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Taxpayer millions will go to shareholders as US co makes $156m offer for NZ's Endace - founding CEO Selwyn Pellett

Another tech company that has received millions in government grants seems set to fall into overseas ownership. 

READ ALSO: Steven Joyce in Twitter war with Selwyn Pellett over Endace sale

California-based, NYSE-listed Emulex has made a £80.7 million ($NZ156 million) cash offer to takeover Endace, the network security company founded by entrepreneur Selwyn Pellett (who resigned from the board in 2010 and sold most of his shares at the same time).

The offer represents a 65% premium on publicaly-traded Endace's last closing price, all but guaranteeing its success.

Endace's technology allows its customers - which include government security agencies - to monitor network traffic. Mr Pellett recently relayed to NBR ONLINE his experience encoutering Huawei staff, and the Chinese military, at a conference in China as he built he built up the company.

Although listed on the London Stock Exchange's AIM board, most Endace staff, and the manufacturing for its network cards, are in New Zealand.

$11m plus from NZ taxpayer
Endace - which was born out of research at Waikato University - has received more than $11 million in direct government grants, and the move is sure to reignite debate over no-strings-attached taxpayer handouts.
 
This arrangement has made Endace founding CEO Mr Pellett uneasy about the deal.
 
Taxpayer money into hands of shareholders - Pellet
"Like many New Zealanders I am not confident this is a good thing long term," Mr Pellet told NBR this morning.

"New Zealand may well end up with more jobs in the near term but over time it's anyone's guess what will happen and no one can predict commercial imperatives that drive decisions in the future.

"My assumption is Endace will be run as a cost center and therefore the government has just lost a source of corporate tax revenue, the very reason the founders made the effort to remain a New Zealand registered company while still listing on AIM.

"I remain unhappy about taxpayers' previous R&D investment in Endace now being put in the hands of shareholders (including myself) via the sales process without compensation to taxpayers.  It's an issue that needs addressing in a country strapped for R&D funding.

"All that said if Endace had to be sold I think Emulex is a great home for what is undoubtedly one of New Zealand's Hi Tech Crown Jewels.  I think the price is acceptable although less than its highs of a year ago.  I think it’s a good outcome financially for the founders, the staff and bulk of the investors."

The CEO has given certain assurances that bode well for Endace's stay here in NZ. Jim Mc Cluney seems a very decent and honorable man who took the time to have lunch with me to give sone personal assurances."

Feel-good intentions, no formal commitment
On a conference call with media today Emulex CEO Jim McCluney said his company intended to keep offices, staff and research and development in New Zealand (Endace has most of its 190 staff in NZ in Auckland and an R&D centre in Hamilton; earlier this year it opened a Silicon Valley office).
 
Sometimes such promises have held good. But other times - as with most jobs associated with Navman - they have evapourated over time.
 
Asked if he would make a formal pledge such as a provision written into the deal to keep jobs in New Zealand for a set time, Mr McCluney said it was too early in the deal process to say.
 
The Emulex boss did reveal that he had talked to senior government officials yesterday (whom he and Endace CEO Mike Riley refused to name). Reassurances were given about New Zealand jobs. Mr McCluney also raised the possibility of more R&D spending, and possible collaboration with universities. 
 
There was potential to expand the local operation, Mr McCluney told NBR ONLINE. Emulex could double Endace's revenue ($US41 million last year), in part by giving it access to the US federal government market. Some of that money would be reinvested in New Zealand.
 
Earlier this week, Kiwi Landing Pad director John Holt - a cofounder of NZ software success story Sonar6 - told NBR such sales often brought money and talent into New Zealand. Many, like TradeMe founder Sam Morgan invested profits in other NZ start-ups (in Mr Morgan's case, one was Sonar6, recently sold to a North American company for $US14 million).
 

Today, Endace boss Mike Riley also made the argument that all of Endace's NZ staff were taxpayers, and that New Zealanders with Endace shares would benefit. Mr Riley said Endace and Emulex had been talking for around a year. Endace needed more funds for R&D, which its new owner could deliver.

Endace results would be reported separately. New Zealand innovation would be highlighted to an NYSE audience.

Flat profit, struggling shares
In May, Endace said its net profit for the year to March 31 was $US1.8 million, or 10.5 US cents per share, in the 12 months ended March 31, down from $US2.2m, or 12.95 cents, a year earlier.

Revenue grew 7.3% to $US41.2m, with wider gross margins at 73.1% from 66.5% a year earlier.

Emulex [NYSE:ELX], a storage and networking company, has a market cap of around US$600 million.

What would happen if Emulex was in turn was bought?

"The world is full of change," Mr McCluney said.

ckeall@nbr.co.nz

 

More by Chris Keall

Comments and questions

Not really a tech darling this past year - its price has collapsed by half since October 2011. Some difficulties in the management's strategic vision, I hear.

Emulex will be doing well to pick this up at a time the price is down and management is appearing a bit distressed.

Large premium on current share price but as you say, the offer isn't even the price the share was at at the start of the year (and it has been a good year for NZ tech companies - DIL, XRO).

Still, given their current price, they have done well.

Why not add strings to government grants so they are paid back in full if the company is sold to a foreign buyer (thus forming part of the buyer's purchase).

Or perhaps add extra strings - if grants are given and the company is later sold at a massive profit to the owners, the grants are structured such that the taxpayer gets some return on their investment, too.

@ #2 Thanks for the spam, loser.

Irony...

Congratulations to Endace for attracting this offer.
But shame on the govt and Reserve Bank for their short-sighted interest rate policy that has resulted in a nil growth in DOMESTIC investment capital, meaning that capital must come from overseas.
We need a govt that realises the simple truth that interest rates should be set at a level that attracts savings, enabling the development of LOCAL capital, or we will be forced to look overseas for funds.
liberte

Tosser, always blame on the government.

Maybe it's time that the Crown, when making these development grants to businesses, took an equity stake in the company so at least it gets something back if the company is taken over.

If they went down this track the problem would be that the government agencies would spend millions of dollars negotiating the terms of the investment and managing the risk, etc, which would reduce the amount actually invested in doing things.

The system would have to almost be a template, you get $x and we get x% of the business. Or as one person later suggests, use a convertible loan - the cash gets repaid, plus interest.

Government grants to tech or any new business should have conditions that the govt own shares in companies to the value of the grant. If full ownership is required by non-residents they pay back the amount.

SAP repaid Right Hemisphere's government loan when it purchased the company. So far the jobs have stayed in NZ since too.

Most of the cases mentioned above have been direct grants for R&D, not repayable.

In the case of SAP, as NBR mentions in its story (http://www.nbr.co.nz/article/right-hemisphere-new-zealand-taxpayer-love-ck-112371), the German company repaid Right Hemisiphere's $14 million-odd govt loan when it bought it last year.

But Right Hemisphere still benefited from five years' worth of govt interest-free loans from Labour and National.

SAP has subsequently added local staff to what used to be Right Hemisphere, and given it more global reach - though of course intellectual property and control is no longer NZ's.

I've got mixed feelings. I'm not saying this phenomenon is a good thing or a bad thing.

But I would like to see more discussion rather than just another round of back-slapping in the tech community as it cheers another successful "exit".

Let's remember this company was sold off shore in 2005 and there is now potentially an aditional $30m odd that will flow back to NZ founders. A decent return and today Kiwi R&D and innovation has been highlighted to smart US-based tech investors via Endace on analyst call. This is a good result for NZ, especially given jobs will be staying here and in part R&D. Hopefully, we see huge positive collaboration between NZ and California now and more R&D jobs creation at Endace here.

Why assume a government grant is necessary at all? Mind you, if my company was the beneficiary of a government grant I would be very complimentary of such a wise and clever political/bureaucratic decision.

As I work in this space I am somewhat perplexed with references to MSI and FORST. They were lumped into the MBIE months ago and the old MSI will basically end up as ATI in the near future, with its investment managers joining that group.

What a waste of money that was, merge two government agencies, then 12 months later merge that new entity with another (2 or 3) and then 12 months later de-merge some of it to form yet another agency.

No wonder no one knows who they are dealing with, but at the end of the day the same people doing the same thing.

But I guess Selwyn is not sufficiently unhappy to give his share back to the Government!

@David B I like your thinking. The govt (that us who pay taxes to) are losing out big time. Trouble is, if the govt took an equity position on every firm that was entitled to the equivalent of a grant then things would rapidly become pretty chaotic pretty quick.

The wider story here is that a frightening amount money seems to leak out of the country via multinationals, many of whom pay very little tax and are headquartered elsewhere. That taxpayer money is also leaking out of our coffers is doubly shameful. Question is, how do we fix this?

You get a govt grant - you pay it back if sold offshore, the govt should also get a margin on it since that will benefit the next lot loaned out. Simple. Problem is this govt and the last Labour one are too dumb – or at least their govt departments are to understand how to do things for the benefit of the country and not just PR for the govt (or departments).
It's only share brokers and money launderers who will pillar this idea. Those people who add nothing to the NZ economy.

Personally, I think that it is awesome to see another tech company sold at a high PE. There are limitless ideas that creative intelligent types can put there energies to. Let's start thinking about the next idea we can turn from nothing into $160m cash. NZ is a great little incubator. Let's keep it up. Over time the broader population will get a handle on the fact that creating value produces rewards!!

Don't forget that R& D gets a tax break of 125% of spending. I know someone who has invented a new type of computer chip. He needs funds for the patent, building his prototype and testing it. He hasn't been able to get any NZ funding whatsoever. His chip is different to anything else and will earn significant carbon credits and speed up all electronic equipment.

Steven Joyce should know better...

We should not let public servants (who by definition have no business drivers) get involved in business like this.

Endace has done a great job in getting sold which releases capital back to NZ based founders who are likely to reinvest into new ventures and create more value to NZ. The sale is somewhat a proxy to an export. Like the film industry, NZ is not so attractive without some form of government incentive and our start-ups are less likely to suceed. Our company has received an MSI grant for R&D related to our cloud-based product and we are currently selling that to UK and Australian based firms. This is a fantastic technology export for NZ and Xero is one of the firms leading the way.

Endace's sale should be considered export earnings. Once R&D moves offshore what are the guys and gals going to do. Short something new and better than the last. This time they have more cash in their pockets to bootstrap the new businesses with. We shouldn't get too caught up with seeing this as a loss to NZ.

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