1. Who were Panda Ethanol, Grove Street Investors, Grove Panda, and Cirracor?

What
were their roles in the case study? Be specific.
2. Discuss the pros and the cons of a reverse merger versus that of an initial public
offering for taking a company public. Be specific.
3. Why did Panda Ethanol undertake a private equity placement totaling $90 million
shortly before implementing the reverse merger?
4. Why did Panda not directly approach Cirracor with an offer? How were the Panda
Grove investment holdings used to influence the outcome of the proposed merger?
In early 2007, Panda Ethanol, owner of ethanol plants in west Texas, decided to explore
the possibility of taking its ethanol production business public to take advantage of the
high valuations placed on ethanol-related companies in the public market at that time.
The firm was confronted with the choice of taking the company public through an initial
public offering or by combining with a publicly traded shell corporation through a reverse
merger.
SOLUTION
1.

Panda Ethanol owned ethanol manufacturing plants in West Texas and was
interested in going public either through a reverse merger or IPO. Grove Street
Investors was the investment bank hired by Panda Ethanol to evaluate their
options and to locate a suitable public shell corporation if the decision was made
to go public via a reverse merger. Acting on behalf on Panda Ethanol, Grove
Street Investors formed Grove Panda LLC to serve as a front for Panda Ethanol
in approaching Cirracor. By making Panda Ethanol less visible to the Cirracor
shareholders, Grove Street reasoned that they might be able to buy Cirracor shares
at a lower price than if the shareholders realized the profit potential of the Panda
Ethanol strategy. As a publicly-traded shell corporation whose shareholders
appeared interested in cashing out, Cirracor was to be the surviving entity of the
reverse merger. By merging Panda Ethanol into Cirracor, with Cirracor surviving,
Panda Ethanol would become a public corporation.

2.

Many small businesses fail each year. In a number of cases, all that remains is a
business with no significant assets or operations. Such companies are referred to
as shell corporations. Shell corporations can be used as part of a deliberate
business strategy in which a corporate legal structure is formed in anticipation of
future financing, a merger, joint venture, spin-off, or some other infusion of
operating assets. This may be accomplished in a transaction called a reverse
merger in which the acquirer forms a new shell subsidiary, which is merged into
the target in a statutory merger. The target is the surviving entity which must hold
the assets and liabilities of both the target and shell subsidiary.
Merging with an existing corporate shell of a publicly traded company may be a
reasonable alternative for a firm wanting to go public that is unable to provide the
2 years of audited financial statements required by the SEC or unwilling to incur
the costs of going public. Thus, merging with a shell corporation may represent an
effective alternative to an IPO for a small firm.
Direct issuance costs associated with going public include the underwriter spread
and administrative and regulatory costs. The underwriter spread represents the
difference between the price the underwriter receives for selling a firms securities
to the public and the amount it pays to the firm. The underwriter spread can range
from less than 1% of gross proceeds for a high-quality company to more than 8%
for lower quality companies. Administrative and regulatory fees consist of legal
and accounting fees, taxes, and the cost of SEC registration. For offerings less
than $10 million in size, total direct issuance costs may exceed 10% of gross
proceeds. For equity issues between $20 million and $50 million in size, these
costs average less than 5% of gross proceeds and less than 3% for those issues
larger than $200 million (Hansen: 1986). Reverse mergers typically cost between
$50,000-$100,000, about one-quarter of the expense of an IPO and can be
completed in about 60 days or one-third of the time to complete a typical IPO
(Sweeney: 2005).

Despite these advantages, reverse takeovers may take as long as IPOs and are
sometimes more complex. The acquiring company must still perform due
diligence on the target and communicate information on the shell corporation to
the exchange on which its stock will be traded and prepare a prospectus. Public
exchanges often require the same level of information for companies going
through reverse mergers as those undertaking IPOs. The principal concern is that
the shell company may contain unseen liabilities such as unpaid bills which in
some instances can make the reverse merger far more costly than an IPO.
3.

Private investment in public entities (PIPES) is a commonly used method of

financing reverse mergers. In such transactions, a public company sells equity at a
discount to private investors, often hedge funds. As the issuer, it is up to the
company to register its shares with the SEC within 120 days. Once approved by
the SEC, the stock may be traded on public exchanges. PIPES often are used in
conjunction with a reverse merger to provide companies with not just an
alternative way to go public but also with financing once they are listed on the
public exchange. For example, assume a private company creates a shell
corporation which is subsequently merged into a public company through a
reverse merger. As the surviving entity, the public company raises funds through a
privately placed equity issue (i.e., PIPE financing) to fund future investments.
PIPES offer the advantage of being able to be completed more quickly, cheaply
and confidentially than a public stock offering, which requires registration up
front and a more elaborate investor road show to sell the securities to public
investors. As private placements, PIPEs are most suitable for raising small
amounts of financing, typically in the $5 to 10 million ranges. Firms seeking
hundreds of millions of dollars are more likely to be successful in going directly
to the public financial markets in a public stock offering.

4.

Panda could have approached Cirracor directly. However, this may have alerted
the Cirracor shareholders to the Pandas intentions and could have encouraged

them to hold out for a higher purchase price for their stock. As an agent for Panda,
Grove was able to buy the stock less expensively since Carraccis shareholders,
desperate to recover a portion of their original investment, would have welcomed
almost any alternative to bankruptcy.
Nevada, the state in which Cirracor was incorporate, state law requires that given
the significant number of new share issued a shareholders vote was required to
approve the new issue. Approval required a simple majority vote. Since Panda
Grove let other shareholders know that it owned 78% and that in proxy materials
indicated that it would vote for the merger and reverse split, it was evident to all
shareholders that approval was imminent.
Total Panda shares outstanding (including 15 million newly issued shares in the
private placement) equaled 28.8 million shares. As a result of negotiations, Panda
shareholders would own 96% of the merged firms and Cirracor shareholders 4%.
This implied that total shares outstanding of the merged firms could not exceed 30
million shares (i.e., 28.8/.96). Consequently, Cirracor shareholders would own
1.2 million shares (i.e., 30 28.8). Since Cirracor shares outstanding totaled 3.5
million before the merger, a reverse split was implemented coincidental to the
reverse merger using a ratio of .340885 shares of Cirracor stock for each share of
Panda stock (i.e., .340885 x 3.5 = 1.19). 1.2 reflects rounding error due to
rounding the number of shares outstanding for both firms.