Is takeover a good or a bad deal for CBT?

How would you like to have set up a company in 1996, have virtually no sales, an accumulated deficit of $6.1 million (€5.8 million), and sell it for up to $85 million? Fantasy or reality? That is precisely what Bill McCabe, founder of Knowledge Well and CBT, two educational software companies, did.

He did this by backing his private Knowledge Well company (he was the majority shareholder) into the publicly quoted CBT group. But he and the other shareholders had to inject more than $10 million to develop Knowledge Well.

Is this a good or bad deal for CBT? Despite repeated requests since the deal was mooted, CBT did not circulate the takeover document to The Irish Times until after the e.g.m. considered the deal, thereby denying this column the opportunity to comment, before that meeting. But now the horse has bolted as more than 98 per cent (mainly proxies) of the CBT shareholders approved the deal after a recommendation of "an independent committee" of the CBT board. It could be argued that that meeting need never have taken place. Instead, Knowledge Well, from the outset, should have been part of CBT. Both companies are in similar businesses though CBT has hotly contested this view. It says CBT provides software to train people in information while Knowledge Well provides management and university training software. Also Mr McCabe said Knowledge Well would not have been a good business for CBT for the first few years because it would have diluted earnings. The reality is that the CBT shareholders are now paying a hefty premium on the start-up costs.

So what have they got? Knowledge Well incurred a loss of $58,000 in 1995-96, a loss of $1.6 million in 1996-97 and a loss of $4.4 million in 1997-98. Nothing unusual about that as it is at development stage.

Knowledge Well's future business and financial results substantially depend upon a software development contract with Kansas State University, according to the offer document. "This contract will allow users of Knowledge Well software to pursue college credits and/or degrees granted by Kansas State University." Earlier this month it signed an agreement under which IBM will feature Knowledge Well on its solution developer programme web site.

The reasons for the takeover are listed thus;

Gain access to new market opportunities through Knowledge Well's development resources.

Take advantage of revenue and marketing synergies.

Gain access to the library of courseware developed by Knowledge Well.

Obtain the benefit of Knowledge Well's relationship with Kansas State University.

Employ the experience, skills and expertise of Knowledge Well's management.

For those reasons CBT agreed to give Knowledge Well's shareholders 4,018,395 CBT shares (Mr McCabe receives 2,792,355 valued at $48.9 million and is also entitled to a further 546,361, valued at $9.6 million on the exercise of Knowledge Well options). Valuations of high technology companies are notoriously difficult because they depend on the whims of the market at a particular time.

Lehman Brothers, charged with this difficult task, used different models, compared Knowledge Well with similar companies and sought advice from Knowledge Well's management on the company's future. It came up with the initial valuation (four million CBT shares valued at $43.2 million plus options) which, of course, has risen in line with CBT's share price rise. Mr McCabe has told The Irish Times that the last investment by the shareholders in Knowledge Well was based on a valuation of $30 million. That was a year ago, and based on that, the $43.2 million does not appear outlandish; the exceptionally high valuations reflect investors' current perceptions and expectation for such stocks and, as recent market gyrations showed, these valuations can vary enormously.

Mr McCabe who sold around $40 million worth of CBT's shares in 1997, before the shares collapsed, in a confidence-building exercise on his return as chairman last year, promised to buy a substantial amount of CBT shares. This happened in January when he bought 61,000 at $18.78 per share at a total cost of $1.15 million. That, and the incorporation of his private company, Knowledge Well, should restore some confidence.

However, considering last year's traumas which culminated in the replacement of its two most senior executives, the number of class actions lodged against the company, and the possibility of lawsuits arising out of year 2000 problems, CBT's performance needs to be closely monitored.