Question
From: (redacted)
Sent: Thursday, December 04, 2008 1:07 PM
To: Verne, B. Michael
Subject: HSR Threshold Analysis
Hi Mike, I have anHSR threshold analysis I would like to discuss with you regarding a transactionthe facts of which are complicated enough that it probably would be helpful foryou to have the details in written form before we talk~ Please see below and Iwill give you a call today to discuss~
CompaniesDelta and Kappa, a wholly-owned subsidiary of Kappa parent, intend to form ajoint venture to manufacture Product A, and the JV will be owned 60% by Deltaand 40% by Kappa. The transaction will be consummated through a series of stepsin which the parties will contribute cash and intellectual property in exchangefor equity ownership in the JV. The JV, NewCo, will be an LLC and the right tothe profits of NewCo and the right to the assets of NewCo upon dissolution willbe in the same percentages as each of the parties' ownership interests~
CurrentlyKappa parent holds a subcontract to Company Zeta to produce Product A pursuantto Zeta's five-year, fixed-price, prime contract with the U.S. Government. Thefive-year contract is in the nature of a requirements contract and has nodefinite quantity of Product A to be delivered over the five years. The partiesestimate that approximately 61 units will be produced pursuant to the existingcontract. Kappa parent will produce Product A until NewCo is established andits production facilities are built (approximately an 18-24 month period) andwill then transfer to NewCo (or Zeta will award to NewCo) the subcontract forproduction. The parties do not place any value on the subcontract because thereis no value that is independent of, or not subsumed within, the product licenseand fees described in detail below. The parties estimate that Kappa parent willproduce approximately 27 units of Product A, and NewCo will produceapproximately 34 units under the existing contract. In addition to rightsgranted under the subcontract, NewCo will have the right to produce and selladditional units of Product A to the U.S. Government and to other customersafter the phased transition from Kappa parent. NewCo's business plan positsthat there may be sales of as many as 165 additional units of Product A, butnone have been sold or are under contract.
Deltaand Kappa have structured the transaction as follows: Delta will acquire anexclusive field of use license from Kappa parent for $58.3 million to produceProduct A ("Product A License"). Delta will contribute the Product ALicense to NewCo. Kappa will pay Delta $23.3 million for a 40% interest inNewCo; Delta will retain a 60% interest. Over time, the parties will contributeup to $200 million in cash, split 60/40, with which NewCo will establishthe manufacturing business.
Deltawill enter into an intellectual property license agreement with NewCo coveringpresently undefined Delta IP manufacturing know how ("Delta Know HowLicense"). The parties have not placed a value on this license and it willnot carry any royalty or fee.
OnceNewCo enters production, it will pay Kappa the following fees:
$1 million per unit as a royaltyfor the right to sell units of Product A to the U.S. Government beyond theexisting term of the subcontract (i.e. this fee does not apply to units ofProduct A produced under the existing U.S. Government contract, but appliesonly to future sales, if any, to the U.S. Government beyond the existingcontract);
$2.5 million per unit as aroyalty for the right to sell to customers other than the U.S. Government; and
$125,000 fee per unit of ProductA that Newco produces (capped at 200 units) to compensate Kappa for its priorinvestment in certain improvements to a component of Product A that NewCo willpurchase from a third party (i.e. recoupment of prior investment costs).
There arecurrently no additional UB. Government contracts or sales contracts for ProductA, nor are any sales imminent, other than under the existing contract with theU.S. Government.
Thetransaction is not reportable whether viewed as multiple transactionscomprising Delta's acquisition of the exclusive Product A License from Kappaparent and the formation of NewCo or as a single transaction comprising theformation of NewCo. We discuss the analysis for each alternative below:
1. Multiple Transactions:
Acquisitionof Product A License: Delta's acquisition of the Product A License from Kappaparent for $58.3 million is below the $63.1 million size of transactionthreshold. The parties' analysis places the actual value of this license at $35million ($58.3 million, less $23.3 million). The structure of the deal waschosen to address Kappa's desire to meet certain accounting goals of Kappaparent while also deriving a 60/40 contribution to match the ownershipgoal for NewCo. The transaction is not reportable because the acquisition price(whether that is $35 million or $58.3 million) is below the threshold. Futuresales of Product A beyond the existing U.S. Government contract are tooindefinite and uncertain to include the $1 million or $2.5 million royalties inthe value of the Product A License.
Formationof LLC: The formation of NewCo is exempt as to Delta under Rule 802.4 becausethere are no non-exempt assets as to Delta. Delta's contribution of the ProductA License and the Delta Know How License to NewCo are exempt intrapersontransactions under Rule 802.30(a) and (b). The cash contributed by Kappa toNewCo is not considered an asset under Rule 801.21 (a). Kappa's acquisitionof a 40% interest in NewCo is not a reportable transaction as to Kappa becauseKappa will not acquire a controlling interest in NewCo. Rule 801.40(c)
2. Single Transaction:
Ifthe formation of NewCo by Delta and Kappa is considered just one transaction,the formation of NewCo is not reportable. Delta acquires a controllinginterest; however, the $63.1 million size of transaction threshold is not met.Delta's contributions of the Delta Know How License and cash are exempt as toDelta as the acquiring person under Rule 802.30(c). Kappa's contribution ofcash to NewCo is also exempt under Rule 802.4 because cash is not consideredan asset under Rule 801.21 (a). The only non-exempt asset as to Delta is theProduct A License contributed to NewCo by Kappa. The value of the Product ALicense, as discussed above, is under the reporting threshold. Thus, thenon-exempt assets as to Delta do not exceed the $63.1 million threshold;Delta's acquisition is exempt under Rule 802.4. Therefore, the formation ofNewCo is not reportable as to Delta. Kappa's acquisition of a non-controllinginterest in NewCo is also not reportable. Rule 801.40(c); see also Rule 801.2(f)(1)(i) and Premerger Notification Practice Manual Interpretation # 80.