smh article Rescue has Chemeq investors over barrelIt's the last...

smh article Rescue has Chemeq investors over barrel

It's the last throw of the dice and shareholders are being asked to give up plenty to stay afloat, writes Michael Evans.

In January last year West Australian veterinary drug maker Chemeq trumpeted the commissioning of its new factory in Rockingham.

"If commissioning runs to schedule, it will take about two months to make first product," the company said.

It was good news for the biotech that had developed a way to prevent and control intestinal bacterial diseases in pigs and poultry, coming after founder Graham Melrose had promised the plant would be commissioned in the first quarter of 2003.

But, somewhat prophetically, the statement also warned that getting the factory up and running was "inherently uncertain" and the "schedule is unpredictable".

This Wednesday, some 14 months later, Chemeq shareholders will vote on a $60 million rescue from Japanese bank Mizuho International that brings new uncertainty.

It follows a year in which production delays stopped Chemeq obtaining unconditional regulatory approval of the factory, the Australian Securities and Investment Commission brought action in the Federal Court alleging continuous disclosure breaches, the company's share price fell 77 per cent and its chief financial officer and two directors quit.

And despite eight major capital raisings since June 2002, Chemeq has burned so much cash getting the plant operational that KPMG recently warned shareholders: "Chemeq will be in a weak financial state towards the end of April 2005, if not earlier.

"Given the frequency and extent of recent capital raising, the company's ability to raise fresh capital from existing shareholders and the broader equity market is considered at best questionable," KPMG's independent expert's report said.

Senior analyst at eG Capital, Patrick Potts, said Chemeq's position was "precarious".

"The stakes are quite high - they obviously need the cash to keep things rolling along and I think their options in raising cash are quite limited.

"If this is the best they can do, that would indicate they are over a barrel. If you're an investor you'd be chewing your fingernails."

Chemeq's board wants shareholders to approve a funding package that KPMG says "will significantly dilute" shareholder interests though at the same time stating it is "fair and reasonable".

The company will receive $40 million as the first part of a $60 million funding package from Mizuho through the issue of 40,000 convertible bonds valued at $1000 each. Mizuho could take up to 40 per cent of the company after the first tranche is converted to shares at the lower of $1.10 or the 30-day trading average before conversion, and up to 50 per cent after the second tranche.

Chemeq will also pay 8.5 per cent interest quarterly.

But the company won't say what it will do with the money because "it would not be appropriate and may be misleading to itemise detailed, proposed allocation of these funds". It promises only that it will "continue to keep shareholders immediately informed of current plans and allocation of funds".

Underlining the company's predicament is a provision allowing Mizuho to walk away with 15 per cent of the company at $1.10 per share, a 35 per cent discount to Friday's close of $1.70, if shareholders don't approve the deal.

In addition, Chemeq will have to pay a $1 million break-fee and Mizuho's expenses - and still faces being out of cash by next month, on KPMG's reckoning.

Even if the motion is passed and funding is forthcoming, it's not the end of Chemeq's immediate problems.

According to a series of covenants agreed to by the company, Chemeq must obtain by May 31 unconditional approval from the Australian Pesticides & Veterinary Medicines Authority for its factory and confirm the successful trials of its product in poultry in South Africa.

The company said last month it expected to achieve that - but eG Capital's Potts said: "They basically need to have a fully operational plant by May 31, and based on what they've said to the market and the number of delays they've had, that could be quite a struggle."

By the end of June Chemeq must also have confirmed orders for the sale of a minimum of 40,000 litres of its polymeric antimicrobial product - which the company says it can achieve.

Should Chemeq fail on any of the covenant conditions, Mizuho can cash in its chips at the fire-sale conditions and walk.

The deal has already brought management changes. Mizuho appointed a management team when the terms of the deal were announced in January.

Mizuho appointees are to take two board seats and a right of veto over senior appointments including the chief financial officer and chief executive officer.

Chemeq's founder, chairman and chief executive, Graham Melrose, has agreed to step back to non-executive chairman on the appointment of a new CEO.

Last week major shareholder and former board member Graeme Major said the KPMG report painted too pessimistic a picture of the company.

Mr Major wrote to shareholders saying the report was too one-sided.

"If it takes 100 pages to argue that something is fair and reasonable, then it probably isn't," Mr Major said.

But analyst David Blake from Bioshares remains sceptical. "The jury is still out on if the Chemeq product is, in fact, a money spinner," he said.

"They're still waiting for the APVMA licence - that's the absolutely critical element. If they don't get that approval I don't know where they're going."

He agrees the Mizuho funding "might be its last chance".

For their part, Chemeq's board told shareholders the company was "poised to capitalise upon its opportunities in the global animal healthcare market" and the Mizuho funding was "a viable and rewarding alternative".

It points out it already has distribution agreements in New Zealand, South Africa and Malaysia.

G

I don't hold. It is on my watch list, but too risky at the moment.