Lipa Pharmaceuticals Limited ACN 070 106 526, in the matter of Lipa Pharmaceuticals Limited ACN 070 106 526

[2007] FCA 1527

FEDERAL COURT OF AUSTRALIA

Lipa Pharmaceuticals Limited ACN 070 106 526, in the matter of Lipa Pharmaceuticals Limited ACN 070 106 526 [2007] FCA 1527

LIPA PHARMACEUTICALS LIMITED (ACN 070 106 526) IN THE MATTER OF LIPA PHARMACEUTICALS LIMITED (ACN 070 106 526)

NSD 1724 OF 2007

EMMETT J
14 SEPTEMBER 2007
SYDNEY

IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY	NSD 1724 OF 2007

IN THE MATTER OF LIPA PHARMACEUTICALS LIMITED (ACN 070 106 526)

LIPA PHARMACEUTICALS LIMITED
Plaintiff

JUDGE:	EMMETT J
DATE OF ORDER:	14 SEPTEMBER 2007
WHERE MADE:	SYDNEY

THE COURT ORDERS THAT:

1.Pursuant to subsection 411(1) of the Corporations Act 2001 (Cth) (the Act):

(a)the Plaintiff, Lipa Pharmaceuticals Limited (ABN 21 070 106 526) (LIPA), convene a meeting (Scheme Meeting) of the holders of ordinary shares in LIPA (LIPA Shareholders) for the purpose of considering and, if thought fit, agreeing to  a scheme of arrangement (with or without modification) between LIPA and the LIPA Shareholders substantially in the same form as set out in Exhibit 1 (Scheme Booklet);

(b)the Scheme Meeting be held on 19 October 2007 at Level 17, 383 Kent Street Sydney at 11.00am (Sydney Time);

(c)John Beresford Harkness or, failing him, Gorge Jovanov, act as Chairman of the Scheme Meeting;

(d)the Chairman have the power to adjourn the Scheme Meeting for such time as the Chairman considers appropriate;

(e)at the Scheme Meeting, a person will be entitled to one vote for each LIPA share they are registered as holding at 7.00 pm on 17 October 2007;

(f)the Explanatory Statement in the Scheme Booklet be approved;

(g)on or before 19 September 2007, there be dispatched by pre-paid post addressed to the relevant address set out in the LIPA register of members:

(i)a document substantially in the form of the Scheme Booklet (which includes the explanatory statement);

(ii)a proxy form for the Scheme Meeting; and

(iii)an envelope addressed to Link Market Services Limited, Level 12, 680 George Street, Sydney, New South Wales 2000, and

(h)the time by which the LIPA Shareholders must return their proxy forms for the Scheme Meeting be 11.00 am on 17 October 2007.

2.Other than Regulation 5.6.13 of the Corporations Regulations 2001, rule 2.15 of the Federal Court (Corporations) Rules 2000 (Cth) shall not apply to the Scheme Meeting.

3.Notice of the hearing of the application for an order approving the proposed Scheme be published once in "The Australian" newspaper by advertisement substantially in the form of "Annexure A" to these Orders, such advertisement to be published on or before 19 October 2007, and LIPA otherwise be exempted from compliance with the requirement to publish a notice at least 5 days before the date fixed for hearing of the application pursuant to rule 3.4 of the Federal Court (Corporations) Rules 2000 (Cth).

4.The proceedings be stood over to 9.30 am on 22 October 2007.

5.Liberty to apply.

6.These orders be entered forthwith.

Note:    Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY	NSD 1724 OF 2007

IN THE MATTER OF LIPA PHARMACEUTICALS LIMITED ACN 070 106 526

LIPA PHARMACEUTICALS LIMITED Plaintiff
JUDGE:	EMMETT J
DATE:	14 SEPTEMBER 2007
PLACE:	SYDNEY

REASONS FOR JUDGMENT

1. The plaintiff, Lipa Pharmaceuticals Limited (the Company), has applied for orders pursuant to s 411 of the Corporations Act 2001 (Cth) (the Act) for the convening of a meeting of its shareholders for the purposes of considering, and if thought fit, agreeing to a scheme of arrangement between the Company and its shareholders. The effect of the proposed scheme will be to transfer all of the issued shares in the capital of the Company to Apil Healthcare International Pty Limited (the Transferee). The Transferee is a wholly owned subsidiary of CK Life Sciences International (Holdings) Inc (CK Life Sciences), a Hong Kong corporation. The proposal would involve the Transferee paying 95 cents per share to each shareholder of Lipa for the shares held.

2. In the proposed explanatory memorandum to be sent to shareholders, Lipa is described as Australia’s leading provider of contract manufacturing services to a broad range of local and overseas based Nutraceutical and Pharmaceutical clients.  The Company’s contract manufacturing capabilities include solid dose, liquid, cream, powder and soft gelatine presentations across the complementary alternative medicine, over-the-counter and prescription product profiles.  The Company’s business was established in 1995 and a custom built factory was opened at Minto in September 2001.  In 2005 the Company expanded its production facility at Minto and introduced the rapidly growing soft gelatine dosage to the product line.  The Company currently employs over 300 people at its facility in Minto.

3. The Company has retained KMPG Corporate Finance (Aust) Pty Ltd (KPMG) to prepare an independent expert report indicating whether the proposed arrangements are in the best interest of the shareholders of the Company.  KPMG consider that the proposed scheme is in the best interests of the Company’s shareholders in the absence of a superior proposal.  KPMG bases that opinion on its analysis of the history of the Company and its prospects.  The Company was listed on Australian Securities Exchange Limited (ASX) in 2004, at a time when there were significant opportunities for domestic contract manufacturers in the Australian complementary healthcare industry.  The largest complementary healthcare manufacturer, Pan Pharmaceuticals Limited (Pan), had recently closed down and a number of smaller manufacturers had left the industry, leaving a considerable hole in the market for high quality contract manufacturers to fill.

4. KPMG say that investors were confident that the Company could take advantage of those opportunities and, as a result, the Company was listed in July 2004 at $1.50 and its share price increased to a high of $2.33 in late December 2004.  However, over the last three years, a number of changes have occurred within the industry and within the Company, with the result that investors have tended to lose confidence in the Company’s ability to meet expectations.  On 16 May 2007, the day prior to the announcement of a strategic review, the shares in the Company closed on ASX at 75 cents per share. 

5. As the industry recovered from the Pan collapse, large supermarket chains emerged with an increased share of complementary healthcare distribution.  That resulted in a trend towards smaller batch sizes and lower cost products.  That also meant tighter margins for contract manufacturers.  KPMG observed that the Company failed to respond efficiently to those changed business conditions and consequently a further earnings downgrade was announced in May 2006, which resulted in a further decrease in the Company’s share price of about 47%. 

6. KPMG have identified opportunities for the Company to increase sales through leveraging relationships within its current customer base, as well as increasing its production of over-the-counter products.  KPMG say that there are opportunities to export products to growing Asian markets that are seeking high quality, internationally manufactured products.

7. However, KPMG identify significant risks involved in realising those opportunities and in the successful turnaround of the Company’s operating performance.  The competitive operating environment is placing pressure on manufacturing margins in the Australian complementary healthcare market.  A new competitor is expected to open a new facility in the domestic market and that will place further pressure on the Company, particularly in the production of soft gelatine products.  KPMG has assessed the offer by the Transferee against that context. 

8. As a global participant in the pharmaceuticals industry CK Life Sciences, the holding Company of the Transferee, has an opportunity to extract significant synergies from the Company, including directing its own production requirements through the Company, which has considerable unused production capacity.  The synergies would also include costs savings through CK Life Sciences’ procurement network in China, increased sales to Asia through CK Life Sciences’ distribution network and providing additional capability in the form of soft gelatine production facility.  KMPG considers that those potential synergies, while not capable of quantification, appear to be considerable and by comparison, the implied premium of CK Life Sciences’ offer of 19% over the three month value weighted average price (VWAP) of the Company’s shares to the day prior to the announcement of the proposed scheme might appear to be low. 

9. KPMG has valued the Company shares in the range of 88 cents to $1.07 per share.  KPMG acknowledge the potential for significant value to be extracted from the Company in the future.  However, a turnaround in performance will take time and there continue to be significant risks to the achievement of that turnaround.  KPMG concluded, therefore, that since the offer that has been made is within its assessed valuation range of the Company, the proposed scheme is in the best interests of the Company’s shareholders.  In particular, by accepting the offer, the shareholders receive a certain cash outcome as opposed to the uncertainty associated with a continued shareholding.  Accordingly, KPMG consider that the offer is fair.

10. KPMG also undertook an analysis of data in order to assess a reasonable range for implied acquisition premiums in Australia.  They consider on balance that it is reasonable to suggest that, in Australia, successful transactions typically complete within an acquisition premium range of 25% to 40%.  Based on the proposed consideration, the implied acquisition premium over the one month and six month VWAP of the Company, prior to the announcement of the proposed scheme, is between 18% and 20%, while the implied acquisition premium over the one month and six month VWAP, prior to the announcement, is between 23% and 26% respectively.

11. After announcing a strategic review in May 2007, the Company met with a limited number of parties that were potentially interested in acquiring it.  Ultimately, CK Life Sciences was the only party to make an offer for the Company and, as there has been no further interest expressed after the announcement of the proposed scheme, the directors of the Company consider that the likelihood of an alternative offer emerging is limited.  Without an alternative offer, the only way for Company shareholders to realise a value in excess of 95 cents per share would be to reject the proposed scheme and wait for the operating performance of the business to improve to the levels required by the market to create share price appreciation.  KPMG consider, however, that, given the Company’s history of disappointing the markets and the significant risks facing the business, it is unlikely to expect a value in excess of the offer price to be achieved in the medium term.  Those are the considerations that lead KPMG to conclude that the proposed scheme is in the best interests of the Company’s shareholders. 

12. The consideration will be paid in cash.  CK Life Sciences Group has informed the Company that it has sufficient internal cash and cash equivalent resources to satisfy all the scheme consideration at the relevant time.  As at 30 June 2007, the cash and equivalents of the CK Life Sciences Group totalled approximately $A237 million.  The Transferee proposes, for its own purposes, to raise new debt to fund part of the scheme consideration and foresees no difficulty in doing so.  However, as at today, the amount and terms of the debt funding have not yet been finalised.  If the proposed new debt funding is finalised, that funding would be applied to satisfying part of the scheme consideration.  CK Life Sciences Group has given an irrevocable undertaking to the Transferee and to the Company to provide sufficient funds to the Transferee to enable it to pay all of the scheme consideration on the Implementation Date.

13. Under the proposed scheme and under a deed poll executed by the Transferee on 12 September 2007 (the Deed Poll), arrangements will be made for the consideration to be paid into an account in the name of the Company, to be held by the Company on trust for the purposes of paying scheme consideration to shareholders in accordance with the regime laid down in the Deed Poll and in the scheme itself.  Under the scheme, the shares in the Company will be transferred to the Transferee without any further involvement of the shareholders.  That transfer will be effective on the Implementation Date, as defined, being the date when the consideration is to be paid.  Under Share Option Deeds dated 17 June 2004, the Company has agreed to grant options to several individuals in return for their agreeing to serve in the capacity as non-executive directors.  It is a condition precedent to the scheme becoming effective that all of those options be cancelled.

14. On 12 February 2007 the Company announced to ASX the issue of Performance Share Rights under an Executive Performance Share Rights Plan approved by shareholders.  Under the terms of issue, upon vesting, the Performance Share Rights entitle the holders to be issued with shares in the Company.  Those rights will vest three years from the date of issue, subject to meeting a three year compound growth performance hurdle.  If the Court approves the scheme of arrangement, the Company’s directors have the power to vest the rights, even though the relevant time and performance hurdles have not been satisfied.  The directors of the Company have determined that the rights will vest on or before the Effective Date under the scheme in accordance with a Scheme Implementation Agreement (the Agreement) that has been entered into between the Company and CK Life Sciences International Inc.

15. The Agreement is dated 3 August 2007.  It provides that the scheme is to be subject to certain conditions, including the granting of necessary regulatory approvals and the non-occurrence of certain events.  The Agreement provides for the intended effect of the scheme.  By the scheme, CK Life Sciences undertakes to procure that the Transferee will, on the Implementation Date, pay scheme participants the scheme consideration.  The Agreement also provides for the deposit of the scheme consideration into a separate bank account to be established in the name of the Company.  The Agreement also imposed contractual obligations on the parties to take the steps necessary to implement the scheme in accordance with the timetable specified in the Agreement.

16. The Agreement provides a non-solicitation obligation.  That is to say, from the date of the Agreement until either the termination of the Agreement or the date of the scheme meeting, the Company must not solicit, and must not, authorise or permit its employees, except with the prior written consent of the Transferee, to solicit, negotiations or discussions with any person other than the Transferee with respect to obtaining a proposal in relation to a competing transaction.  The Agreement also imposes an obligation upon the Company to vest the performance share rights to which I have already referred.

17. The Agreement also provides for the payment of a break fee.  If the Transferee breaches a material term of the Agreement and the Company terminates the Agreement or either party terminates the Agreement by reason of approval not having been obtained from a majority of the shareholders of the Company, then the Transferee must pay the break fee amount to the Company.  If the Company breaches a material term of the Agreement and the Transferee terminates the agreement, then the Company must pay the break fee amount to the Transferee.  The break fee is the sum of $1 million.  While that sum is marginally in excess of the 1% of the total consideration that is referred to guidelines issued by the Takeovers Panel, the break fee is not in the usual category, in the sense that it is payable by either party and is only payable, in effect, for breach of the terms of the Agreement.  The break fee would not be payable if, for whatever reason, the shareholders do not agree to the scheme.

18. A draft of the proposed explanatory memorandum has been provided to the Australian Securities and Investments Commission (the Commission).  By letter of 13 September 2007 to the Company’s solicitors, the Commission has indicated that it does not currently propose to appear to make submissions or intervene to oppose the proposed scheme at the hearing today.  I have considered the proposed explanatory memorandum and it appears to me to be a satisfactory disclosure to shareholders of their rights and the consequences of their agreeing to the scheme. 

19. I am satisfied that the scheme is one that reasonably and properly informed shareholders may find commercially acceptable. It is a scheme that, if not opposed, would be likely to be approved by the Court if the members agree to it in accordance with the majority required by s 411 of the Act. In all of the circumstances, I propose to accede to the Company’s application for orders for the convening of a meeting of its shareholders.

I certify that the preceding nineteen (19) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Emmett.

Associate:

Dated:        8 October 2007

Counsel for the Plaintiff:	I M Jackman SC
Solicitor for the Plaintiff:	Blake Dawson Waldron
Date of Hearing:	14 September 2007
Date of Judgment:	14 September 2007