The DTI Report on Astra Holdings plc provides a classic case study on how not to conduct an acquisition. The bulk of the 550 page report covers the ill-fated acquisition by Astra of PRB, the Belgian munitions company, in 1989.
The Report highlights conduct and practices that are not untypical of many acquisitions made in the late 1980's: a highly acquisitive purchasing company; a deal driven by a powerful chairman with little collective decision making by the board; inadequate due diligence; an unrealistic timetable; and confusion over the roles of professional advisers.
Between 1986 and 1989 Astra was transformed from a small group specialising in fireworks and military pyrotechnics, with assets of £1.5 million and an annual turnover of £6.2 million, to an international manufacturer of armaments and ammunition and other defence related products with net assets at 31st March, 1989 of £54 million and an annual turnover of £96 million.
The acquisition of PRB was perceived by Astra's chairman, Gerald James, to be crucial to his vision of making Astra a major defence contractor. But the DTI inspectors concluded that his desire to fulfil this vision led to significant compromises in the conduct of the acquisition.
The inspectors concluded that the highly acquisitive nature of Astra, its management structure and lack of board procedures were all major contributing factors to the failure of the PRB acquisition.
Growth through acquisitions. Astra's rapid growth between 1986 and 1989 was due almost entirely to a series of acquisitions. Over this period of three years it made seven acquisitions at a cost of approximately £115 million, leaving little time for rationalisation and consolidation.
Accounting treatment of acquisitions in the UK has traditionally encouraged acquisitive companies by showing the post-acquisition results of an acquired company in an unduly favourable light. This may change if the proposals contained in the ASB discussion paper 'Fair values in acquisition accounting' are adopted. If the ASB has its way, trading losses and reorganisation costs of the acquired company will be a charge on the post-acquisition profit and loss account. Reported profits will therefore be lower than at present (see PLC, 1993, IV(4), 84).
Dominant chairman. It is clear throughout the Report that the acquisition of PRB was driven by Gerald James. He made a number of key decisions without full consultation with other members of the board. The Inspectors concluded that his enthusiasm for the potential benefits overrode all matters of concern about the acquisition which were expressed to him.
Non-executive directors. Non-executive directors expressed repeated concern about the acquisition but their reservations appear to have been largely ignored.
One executive, Edward Album, a partner in Baileys Shaw & Gillett, resigned a few months before signing of the acquisition agreement because he had lost confidence in Gerald James. He was replaced by Laurence Kingswood, another partner in Baileys Shaw & Gillett. According to the Report, Astra was one of Baileys Shaw & Gillett's most important clients.
Although Mr Kingswood was commended for his legal input in the transaction, the inspectors criticised him for taking on a position in which he was bound to face a conflict of interest. "A solicitor who becomes a director of a company which is one of the firm's most important clients is, in our view, taking on an office which may at some time result in his finding himself in a position of personal conflict in properly discharging his duties to the company in his capacity as a director whilst at the same time wholly putting out of his mind his firm's interests as the company's solicitors."
The Cadbury Code states that non-executives should bring an independent judgement to bear on issues of strategy, performance, resources etc (paragraph 2.1) and that the majority should be independent and free from any business or other relationship that could materially interfere with the exercise of their independent judgement (paragraph 2.2). The appointment of professional advisers as non-executive directors of public companies should therefore now be very rare.
The Report highlights the dangers of paying lip service to the views of non-executive directors. It criticises the executive directors for having done so but also criticises non-executives for not having expressed their views more forcefully. They could have done so by circulating memoranda, convening board meetings or ultimately resigning.
Information and board procedures. Astra had no formal structure for the circulation of information relating to the acquisition or for board meetings.
The fact that preliminary discussions were taking place about the acquisition was noted at a board meeting in January 1989. The acquisition was apparently not discussed at any other board meeting until signing of the acquisition agreement.
Key information and reports were not circulated to all members of the board. These included reports and letters by Stoy Hayward expressing concern about the acquisition, the memorandum of intent, a technical report prepared by Astra employees and the Astra group working capital report which was only produced in draft form at the signing.
Again, this conduct would probably now contravene the Cadbury Code which provides that a board should have a formal schedule of matters specifically reserved to it for decision to ensure that the direction and control of the company is firmly in its hands (paragraph 1.5). The Cadbury Committee recommends that the schedule would include acquisitions that are material to the company (Note 2).
Considerable confusion about the role and expectations of professional advisers emerged from the Report.
Paine Webber. According to the report, Paine Webber, Astra's chief financial adviser on the deal, did not consider that it was their duty to advise whether the acquisition was a good or bad deal for Astra. Astra's directors disputed this interpretation of Paine Webber's role but the terms of their retainer were not formally recorded in any agreement. This obviously illustrates the importance of a carefully drafted engagement letter.
Stoy Hayward. Stoy Hayward were key advisers to Astra in the acquisition. Their main areas of involvement included reports on PRB and a working capital report on Astra.
Their letter of instruction required them to produce a long form report on PRB. This is standard practice on a major acquisition. But three months before signing, Gerald James agreed with Paul Smith, a corporate finance partner in Stoy Hayward that they need only produce a summary of findings. The revised instructions were not defined in writing. The Inspectors pointed out, this was unsatisfactory from both Astra's and Stoy Hayward's point of view.
Due to pressure of time, Stoy Hayward did not produce a working capital report on the Astra group until the day of signing. The report expressed serious reservations about Astra's cash flow and emphasised the critical importance of planned disposals. No prior consideration was given by the directors of Astra to the working capital report.
The Inspectors concluded that there was a serious shortcoming on Stoy Hayward's part that they did not advise the directors and other advisers that the working capital report raised matters of material concern which the directors ought collectively to have considered. Stoy Hayward was also criticised for not having procedures whereby such an important document was reviewed by another partner at the firm.
It is highly desirable for all professional advisers to adopt procedures for second partner reviews of important documents. Stoy Hayward have now introduced such a procedure.
Baileys Shaw & Gillett. The most surprising feature of the role of Baileys Shaw & Gillett was that they were not engaged until a month before signing.
They had no part in the drafting of the memorandum of intent. The memorandum contained many provisions which put Astra at a disadvantage: a share sale agreement was to be drafted by the vendor's advisers and was to be subject to Belgian law; limited warranties were to be asked of the vendors.
Even though memoranda of intent have only moral force, they can significantly weaken a party's negotiating position if not carefully drafted. It is for this reason that a lawyer's input is usually highly desirable.
Baileys Shaw & Gillett tried to apply the brakes to the transaction, advising at several points that more time was needed to conduct proper due diligence and criticising the fact that there would be no long form report. They did not see a working capital report before signing and were therefore unable to draw possible concerns to the attention of directors.
Baileys Shaw & Gillett's predicament will be familiar to many lawyers that are introduced to a transaction when their client and other advisers have already determined to proceed towards a speedy completion.
Baileys Shaw & Gillett could have declined to act although the Inspectors observed that in all the circumstances this would have been difficult to do. Failing that, the only practical measures that they could have taken were to give repeated advice about their reservations - preferably in writing. Key advice about the Financial Services Act implications for directors of providing misleading information in the rights issue circular appears only to have been given orally, and was later disputed by Astra.
A number of other factors contributed to the failure of the acquisition.
PRB. Cross-border acquisitions inevitably present difficulties that are not encountered in domestic transactions. Astra clearly knew little about PRB and its management were reluctant to supply Stoy Hayward with much information that they required. Belgian labour laws and management attitudes would limit the ability of Astra to restructure PRB after the acquisition.
Timing. The acquisition was conducted at breakneck speed which led to compromises at every stage. The reasons given were hardly convincing: the fear that the vendors may lose interest and the fact that underwriters of the rights issue (needed to fund the acquisition) would go on holiday if the agreement was not signed by mid-July.
Due diligence. Many shortcomings of the due diligence exercise have been highlighted above, in particular, the fact that no long form report was produced. The acquisition agreement was also signed without any report on title of PRB's properties.
Rights issue. No verification notes were produced covering the rights issue circular. The importance of verification should never be underestimated given the potential liabilities of directors for false or misleading information in shareholder circulars.
Paine Webber failed to lodge a 5.15 letter with the Stock Exchange .
The letter (named after the rule in chapter 2 of the Yellow Book that requires it to be lodged) is an important safeguard and confirms, amongst other things, that the adequacy of working capital has been properly addressed by a company and its advisers. Clearly it had not been.
No plans had been made at the time of the acquisition for the post acquisition management of PRB or its integration into the Astra group. Unsurprisingly there were significant disagreements between the managements of PRB and Astra after the acquisition about how PRB should be run. It soon ran into financial difficulties.
The acquisition agreement was signed and shareholder circular posted on 17th July, 1989. PRB was put into the equivalent of liquidation by the Brussels commercial court exactly one year later. CJM
The DTI report on Astra highlights a number of areas where acquisitions can go wrong. A checklist drawing lessons from the failed acquisition might read:
The following diagrams are also available in the >PDF version of this article: