ASIC tack on iSoft leaves parties at sea More than 8000 hospitals in 40 countries use iSOFT's software Source: The Daily Telegraph HEALTHCARE systems provider iSoft hopes shareholders of the debt-laden group won't let the supposed "benefits" that one shareholder, private equity group Oceania Capital Partners (OCP), will receive cloud their vision when they vote on a proposed takeover by US IT giant Computer Sciences. On April 2, iSoft announced a recommended offer of 17c a share, which valued the equity at $180 million and represented a premium of 227 per cent to the pre-offer price of 5.2c a share and 270 per cent to the one-month VWAP of 4.6c a share. The acquisition would be by way of a scheme of arrangement. OCP, formerly Allco Equity Partners, owns 24.5 per cent of the iSoft equity and announced it supported the acquisition, subject to a superior proposal. CSC proposes to repay iSoft's debt -- senior banking facilities and convertible notes -- in full, which would take the total cost to $460m. The problem, if there is one, is that an OCP entity, Oceania Healthcare Technology (OHT), owns the convertible notes. The five-year notes have a face value of $39.7m and are redeemable on October 31 and November 19 next year. They are entitled to interest equal to the dividend paid on the ordinary shares but, as there is no prospect of iSoft being able to pay a dividend before maturity, they are, in effect, interest free. OHT's accounts as at December 31 put the net present value of the convertible notes at $21.1m, no doubt reflecting the fact that iSoft, in the absence of a takeover by CSC, would find it difficult to repay or refinance its senior debt, let alone repay the convertible notes. The scheme would ensure full repayment of the convertible notes and OHT would also have the use of the money at least 15 months earlier than otherwise. That attracted the ire of iSoft founder and former executive chairman Gary Cohen, who said early redemption of convertible notes would not be possible under a takeover offer because it would represent a prohibited collateral benefit -- a benefit provided to one shareholder but not to all. Section 411 (17) (a) of the Corporations Act stipulates a court must not approve a scheme unless satisfied it has not been proposed to enable avoidance of any of the takeover provisions. Cohen argued that but for the redemption of the convertible notes the iSoft scheme could have been proposed as a takeover, and threatened to object in court unless the scheme, as proposed, was withdrawn. Cohen quit iSoft last year under a cloud. Guidance early last year of a $110m EBITDA for 2009-10 was downgraded in June to $45m to $60m. It later reported EBITDA of $30m and a $383m loss after a $341m writedown of goodwill. Cohen stepped down as executive chairman in June, as chief executive in August and left the board in September. Lonergan Edwards, the independent expert called on to say whether the scheme was in the best interests of iSoft shareholders, initially assessed only the shares, valuing them in a range of 10.8c to 14.1c in concluding the offer was fair and reasonable and, absent a superior offer, in the best interests of shareholders. The report, lodged with ASIC, drew no protest. But at the first court hearing ASIC raised the issue of the scheme booklet and took the view that OCP would, under the terms of the proposal, receive a benefit. It wanted other shareholders to be told the extent of the benefit it would get as a noteholder and Lonergan Edwards to provide a market valuation of the convertible notes, "in the absence of a change of control transaction" (such as a takeover or a scheme). The court accepted ASIC's view, so the equity is valued on the basis of a change of control transaction (the reality) but the notes are valued as if there is no change of control transaction. Moreover OCP, as both shareholder and noteholder, is treated as a separate class, so the other shareholders will decide the scheme's fate. In valuing the notes as if the scheme didn't exist Lonergan Edwards has had to hypothesise on the most likely outcome. It considers iSoft unlikely to be able to repay or refinance its debt, and believes the senior lenders are reluctant to place it in administration and possible liquidation because of the value destruction involved. Lonergan Edwards thus considers it probable that a big chunk of the senior debt would be swapped for equity and a pro-rata entitlement offer would raise more equity. But that would dilute existing shareholdings. Lonergan Edwards values the convertible notes in the $18.3m to $26.7m range and explains that, on that basis, OHT would benefit by $13m to $21.4m on repayment of the notes. But it's clear the expert does not agree with the valuation methodology it's had to apply. "In our opinion, when assessing the value of the equity in iSoft, it is incorrect to deduct the market value of the notes," it said. The reasons included that iSoft would not have the resources to redeem the notes at a discount, there was no evidence to suggest OCP would be prepared to sell the notes to iSoft at a discount, given that iSoft had a legal obligation to repay the notes in full, in the absence of a scheme the notes would need to be repaid in full before any return to shareholders and adopting market value understated the value of iSoft's legal obligation to repay the notes on maturity, and would result in "a corresponding overstatement in the value of iSoft shares." The independent directors suggested shareholders, in assessing the benefit to OHT, consider that in the absence of the scheme or alternative offer it was doubtful iSoft would be able to repay or refinance its debt and that shareholders were likely to be materially worse off relative to the scheme consideration and could, in certain circumstances realise no value for their shares. Moreover, as is common practice, CSC required repayment of senior debt and convertible notes to give it the benefits of full ownership, such as access to iSoft's cash flow and tax consolidation. If the notes were not paid out OCP could hold CSC to ransom by converting a handful of notes, thereby denying the US group the benefits of full ownership. The independents believe most others wishing to acquire full control would also seek to acquire the convertibles on similar terms to CSC. In fact, in the iSoft sales process that led to the CSC offer, indicative bids by other parties are said to have all envisaged buying the convertible notes at the full face value. So what is common practice in this instance only creates a problem because OCP happens to be also a shareholder of iSoft. ASIC arguably is misconceived in its approach because, while OCP may receive a benefit, it does not do so as a shareholder but rather as a debt holder.