions. And because we weren't sure whether white knights could move fast enough, we also started looking at leveraged buy-out firms. For those of you who have ever talked with people in New York who do buy-outs and that sort of thing you will recognise what I'm talking about. Over one weekend they had financing for three tiers of debts plus the equity pretty well lined up looking at all our numbers and projections. And the ink was still wet on the offer document going out to the white knights. They are pretty special movers and shakers. Now back to the Australian/American legal issues. Memtec unfortunately was incorporated in Australia. Although everybody agreed, including our Australian lawyers, that the US defence strategy would increase shareholder value by gaining a higher offer price, the Australian lawyers described the US style of legal defence as courageous in the extreme for the Australian directors of Memtec and for those of you who have seen Yes Minister you know what courageous in that context means.
The lawyers explained that the directors would be breaking Australian black letter law and would be liable for the result of their actions. Thus they stood to lose all their personal assets and should consider what the world might look like from jail. The board, not surprisingly, went a bit weak-kneed on me. The poorhouse jail was an unattractive option. And that led to our knock-down. The Australian lawyers had bought us time and the Part B was coming along all right, and the Australian shareholders did seem to be happy to wait. But the US shareholders flipped the shares as soon as they learned, obviously from the takeover company, that there was no poison pill. To understand this, you need to realise that in the US, institutions and principal shareholders don't manage takeover situations. These are managed by specialty organisations called arbitrageurs (this refers to equity abritage which is a high-risk activity involving buying and selling shares during price movement events such as takeovers. Arbitrageurs both buy and sell the securities of the participants involved, betting on the eventual outcome of the transaction).
As soon as long-term US shareholders have a reasonable view that things can happen quickly these institutions will sell out to the arbitrageurs. The arbitrageurs were probably the ones keeping the $33 price up. As soon as the large US institutions decided that they cannot hold the stock and sell their shares, the takeover is lost. And that's principally because the arbitrageurs are not long-term holders. Although, the Australian defence was going alright we were helpless in a global sense and the company was lost probably within the first four weeks. However, we still had a lot to do. We revised our strategic focus to maximising returns for our investors. The US bankers identified 200 white knights and we got responses from one in four of these who were willing to sign confidentialities to take 50 Memtec information packages. These were whittled to 10 potential firms and that quickly came down to about five because of the limited time available for them to do diligence work. We knew we still had some reasonable things to offer but with only weeks to work with it is hard for others to overcome the work load needed for them to get comfortable to make an offer of better than 44 times earnings.
To buy more time we announced that we would be making presentations to interested parties in both New York and Boston. These were to be public . Out of 50 or so packages sent out, five were really interested and one very interested. In New York we were able to show a fair bit of confidence in our presentation. And the meeting went well, in fact the share price went up to $34, and I guess we thought, hey, we're doing okay here. This little insignificant company, we're going to show them. Well, that was how it was as we turned into the home straight. But the finish line was still a long way off. What then happened is that all the potential white knights came back and said, you want an answer in two weeks, we can't do the due diligence, can't do this, can't do that, really can't get that through our board, so one by one the white knights bowed out. Where is an Alan Bond when you need him? However the due diligence of the potential buy-out firm really consisted of shackling the left leg of all the key people in the company to a ball and chain, and only taking it off when you actually made them a lot of money. Their diligence was somewhat akin to indentured slavery. But it was something we were happy to contemplate as it was now the only real card we could play.
It started to look like we could get a buy-out offer at the current arbitrage price of $34. We thought, hey, things aren't that bad. Lazarus rose from the dead. The momentum was going our way. Then the takeover offer from US Filter was increased to $34.50. Why pick $34.50 I don't know. I don't think anyone told them they are just clever at understanding how the game is played. They also went unconditional with their offer.
The next thing I know we're meeting the enemy in our New York counsel's office. We told them with a straight face that we were going to kill them and not one thing was a problem for us. They kept talking "hey, let's be friendly". In fact, I had an offer to go for a walk around the block with their chairman. Many times over the last couple of years I wish I'd gone, just to see what happens when you go for a walk in New York, but I did not go. My legal people were aghast at the thought. I mean I was sort of under the lawyer's left heel by this stage. So I didn't go for that walk. Instead we boldly asked if they had a higher offer that we might refer it to our board reluctantly. Here's us with nothing. Just a deck of cards with blanks on them. We told them to lift the price to 38 bucks otherwise we're not interested. In addition, we told them to get rid of all the legal threats. By then there were a mass of things that we were concerned about being sued over personally. This is interesting for all Australian directors because it seems to me in the US directors cannot be sued personally as often as you can here.
We told them to lift the price, get rid of all the legal mumbo jumbo and then just maybe we could consider the term friendly and that we could progress to discuss who would feed the cat and all the other things you talk about in a divorce. What followed was 36 continuous hours of negotiation - and I have to say thank God it was the lawyers who did most of it. They seemed to revel in it and it was then I that I knew why my guy had two sets of support staff, because normal people died. I know I did. In the end of the negotiations we lost all the etceteras but we gained everything we needed for the key issues. We got a $36 price. Battered and bruised I flew back to Australia for our shareholders meeting. It was an enthusiastic gathering. The meeting was populated by small shareholders who felt that the United States was stealing another part of Australia and all of them wanted to fight on. If spirit counted, we could have launched an attack on Los Angeles within 24 hours ... Not that LA would have noticed. Unfortunately, I had to stand there and tell them that it was over. We were dead.
The staff were pretty sad including myself, particularly as I was one of the head office staff, and we'd all lost our jobs. I think the fundamental thing in a takeover that's really interesting is that everyone else was saved. Part of our negotiations was to make sure that nothing got moved. Okay, the deck chairs up on the top level of the Titanic got shuffled, but good people stayed and the business has gone on magnificently under their care. As a post mortem, and it's funnier now than it was at the time, For about eight or nine weeks, I worked in New York one week, Sydney the next. Together with all the other travel that I have made on Memtec's behalf I have been awarded a permanent membership in the United mileage-plus program. But I still have the one and half million frequent flyer miles I accumulated. I do not have much of an urge to travel. I know since the transaction occurred that Australian Memtec shareholders were shortchanged by the Australian takeover code. The takeover was strategic. We had won every bid in the United States for drinking water plants using membranes over the previous 12 months.
What we were up against was the biggest water and waste water company in the United States. They told me after the event that it wasn't so much that they were worried about competing with us. They thought they could probably do that. Their concern was that under Australian code (no poison pill) we could not defend Memtec against a takeover. They thought if they didn't take us over, someone else would. And if some other big player got us, with the technology we had, it would be a strategic problem for them. I guess the key thing is that when you start playing the global game, you have to start thinking about the legal systems you operate under. And the Australian legal system, with its cute little Part A, Part B stuff just isn't something you want to be saddled with. You cannot get, in 30 days, a reasonable defence setup. And that means that if you are operating offshore you are likely to have a hostile bid launched against an Australian incorporated company. The US have had global multinational companies for 50 years. For us working out of Australia and trying to enter the US and/or global market, it was all a first-time experience. The big thing that came out of it for me is that I would never try to grow a publicly listed business with global potential if it is incorporated in Australia again, unless the takeover laws here are changed to provide US-style protections. We can only hope ...
* Denis Hanley gave this presentation at the AICD annual conference. This is an edited version
The purpose of this database is to provide a full-text record of all articles that have appeared in the CDJ since February 1997. It is aimed to assist in the research and reference process. The database has a full-text index and will enable articles to be easily retrieved.It should be noted that information contained in this database is in pre-publication format only - IT IS NOT THE FINAL PRINTED VERSION OF THE CDJ - therefore there might be slight discrepancies between the contents of this database and the printed CDJ.
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