IsoTis/Integra Merger Vote In Jeopardy

IsoTis logoAfter struggling for several weeks to get shareholders to vote in favor of a buyout by Integra LifeSciences (ticker IART), orthobiologics company IsoTis (ticker: ISOT) conceded partial defeat last Friday by postponing its meeting for 10 days to solicit additional votes. The trouble at IsoTis started in February this year when the FDA put approval of IsoTis’ Accell products on hold.

Low on cash, IsoTis took a loan from Merrill Lynch, most of which would become available only if IsoTis found another $18 million in additional financing. Absent such new financing, the entire loan would become due. With the unfavorable FDA decision on Accell, IsoTis was unable to secure equity financing and opted instead to approach strategic acquirers. That’s how it ended up in the merger with Integra.

Shareholder meetings are usually postponed when management proposals face shareholder opposition, and management needs extra time to convince shareholders to vote their way. Because management has access to the voting tally whereas shareholders don’t, the system is intrinsically biased in favor of management. A recent example is the merger vote in Topps, where the pro-buyout management kept postponing the meeting until they had enough votes.

IsoTis stands out, however, in that nobody opposes the merger with Integra. To a large extent, the pain of non-votes is self inflicted. IsoTis Inc’s predecessor IsoTis SA used to be listed on the Swiss and Toronto stock exchanges and moved to a NASDAQ listing in February of this year. By the end of all acceptance periods, over 90% of the shares were tendered into the exchange offer for the NASDAQ stock. It is difficult to understand why IsoTis can not even get 50% of shareholders to vote a mere seven months later.

IsoTis still has a large retail shareholder base in Europe and faces an uphill battle to get these shareholders to vote based on proxy materials written not just in English, but in what’s much worse: English legalese. Aware of the problem, management had the materials translated into Dutch, French and German and promptly ran into the law of unintended consequences. English legalese is hard enough to understand, but becomes incomprehensible when translated into foreign languages. What makes the situation worse is the poor quality of the translation. For example, the German version contains a literal translation of “proxy voting document” into a string word that doesn’t even exist. So it’s safe to assume that confused shareholders will simply toss their voting materials into the recycling bin.

As a result, IsoTis finds itself squeezed in a corner: shareholders don’t vote, and management claims that absent the merger, its cash is sufficient only to fund operations through October. Management has one week to get the extra votes. For a start, we suggest that they get a new translation of their materials. Maybe some more easily understandable documents would be even better. A good example of successful and easy to understand proxy material is provided by Aquila‘s vote for its merger with Great Plains Energy. The effort was rewarded with 96% of shareholder approval.

Instead, IsoTis is resorting on scare tactics. Arguing that the available cash is sufficient only to fund operations through October, management claims that it will have to seek bankruptcy protection if the merger cannot be consummated. IsoTis President and CEO Pieter WoltersPresident and CEO Pieter Wolters insists that financing is “unavailable on acceptable terms.” We have no doubt that this was correct at the time the merger was negotiated. However, we think that IsoTis’ situation has since changed fundamentally due to an August 10 FDA approval of its Accell products. IsoTis may now be viable as a stand-alone entity. Because the major uncertainty factor around its product line has been cleared, it should be able even to find additional financing. After all, there are still plenty of hedge funds with cash looking for attractive opportunities, despite the market turmoil. Of course, given the expediency of the cash need, shareholders will be diluted significantly, but that would still be preferable to bankruptcy. We hope that management is working actively on a Plan B. Integra would be an obvious candidate for emergency financing in return for some equity, because clearly they are interested in IsoTis’ technology. We have mixed feelings about management’s ability to pull off a last minute rescue effort. All that we have seen so far indicated that we may be dealing with a practical example of Carl Icahn’s version of corporate Darwinism.

IsoTis trades roughly 17% below its buyout price of $7.25. One week remains to get another 1 million shares to vote to reach the minimum of 3.55 million shares needed to get approve the merger. Anyone speculating that the merger will go through is effectively gambling on management’s ability to do a significantly better job at getting votes than before. If they can pull it off, the upside is an annualized return too high to be put in writing.

The author manages the Pennsylvania Avenue Event-Driven Fund (PAEDX), which owns shares of IsoTis.

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