Re Cellestis Limited [2011] VSC 284 (24 June 2011)

1 On 14 June 2011 I heard an application by Cellestis Limited ("Cellestis") pursuant to s 411(1) of the Corporations Act 2001 (Cth) ("the Act") for an order to convene a meeting ("the scheme meeting") of the holders of ordinary shares in Cellestis for the purpose of considering and, if thought fit, agreeing to a proposed scheme of arrangement between Cellestis and its shareholders ("the scheme"). I made the orders sought and now publish my reasons.

2 The scheme, if implemented, will result in the acquisition for cash consideration of all of the ordinary shares in Cellestis by QIAGEN Australia Holding Pty Limited ("QIAGEN Australia"). QIAGEN Australia is a wholly owned subsidiary of QIAGEN N.V., a company registered in the Netherlands and listed on the New York Stock Exchange.

3 The cash consideration to be paid by QIAGEN Australia is the amount of $3.55 per share less the amount of any "special dividend", if declared and paid by Cellestis. Cellestis is under no obligation to declare such a dividend. Furthermore, the declaration of any special dividend is subject to Cellestis receiving a favourable class ruling from the Australian Taxation Office. If declared, it is expected that the special dividend will be (subject to the financial position of Cellestis) up to 7 cents per share fully franked.

(a) 96,151,778 ordinary shares, held by 4,857 shareholders;

(b) 2,420,000 unlisted employee options held by 20 option holders, 19 of whom are employees of Cellestis and the other is a director of Cellestis.

5 It is proposed that the options will be cancelled pursuant to a deed entered into between Cellestis, QIAGEN Australia and each option holder ("the option cancellation deed"). Under the option cancellation deed, the option holders have agreed, subject to the scheme becoming effective, to have their options cancelled with effect from the implementation date of the scheme. There are three tranches of employee share options, with each tranche having a different exercise price. The consideration to be paid by Cellestis to the option holders for the cancellation of the three tranches of options was derived using a Black-Scholes methodology. The Black-Scholes valuation methodology is one of the two commonly used methodologies used for valuing unlisted or thinly traded options and is referred to in ASIC Regulatory Guide 111.[1]

6 Two directors of Cellestis who collectively hold 23.8% of the shares in Cellestis have granted QIAGEN Australia a call option over 19.9% of that shareholding pursuant to separate call option deeds entered into with each of the directors. The consideration payable to the directors for granting the call options was $10.00. The call option can only be exercised in the event that a competing proposal is announced. Save for where the grantees of the option deal with the option shares in a manner other than as contemplated under the respective deeds. The exercise price under the option deeds is $3.55 per share. This exercise price mirrors the scheme consideration amount of $3.55 to be paid by QIAGEN Australia and its parent company to shareholders under the scheme (subject to the reduction of the scheme consideration by reason of any special dividend declared and paid by Cellestis).

7 These matters are explained in the scheme booklet.

8 The directors unanimously recommend that the Cellestis shareholders vote in favour of the scheme, in the absence of a superior proposal. Subject to that same qualification the directors intend to vote in favour of the scheme in respect of their own shareholding.

9 An independent expert, Deloitte Corporate Finance Pty Ltd ("Deloitte") has expressed the opinion in a draft report that the proposed scheme is fair and reasonable and in the interests of the shareholders of Cellestis. The independent expert's report is contained in Annexure 1 to the scheme booklet.

10 The Court's role in applications of this kind is supervisory and the Court is concerned to ensure that the procedural and substantive requirements of s 411 have been met.[2] In Re Orica Limited, I made the following observations about the function of the Court:

The function of the Court on an application to convene a meeting essentially is:

(a) to consider whether the scheme booklet that will be provided to the shareholders sufficiently discloses the detail and effect of the scheme to enable shareholders to make an informed decision on how to vote;

(b) to consider procedural matters about the calling and conduct of the meeting;

(c) to ascertain whether the Australian Securities and Investments Commission ("ASIC") has had reasonable opportunity to examine the proposed scheme;

(d) to consider whether there may be matters that may make it unlikely that the scheme would be capable of a grant of approval by the Court if, in due course, its approval is sought and so make it futile to put the scheme to the shareholders for their vote.

It is not the function of the Court on an application for an order convening a meeting to consider the business or commercial efficacy of the proposed scheme, as that is a matter for the shareholders nor is it the Court's role to express a view on whether the proposed scheme should be approved, if the requisite majority of votes is obtained. An order of the Court that the meeting be convened is not an indication that the Court has a view as to the merits of the scheme or as to how shareholders should vote.[3]

I am satisfied that these requirements have been met in this case.

11 The scheme booklet prepared for the shareholders contains information about the proposed scheme; why the independent directors unanimously recommend the proposed scheme; a summary of the scheme, the independent expert report of Deloitte and a supplementary report from Deloitte, the proposed scheme documents, together with the information which the directors have formed the view is required to be disclosed to the shareholders for the purposes of voting on the proposed scheme. ASIC has also been informed about the scheme and has had a reasonable opportunity to consider it.

12 The proposed features of the scheme, however, raise certain matters for consideration.

13 The first matter concerns the option cancellation deed. It is not proposed that there be separate scheme meetings for the option holders but the Court should consider whether the option holders should be regarded as a separate class for the purposes of voting on the scheme of arrangement.[4]

14 The well established test for identifying a class for the purposes of a scheme of arrangement was expressed by Bowen LJ in Sovereign Life Assurance Co v Dodd.[5] His Honour stated:

The word "class" is vague, and to find out what is meant by it we must look at the scope of the section, which is a section enabling the court to order a meeting of a class of creditors to be called. It seems plain that we must give such a meaning to the term "class" as will prevent the section being so worked as to result in confiscation and injustice, and that it must be confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest.

In Re Foster's Group Limited[6] Ferguson J, after referring to the class test as formulated by Bowen LJ in Sovereign Life Assurance, observed as follows:

That test has been adopted ever since in members' schemes. In more recent times, the courts have observed that the test laid down is not one of identical treatment but rather one of community of interest. As Santow J has noted, "divergent commercial interests extrinsic to share membership are ordinarily not a factor which should differentiate classes." The courts are also mindful that if there is more than one class, each will have a power of veto.[7]

15 Thus the question for the Court is whether the rights of the option holders are so dissimilar to the rights of the shareholders that they cannot sensibly consult together with a view to their common interest. If their rights are significantly similar, there should be a single meeting.

16 It was submitted that the proposed treatment of the options does not give rise to any class issue because (a) the scheme relates to the shares in Cellestis and any shares held by the option holders will participate on the same basis and receive the same scheme consideration as shares held by all other Cellestis shareholders who are not option holders, that is, all shareholders are treated equally under the scheme; (b) the scheme relates to the transfer of ordinary shares and therefore the proposed cancellation of the options is not part of the scheme but part of the broader transaction; (c) the consideration to be paid for the cancellation of the options was derived using the Black-Scholes valuation methodology which is a commonly used methodology for valuing unlisted or thinly traded options and the extent of any difference in the consideration to be paid to the option holders and the scheme consideration is a product of the Black-Scholes valuation methodology; and (d) not all of the option holders are shareholders in Cellestis.

17 It was further submitted that the existence of the option cancellation deed does not mean that the rights or interests of the option holders who also hold shares are so dissimilar as to make it impossible for them to consult in one meeting with other shareholders of Cellestis.

18 I accept the submission that the proposed treatment of the options does not give rise to any class issue and there is no need for separate classes in the present case.

19 The next matter for consideration is the call option deeds. Under the terms of the call option deeds QIAGEN Australia can only exercise the call option in the following circumstances:

(a) where a competing transaction has been announced or received by Cellestis and QIAGEN Australia has provided to Cellestis a matching or superior proposal to that competing transaction in the manner contemplated by the matching rights clause in the scheme implementation deed;

(b) where a competing transaction that is superior to the scheme has been announced or otherwise received by Cellestis, QIAGEN Australia has not provided to Cellestis a matching or superior proposal to that competing transaction and QIAGEN Australia reasonably forms the view that the competing transaction is likely to be successful if the shares the subject of the call option participate;

(c) where during the option period the two Cellestis directors deal with any of the option shares or with any of the rights or interests in relation to the option shares except as contemplated by the deeds. In that event, QIAGEN Australia is not obliged to participate in any competing proposal in respect of any of the shares.

(a) the event triggering the right to exercise is the emergence of a competing proposal;

(b) those directors will receive the same scheme consideration for their parcel which is the subject of the call option as other scheme shareholders will receive;

(c) both directors have recommended the scheme to the shareholders and have stated their intention to vote their shareholding in favour of the scheme in the absence of a superior proposal;

(d) the call option deeds expressly provide that nothing in the deed restricts the ability of the grantor of the option to exercise the votes attaching to the option shares in the grantor's discretion (clause 2.5);

(e) the directors also have another parcel of shares not covered by the call option which will be participating in the scheme.

21 Another matter brought to the attention of the Court was a valuation of Cellestis done by or on behalf of a group describing themselves as the Cellestis Shareholders Action Group. In May 2011, the Cellestis Shareholders Action Group wrote a letter to Cellestis shareholders regarding the proposed scheme of arrangement. The letter informed shareholders that they should visit the website referred to in that letter and read what were described as an "independently produced Cellestis research report" and the group's "private valuation of Cellestis". Following consultation with ASIC, Cellestis engaged Deloitte to consider the documents referred to in the group's letter and any other material Deloitte considered appropriate and to prepare a supplementary report for inclusion in the scheme booklet expressing its opinion:

(a) as to whether the matters raised, the conclusions reached and the opinions expressed in that material alter or otherwise affect the conclusions reached and the opinions expressed in Deloitte's independent expert report;

(b) as to the appropriateness or otherwise of any assumptions relied upon, the methodology adopted, the conclusions reached and the opinions expressed in that material.

22 On 7 June 2011, Cellestis received the supplementary report prepared by Deloitte and a copy of that report was provided to ASIC. Deloitte concluded that having considered the group's materials, it held to the valuation opinion as expressed in its independent report that the offer by QIAGEN N.V. was in the best interests of the Cellestis shareholders. The opinion expressed by Deloitte in the supplementary report is that overall it does not consider the group's valuation of a Cellestis share to be reasonable due primarily to the following matters:

(a) it does not consider that the discounted cash flow methodology adopted in the group's valuation to be an appropriate primary valuation methodology for the valuation of Cellestis due to the inherent uncertainties around the key drivers of Cellestis' businesses which can lead to a wide range of possible future cash flows and valuation outcomes;

(b) that in Deloitte's opinion, the revenue growth assumptions adopted were optimistic in that such assumptions imply that Cellestis would achieve a market share of 36% by 2020 whereas Cellestis had only achieved a market share of approximately 5% in the 10 years since 2001;

(c) the operating margins adopted in the group's model increase from 30% in the 2011 financial year to 48% in the 2020 financial year and that in the absence of any evidence provided by the group to support that increase in profit margin it was difficult to understand how Cellestis could achieve that projection when none of the comparable companies considered by Deloitte consistently achieved an earnings before interest and tax margin in excess of 30%;

(d) the group's valuation was premised on the assumption that Cellestis' profits will grow from $8,300,000 for the 2010 financial year to $74,500,000 within 8 years;

(e) the discount rate adopted in the group's valuation of 8% was too low;

(f) there were inconsistencies between some of the assumptions adopted in the group's model including that the model has projected strong revenue growth while concurrently reducing marketing costs (as a percentage of revenue) over the next 10 years; and

(g) the cross check undertaken by Deloitte illustrated that the group's valuation is approximately 300% of the recent prices at which Cellestis shares have been traded and the EBIT multiple implied by the group's valuation (99.4 times) is significantly higher than the EBIT multiples observed for all comparable companies.

23 Deloitte in its supplementary report has adequately explained its reasons for holding to the valuation opinion as expressed in its independent report. Those reasons have cogency and Deloitte has justified why it did not agree with the group's private valuation. The Deloitte supplementary report sufficiently explains Deloitte's opinion. It has also been seen by ASIC and will be included in the scheme booklet.

24 Counsel has also brought to the Court's attention a deemed warranty to be given by the shareholders as to their capacity to transfer their shares free from encumbrance. These warranties are commonplace and provided that there has been proper disclosure in the scheme booklet as there is in this case, no issue arises. The scheme also includes exclusivity and reimbursement fee provisions. These kinds of provisions are also commonplace in schemes and I am satisfied that those provisions are adequately disclosed in the scheme booklet. Finally there are provisions in the scheme documentation directed to ensuring that QIAGEN Australia is bound to perform its obligations and that its obligations are able to be enforced.

25 ASIC has provided its usual letter to the Court advising that it does not object to the calling of the first meeting.

26 In the circumstances, I propose to make the orders that are sought.

[1] Australian Securities and Investment Guide 111, 'Content of expert reports', March 2011, RG 111.73.

[2] Corporations Act 2001 (Cth) s 411(1); Re Orica Limited (2010) VSC 231; Re AWB Limited [2010] VSC 456; Re Foster's Group Limited [2011] VSC 93; Re AXA Asia Pacific Holdings Limited [2011] VSC 4.

[3] Re Orica Limited [2010] VSC 231, [7]-[8] (footnotes omitted).

[4] The Mac Services Group [2010] NSWSC 1316; (2010) 80 ACSR 390.

[5] [1892] 2 QB 573 at 583.

[6] [2011] VSC 93, 4-5 [15].