In Deep Water: Boardroom Tussle at Asia Water Technology Case Overview Listed on the Singapore Exchange in March 2005 , Asia Water Technology Ltd (AWT) faced problems such as rapidly deteriorating operating cash flow problems and a breach of financial covenants relating to the bonds it issued. The board then proposed to accept an injection of funds from a new investor that involved the issue of a large number of new shares and a non-renounceable rights issue, which would substantially dilute existing shareholders. This led a substantial shareholder to propose the removal of directors on the basis that the directors had not acted in the best interests of the company. A boardroom tussle then ensued. The objective of this case is to allow a discussion of issues such as the evaluation of financing options, duties of directors in an insolvency situation, board composition, the removal of directors by shareholders and the resignation of directors. Online Final Assessment Spring 2020 Teacher Name: Muhammad Sharif/Usama Iqbal Course: Fundamentals of Corporate governance Student ID: Date of Submission: 21 st May, 2020 Maximum Marks: 40 Programme: BBA Morning (Hyderi & SMCHS) Student Name: Email ID: Background AWT is a water treatment specialist, providing comprehensive and integrated engineering solutions for water purification and wastewater treatment systems. Its business was conducted primarily in the People’s Republic of China through its subsidiary, Wuhan Kaidi Water Services Co Ltd. The company’s main revenues came from three core business segments: water purification, wastewater treatment and other auxiliary projects. Before June 2004, AWT specialised in engineering, procurement and commissioning (EPC) contracts for water purification treatment systems. However, business opportunities presented AWT a chance to expand its business model. In 2004, AWT shifted from pure contracting to a mixture of ownership of projects and providing EPC services Bond Subscription Agreement (BSA) As AWT’s projects were generally capital-intensive and required considerable upfront capital commitments, the company took on substantial financing. Although the shift of business model was initially successful, AWT’s business went downhill when it gradually expended its available capital. To reduce the risk of relying too much on short-term borrowing to finance long-term projects, and to access additional longer term capital to fund its expansion, AWT entered into a Bond Subscription Agreement (BSA) on 8 August 2007 with shareholders’ approval. Structured and convertible bonds worth US$60 million were to be issued in two tranches, with the proceeds to be utilised for various water treatment projects. The issuance of Series 1 bonds gave AWT a capital inflow of US$25.4 million, allowing the company to secure 54 new projects. Deteriorating Business Challenging economic conditions surfaced soon after and AWT was faced with rapidly deteriorating operating cash flow problems. In December 2007, AWT exceeded a gearing ratio, breaching a financial covenant relating to the Series 1 bonds issued. Although AWT obtained a waiver on the covenant breach, it breached another covenant due to the failure to complete a restructuring plan. As a result, the second US$30 million tranche of bonds was cancelled. However, at the request of AWT, bondholders agreed to observe a standstill period, where they would not terminate the BSA or demand for the An official waiver was subsequently obtained on 31 December 2008 but AWT was subjected to a revised set of financial covenants, requiring it to repay specific principal amounts with accrued interest on stipulated dates. For such repayments, a redemption amount of US$2 million was scheduled for payment on 31 March 2009. However, unable to pick up its business within such a short time, AWT failed to meet the repayment again. It obtained an extension until 5 June 2009, pending the conclusion of an agreement for new injection of funds into the company by potential investors. When AWT did not meet the second payment deadline, bondholders granted a further extension on condition that AWT entered into a legally binding written contract with potential investors. After conducting numerous meetings and negotiations, AWT received two written offers, including an offer from SI Infrastructure. outstanding amounts. In exchange, the company was restricted from further investments in any projects and prohibited from executing any related EPC contracts. Offer from SI Infrastructure The board considered SI Infrastructure’s offer to be superior, given the latter’s financial stability and the potential for synergy. Under a deal2 signed on 16 June 2009, SI Infrastructure would subscribe for up to 1.67 billion new shares and a non-renounceable rights issue of 98.45 million new shares at an exercise price of 2 cents per share, on the basis of one rights share for every two existing shares held. Net proceeds from this issue were estimated to be between US$21.2 million and US$23.9 million. With the successful completion of the deal, SI Infrastructure would hold not less than 83.3 per cent and up to 85 per cent of AWT’s enlarged share capital. The injection of capital by SI Infrastructure would improve the financial condition of AWT and allow its principal business to remain as wastewater treatment and water purification in China. AWT would be able to leverage on SI Infrastructure’s network and business expertise to expand into the waste water treatment and water purification industry. Boardroom Tussle The boardroom tussle began when a substantial shareholder of AWT objected to the financial rescue plan3 . Through EGN Nominees Pte Ltd (EGN), Kareti Venkataramana started buying AWT shares from early June 2009. At the highest point of ownership, EGN held 24.38 per cent4,5,6 of AWT. On 2 July 2009, EGN issued a notice for an Extraordinary General Meeting (EGM). It proposed the removal of four directors (Addyson Xue, Ng Fook Ai Victor, Simon Littlewood and Sha Guangwen) and the appointment of two new directors (Venkataramana and Peter Lai), as well as the rejection of SI Infrastructure’s offer7 . SI Infrastructure’s offer was questioned as the proposal involved a 77.8 per cent share price discount and virtually all of the share value of AWT’s current shareholders would be eroded. The last transacted share price was 9 cents on 12 June 20098 . Venkataramana felt that AWT’s directors had acted without considering the best interests of the company, and believed that the board should be held accountable for failing to justify the issue of shares at the grossly discounted price to SI Infrastructure. “Why should you think that heads should not roll for such financial mismanagement?”9 — Shareholder, Mr Ong C.H., 30 July 2009 (Today, Singapore) In addition, Venkataramana felt that the significant deterioration of AWT’s financial health over the past three years indicated poor leadership. He cast doubt on the board’s ability to lead the company, citing repeatedly bad corporate decisions that he argued had been made. In Venkataramana’s view, the board has also not undertaken adequate project financing planning, given the bad cash flow management in the company. “Nobody has said that this is a bad company or that it lacks strong fundamentals. But the company is in trouble because of poor cash flow management.” — AWT Investor, 31 July 2009 (The Business Times, Singapore) Venkataramana further argued that the board’s dealings with bondholders were questionable, as the monies received from the issuance of Series 1 bonds should have been used to repay short-term lending instead of securing new projects. As a result, in the same month when the issue of the Series 1 bonds was completed, the company had already breached a financial covenant relating to the bond. He argued that the severe lack of judgment on the part of the board also led to AWT’s failure to complete the restructuring exercise, resulting in the cancellation of the Series 2 bonds. Another issue raised was SI Infrastructure’s motive behind the investment. SI Infrastructure’s subsidiary, General Water of China (GWC), had separately signed a letter of undertaking with AWT’s bondholders to purchase US$29 million worth of AWT’s assets if the proposed refinancing deal was vetoed by shareholders10. As such, Venkataramana questioned if the deal would protect AWT’s interests, as it appeared that SI Infrastructure was only interested in AWT’s assets. Following the notice issued by EGN, the directors of AWT made an announcement in response to Venkataramana’s claims. They sought to explain their actions to improve AWT’s liquidity, citing the challenging macro environment conditions that the company faced. At the EGM held on 29 July 2009, investors holding over 50 per cent of the issued share capital shot down the proposal to remove the directors11. However, Venkataramana wrote to AWT on 12 August, calling for the resignation of the four directors, failing which a second EGM12 would be called. On the same day, AWT announced that three of its directors – Ng Fook Lai Victor, Simon Littlewood and Addyson Xue – had resigned on 11 August. In another letter dated 13 August, EGN called for the appointment of Venkataramana and Peter Lai as the non-executive and independent directors respectively. The letter also carried the same threat - if AWT did not comply, EGN would call for another EGM to effect the appointment and remove the remaining two directors, CEO Huang Hanguang and Sha Guangwen. On 17 August, EGN called for an EGM to be held on 23 September. Eventually, Huang Hanguang was removed from the board and as CEO13, and four new directors were appointed. The proposed investment by SI Infrastructure was also aborted. Changes in the Board The old board comprised six directors, with one executive director, two non-executive directors and three independent directors. Most of the directors had related energy industry knowledge. There was diversity of competencies, with qualifications in the areas of engineering, science, economics, banking and business. The board members held many other directorships and some also had prior working experience together. During the boardroom tussle, Tan Tew Han and Huang Hanguang said that they would voluntarily resign14 if the other four directors were to be removed. Eventually, Huang Hanguang was removed by shareholders in a resolution, while Simon Littlewood, Victor Ng, Sha Guangwen and Addyson Xue resigned. All four directors gave similar reasons for resigning – “the need for an extensive time commitment to the distressed company was something that they were unable to handle”. Also, Victor Ng and Tan Tew Han cited health reasons. Time commitment was also cited in the resignation of the newly-appointed independent director, Peter Lai. At the end of the struggle for control, a new board was formed with a nonexecutive chairman, three other independent directors and an interim executive director, Venkataramana. In November and December 2009, two more non-executive directors were appointed. AWT’s Share Price Beginning in late 2007, AWT’s share price started declining. The fall persisted through 2008 and stabilised somewhat in 2009. AWT’s financial health deteriorated with a negative growth of 20 per cent from 2008 to 2009, and losses increased 9 fold in the one-year period, attributable to the rise in doubtful debt expenses and finance expenses, and the 50 per cent drop in gross profit for its main power plant business15. For the second half of 2008, high construction costs in the power plant water purification projects in China and the delay in earnings from two other major projects affected AWT’s performance. Furthermore, a major earthquake in Sichuan in 2008 threatened the progress of their water infrastructure projects, and higher loans and borrowings caused the Group to breach its debt covenants during the quarters ended 30 June and 30 September 2008. The company’s share price fell from over 20 cents to below 10 cents16. In June 2009, at the beginning of the boardroom tussle, the company’s share price was at 9 cents. To raise his stake past 30 per cent, where he would be able to trigger a general takeover offer of AWT under the Code of Mergers and Takeovers, Venkataramana purchased shares in the open market. On news of a possible takeover, AWT’s share hit a fivemonth high of 12.5 cents and a total of 1.25 million shares were traded on 22 July 200917. While the peak in August and September 2009 could be due to Venkataramana’s continuous purchase of shares, it might also be attributable to investors’ rising confidence in the firm and the possibility of a takeover by EGN. In addition, the Group announced in late August a loan of RMB158 million obtained from the Industrial and Commercial Bank of China and Chinese Bohai Bank18. With additional working capital for its projects, it was good news for the market. However, AWT’s shares were suspended for trading on 8 September 2009, with its last traded price at 20 cents. The company went into receivership in the same month. Discussion Questions Question # 1. When considering financing options for a company seeking to expand or trying to stay afloat, what are the key factors that the board and management should consider? (Marks 07) Question # 2. In your view, did the old AWT board adequately discharge its duties? Do you think the board acted appropriately when the business started to deteriorate? (Marks 07) Question # 3. Do you think the board could have done more to avoid the boardroom tussle? (Marks 06) Question # 4. Do you think the directors were resigning too easily? Do you find the reasons for their resignation acceptable? Under what circumstances should a director resign? (Marks 07) Question # 5. Identify any corporate governance deficiencies in AWT’s board of directors - both the old and new board. (Marks 06) Question # 6. A common complaint amongst shareholder activists in the U.S. is that shareholders have no rights because it is difficult for them to appoint directors of their choice or to remove directors. To what extent should shareholders be given the power to appoint or remove directors? In AWT’s case, do you think the substantial shareholder’s action in removing incumbent directors and appointing new directors was beneficial to AWT?