62 Exempt Market Updatepublished by the EXEMPT MARKET DEALERS ASSOCIATION OF CANADA

Connecting You Coast to CoastIssue 3/ February 2013

If you are an executive or director of a public company, a key question to consider is this: as stewards for the shareholders, do you think you and your board are prepared to react properly to an unsolicited approach? M&A transactions involving public companies can surface and evolve in unpredictable ways. This is particularly so if a company is the target of an unsolicited takeover bid - where the stakes are high, events move quickly, and the timelines are very tight. At Crosbie & Company, we have found that some boards are surprised to find that they are not organized or prepared for such an event.

A hostile takeover bid is a possibility for any public company, but the risk is greater for companies whose shares are widely-held and particularly when the shares are trading at a “low” valuation. However, if an unsolicited bid is managed effectively, not only can shareholder interests be protected, but it can in some cases serve as a favourable catalyst. Having said this, the board’s state of preparedness is critical to its ability to respond quickly and be able to steer the company through this complicated and very time-sensitive process. In today’s world, where the performance of Boards and good corporate governance is coming under increased scrutiny, shareholders of public companies have come to expect their boards to be prepared for the unexpected.

At Crosbie, over the course of numerous board advisory engagements, we have experienced first-hand the difference that a prepared board can make. The takeover defense of Virtek, an industrial technology company based in Waterloo, Ontario, is an excellent example of the benefits of preparation. Virtek was the subject of a hostile takeover and was able to turn the tables on the hostile bidder, to the great advantage of its shareholders. Virtek had two divisions

– its well established and profitable imaging division and an earlier stage, cash flow negative division. Roughly a year prior to the hostile bid, Virtek had received an unsolicited but friendly offer for its profitable imaging division. At the time, the board retained Crosbie as its financial advisor to evaluate the offer and consider appropriate alternatives. As a result of this review, Virtek’s board and management developed clear perspectives on the value of the imaging division, who the other possible buyers could be, the economic and strategic considerations associated with breaking up Virtek and selling the company in parts, and the implications of various other courses of action.

A few months after this work was completed, a second party made an unsolicited takeover bid for the whole company that was hostile. As with most hostile situations, time was of the essence. The Virtek board had thirty-five days under Canadian securities laws to implement its defence tactics. Equipped with the information from the prior process, the board immediately retained Crosbie to pursue a sale of the imaging division. Crosbie knew which buyers would likely be most interested and could move quickly. We began discussions with buyers the day we were hired and, over the next 35 days, ran a successful auction resulting in two strategic buyers bidding aggressively for the imaging division and the execution of a sale agreement with a “fiduciary out” (i.e. allowing the Board to accept a superior proposal from a competing bidder if one should arise). While this would have been a successful outcome by itself, the group that lost the auction for the imaging division returned to the table and made a successful bid for the entire company at a 60% premium to the original hostile bid. In the final analysis, the shareholders of Virtek received a 110% premium to the trading price the day prior to the hostile bid!

The Difference a Prepared Board Can Make

By: Colin Walker, Managing Director, Crosbie & Company Inc.

Romit Malhotra, Vice President, Crosbie & Company Inc.

M&A CORPORATE ADVISING

Exempt Market Updatepublished by the EXEMPT MARKET DEALERS ASSOCIATION OF CANADA

63Connecting You Coast to Coast

Issue 3/ February 2013

The outcome for Virtek shows how a board’s state of preparedness can help turn difficult circumstances into a very positive outcome for the company’ shareholders.

Through our work with public boards, we think there are a number of things that boards can do to prepare for such unpredictable developments:

1. Understand and Monitor the Risk: In general, understand the company’s exposure to a hostile advance. There is a continuum of risk for public companies depending on their shareholder base and valuation. The risk is lower for companies that are closely held where control or effective control rests with a few parties, and also for companies whose shares trade at values that are in line with intrinsic value. On an ongoing basis, boards should keep their antennae up! Do the shares seem like they are fairly valued? Does recent trading activity suggest someone is accumulating stock?

2. Expect the Unexpected: Be Organized: When it rains, it often pours. When the skies are clear, boards should take the time to consider how well prepared they are for stormy weather. Consider the following checklist to achieve a state of readiness for an unsolicited approach: » Does the board have the appropriate personnel to

lead the company through such a process? » Identify appropriate members of a Special

Committee. Consider the directors’ background and experience. Define their roles clearly – ambiguity slows decision-making and can cause unnecessary conflicts among the directors

» Consider any conflicts of interest that may bring the Special Committee or the board under attack in the middle of a hostile process

» Identify legal and financial advisors that can offer independent advice to the board

» Prepare a takeover defence playbook with your advisors – include valuation analysis, list of potential buyers, prepare a draft confidentiality agreement containing a standstill, etc.

» Consider organizing an electronic data room. Some companies do this and update it annually

» Implement a shareholders rights plan or have a draft plan ready

» Understand the motivations of all key stakeholders, including management

3. Monitor the Risk/Reward Equation: Periodically assess and revisit the company’s exposure versus its state of preparedness. Being prepared requires time and money – strike the right balance.

Virtek’s board of directors would tell you the time and resources they invested prior to the hostile bid paid huge dividends. Not only did it allow them to take control of the process and benefit the shareholders but it reflected well on each of them.

For more information contact: Colin Walker - cwalker@crosbieco.com Romit Malhotra - rmalhotra@crosbieco.com

Board of Directors’ Checklist for an Unsolicited Approach √ Does the board have the appropriate personnel to lead the company through such a process?

√ Identify appropriate members of a Special Committee. Consider the directors’ background and experience. Define their roles clearly – ambiguity slows decision-making and can cause unnecessary conflicts among the directors.

√ Consider any conflicts of interest that may bring the Special Committee or the board under attack in the middle of a hostile process.

√ Identify legal and financial advisors that can offer independent advice to the board

√ Prepare a takeover defence playbook with your advisors – include valuation analysis, list of potential buyers, prepare a draft confidentiality agreement containing a standstill, etc.

√ Consider organizing an electronic data room. Some companies do this and update it annually.

√ Implement a shareholders rights plan or have a draft plan ready

√ Understand the motivations of all key stakeholders, including management