The too-quick flip?

Proving meaningful collusion in private equity is no easy task. Just ask the US Department of Justice, which has supposedly spent the last six years trying to prove that some of the world’s biggest buyout firms colluded unfairly on various boom-era deals.

But there are certain scenarios where alarm bells are bound to ring, and there’s one apparent example coming to a federal court in Australia in November. US mid-market firm Castle Harlan bought a Canadian mining services business called Norcast Wear Solutions from Swiss-headquartered firm Pala for $190 million – and then sold it to Australian listed business Bradken just seven hours later for AUS$202 million. Based on exchange rates at the time, that represented possibly the fastest $25 million profit in the history of the industry.

Castle Harlan and its LPs were no doubt delighted by this apparently easy win. However, Pala certainly was not. Its argument is that if Bradken had bid directly for Norcast, it would have had to pay a lot more, because of the synergies it stood to realise from the deal. In fact, even factoring in the ‘fee’ paid to Castle Harlan, Pala still believes Bradken bought Norcast on the cheap.

As a result, it’s now suing Bradken in Australia for at least $25 million in damages, claiming that the company engaged in ‘misleading and deceptive conduct’ and ‘bid rigging’; the latter is a relatively new addition to Australian law, and covers situations where companies in a position to compete against each other in a bidding process come to an arrangement not to do so. Pala is also pursuing legal action against Castle Harlan in the US (although this process isn’t quite as advanced).
Precisely how Castle Harlan and Bradken plan to defend these charges is unclear; the two groups declined to provide comment for this article.

However, Bradken has previously appeared to suggest that bid-rigging charges couldn’t apply – because it wasn’t involved in the original process. In May, Bradken CEO Brian Hodges told the Sydney Morning Herald newspaper: “Basically they failed to offer the business to us, in fact they excluded us from their sale process … So there can be no cartel or bid-rigging because we weren’t invited into the process.”

Pala disputes this, however; the firm insists it had no reason to exclude any potential bidder, let alone one with as many potential synergies as Bradken. It also has email evidence from Goldman Sachs confirming that Bradken was specifically told Norcast was for sale. And even if you accept the notion that bidders need to be ‘invited’ into an M&A process, Pala points out that Castle Harlan received no such invitation – and it didn’t stop them bidding.

Could Bradken conduct the necessary due diligence and agree a deal of this magnitude from scratch within seven hours? It seems implausible.

And there are clear and long-standing links between Bradken and Castle Harlan. CHAMP, the latter’s Australian affiliate (in which it owns a 50 percent stake), was part of a consortium that took Bradken private in 2001, and relisted it in 2004. Since then the two firms have, by their own admission, invested together on the acquisition of AmeriCast in 2006.

Then there’s Nick Greiner. An influential former politician who resigned as Premier of New South Wales in 1992 after a corruption row, Greiner – who’s been named as a co-defendant in this trial, along with Hodges – is currently chairman of Bradken, and (according to his personal website) deputy chairman of CHAMP Private Equity. His role will clearly be a key focus for Pala as it attempts to prove that the two groups had some sort of arrangement in place: he is due to take the witness stand a few days into the trial. Particularly given the nature of the charges, that’s likely to attract plenty of publicity in Australia.

Nonetheless, it remains to be seen whether the case will stand up in court. The onus is on Pala to prove there was some kind of arrangement or understanding in place between Castle Harlan and Bradken. And since there’s unlikely to be specific documentary evidence of this, Pala must piece together its argument from phone calls, emails, patterns of behaviour, chronology and so on. Then it’s up to the sitting judge to decide whether it can be inferred, on the balance of probability, that an agreement existed.

This was still a good deal for Pala: it sold Norcast for more than twice as much as it paid to take the company private in 2007. But it earned its return the hard way: by improving operations, changing management and boosting the top and bottom line (some of which was due to a merger with a Singaporean company). So it’s easy to see why it’s angry about its eventual return being somewhat lower than it could have been, particularly since the deal delivered a healthy profit to another firm that added no value.

Of course, buying a company cheaply and selling it for a profit is not a crime. The question is: did Castle Harlan achieve this by virtue of its superior transaction skills, or by bending the rules?

Thus far, attempts to reach a settlement have come to nothing. Australian law requires a pre-trial mediation process, but assuming this is equally unsuccessful – as most of those involved seem to expect – proceedings are due to start on November 5th.