A high-flying small-cap worth buying?

Crikey. Animalcare is taking over Ecuphar, a Belgian animal health company. Or is Ecuphar taking over Animalcare? WTF is a reverse takeover anyway, Richard, and what do you think of it?

Mate, I'm as confused as you. Let's try and work it out together. Starting with what's already happened…

Go on then, what's happened?

Animalcare announced it plans to acquire Ecuphar last Friday. Its shares were temporarily suspended from trading and while they were suspended the company agreed to issue new shares and sell them to selected investors on condition the acquisition goes through. The placing will raise £30 million to pay most of the cash component of the deal.

Stop right there. The investors who bought shares in the placing paid 350p. That's about 40p less than the price of the shares before they were suspended. Is that fair?

Interesting question. It happens a lot. And private shareholders often complain when it does, even though shareholders routinely vote through resolutions that waive their pre-emption rights at Annual General Meetings.

Pre-emption rights?

Generally, shareholders have first refusal if a company issues new shares. This allows us to prevent our holdings being diluted, which, other things being equal, reduces their value because it reduces our proportionate holding of the firm.

Offering shares to all shareholders in what are known as rights issues is expensive, though, and takes a long time to organise, so companies routinely ask shareholders to give up their pre-emption rights when relatively few shares are involved, the issue of shares of up to 10% or 20% of the company's share capital, say, in the coming year.

So we only have ourselves to blame when a company places shares at a discount?

It depends what you mean by 'we'. Small private shareholders are often powerless to protect their pre-emption rights because large institutional investors, fund managers for example, command the vote.

The same large institutional investors may be offered shares in placings, so they have less to lose by waiving their rights. Most private investors, though, are left out in the cold because the whole point of waiving our pre-emption rights is to avoid the administrative hassle of fulfilling them.

But if the acquisition is so good, shouldn't investors be queuing up to invest? Why does Animalcare need to offer a discount at all?

Very good questions. One can only assume, the new investors required a sweetener.

I'm predisposed to hate the deal already. Should I be?

It all depends on whether it's a good one. If the new company is a much better business than Animalcare on its own, the fact that existing shareholders not offered new shares will bear a small additional cost will be little more than a footnote. The difficulty is knowing…

So Animalcare will get the money. What next?

It issued an admission document on Monday morning, and the shares resumed trading. Subject to a majority vote at a General Meeting on 12 July, the new combined entity will be admitted to the stockmarket on the 13th.

The shares went down, didn't they? What does that mean?

Yep, fell 7% to 365p on Monday. You know I don't pretend to divine meaning from short-term price movements but since there are more shares in issue, all other things being equal you'd expect the price of each share to be lower.

All other things aren't equal, though. Animalcare's just told the market it plans to become a completely different company. At the moment, it looks as though news of the acquisition has not been sufficiently exciting to make up for news of the dilution.

If the takeover happens, the Animalcare we all know, and to a certain extent love, will become a subsidiary of Ecuphar.

Wait a minute… Animalcare's taking over Ecuphar isn't it?

Not really, although that's how the first stage of the transaction is described. Actually this is a "reverse takeover".

The two companies have agreed a deal that, at the placing price of 350p, values Animalcare at 37% of the value of the combined entity and Ecuphar at 63%.

Although Ecuphar's shareholders will own only 48% of the shares in the enlarged group (because some of the consideration is in cash), it's two principal owners Chris Cardon and Marc Coucke, will own almost all of them. Together they will have a controlling interest in Animalcare.

Cardon will take over from Animalcare's Ian Meneer as chief executive. Animalcare's chairman will move to a non-executive directorship, and its finance director will stand down from the board to make way for Ecuphar's.

Once the acquisition of Ecuphar is complete, Ecuphar will legally acquire Animalcare. So, you decide. Who actually has taken over who?

Uh, oh. Brave New World then? What do we know about Ecuphar?

Not enough for my usual analysis. The admission document contains some history and three years of financial information. It shows Ecuphar has grown rapidly in recent years, unsurprisingly perhaps, having made a series of acquisitions. In 2016, profit at Ecuphar exceeded Animalcare's profit, but in earlier years it hasn't.

While Ecuphar is also developing new drugs, like Animalcare, its reliance on acquisitions makes the combined group a different kind of investment to Animalcare.

Also, unsurprisingly perhaps, Ecuphar has substantial borrowings, unlike Animalcare, which is debt free. I equate substantial acquisitions and debt with risk, so these are not welcome developments.

On the other hand… the Animalcare directors think the combination is a strategic leap forward. They say the two companies are complimentary. Its larger sales force will improve its competitive position in Europe, and allow it to operate across most of the continent, while relying less on other distributors.

Meanwhile, it will have more drugs to sell and a broader product portfolio that will also include vaccines and nutraceutical products. It accelerates Animalcare's move into novel drugs, which were possibly a decade from commercialisation, because Ecuphar owns three unique drugs as well as a host of patents and trademarks. Combined Research and Development nous may accelerate and improve drug development.

Sounds plausible...

It does. But Ecuphar is an agglomeration of European animal health business acquired since Cardon founded it in 2001. I don't really know what lessons their histories would tell us, and whether profit is sustainable let alone profit growth. Ecuphar made a loss in 2015, and a relatively small profit in 2014.

You mention the Animalcare directors. What's in it for them?

There's an opportunity in placings and takeovers for insiders to cash out. Two of them, chairman James Lambert and Lord Downshire, another non-executive director, each owned substantial shareholdings of just over 6% of Animalcare before the placing. Lambert did not sell any shares in the placing and Downshire sold about 17.5% of his holding.

The two current executive directors, Meneer and Brewster, did not have particularly large shareholdings but were in line for substantial grants of shares through long-term incentive plans which the company awarded early. In the placing, they each sold a significant portion of the shares but they kept more, and they will have larger stakes in the new business than they had in the old.

On the whole then, and considering most of them are taking up less exalted positions in the firm, the directors seem committed for now.

You don't really like it, do you Richard?

You know me, I never rush to judgement. The two companies could be a fantastic combination. But I'll tell you how I feel. Because Ecuphar is a private company built by acquisition, it's a bit of an unknown quantity.

I feel like a guy who left his bungalow one morning to go to work and returns for dinner to find DIY SOS have demolished it and rebuilt it as a two-storey house. He was planning an extension because he could do with the extra space, but he's not sure about the dimensions, fixtures and fittings and build quality of the new place.

He'd got used to the bungalow and had learned it was built on sturdy foundations. But the foundations of this new house are hidden, so he's worried he won't be happy there.

Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard