With 10-K season now upon us, we at Westlaw Business see it as our job to keep you informed of issues and events, based on SEC correspondence and other related documents that may impact your filings. To help you prepare your disclosures, we’ve begun this series, covering important 10-K considerations during the current economic climate.

Are we starting to see a mutual admiration society or is it a passing fad?  Recent market volatility has led companies to form joint ventures, which allows them to mitigate exposure to some risks, yet avoid any change in ownership that would occur with a merger or acquisition.  These strategies are not without risk, however, as joint ventures can be costly to implement or end up knocking a company flat on its face should the partnership fail.  The presence of cultural differences, opposing objectives, and a sense of “too many cooks” can all end up disjointing an otherwise healthy relationship.

Simply put, joint ventures (JV) allow entities to engage jointly in transactions – for mutual benefit.  The benefits may be legal, financial or both.  Fluidly structured, they can be set up by contract or through the structuring of a more formal JV entity.  Either way, a JV can offer a number of specific benefits, including side-stepping constraining change of control provisions, leveraging assets more fully, and sharing of financial and other business risks.

Change of control provisions pose a particular burden in today’s financing environment, as financing contracts often embed these as grounds for termination. To avoid this, companies that, at other times, might have attempted a change of control transaction instead choose a joint venture structure.  Consider the example of General Atlantic Partners, a massive PE firm, which bought a 52% stake in Emdeon Business Services for $1.2 billion. Last year, when HLTH Corp, which still owned the other 48% of Emdeon, decided to sell out General Atlantic, it had to call in Hellman & Friedman, another giant PE firm. The affiliates of the two firms structured the deal as a joint venture to avoid tripping change-of-control provisions in the target's loan covenants.

Asset leverage, particularly relating to expensive Intellectual Property assets, drives another major source of JV formation.  For the IP contributor, this can reduce development time and risk, while for the other JV partner, it gets early access to desirable IP with reduced licensing costs.  These JVs pervade many industries, not only the tech and pharma industries one might think. As examples, consider cigarette company Philip Morris.  To further promote some of its products, it just announced the formation of a joint venture with fellow tobacco company, Swedish Match, to license some of the company’s trademarks and other intellectual property.  Resort and hotel operator Morgans Hotel Group formed a joint venture to gain the rights to use the Hard Rock Hotel and Hard Rock Casino trademarks.  Lab equipment maker Bruker Corp. stresses the need to maintain its technology “base” and must continue to enter into JVs or otherwise perish.

Mitigating business risk often lies at the heart of joint ventures.  In one example, to avoid unnecessary financial risks, the oil and gas industry has long implemented joint ventures as a way to defer drilling or other operating costs.  American Oil & Gas claims the deferred drilling costs its joint venture provides allow the company to drill more wells and avoid the expiration of well leases on productive property.  Texas-based oil driller Endeavor International uses joint ventures to receive reimbursements of funds necessary to meet contractual obligations such as rig commitments.  Of course, joint ventures are not limited to the oil and gas industry, however, as Jones Soda clearly illustrates.  The boutique beverage maker’s line of credit was terminated last November, and the company claims it may resort to the formation of strategic alliances to raise much needed capital. 

Finally, marketing presence drives yet others. While the need to raise capital is important to all companies, those already “capitally secure” can use joint ventures to expand their foreign market presence.  In the case JVs inspired by the mantra of “if you can’t beat ‘em, join ‘em,” issuers seeking to penetrate markets and snatch competitors’ market share frequently enter into joint ventures.  Battery maker Ultralife Corp. formed a JV with one of its distributors in India to allow the company to have a more hands off approach to its “sales and marketing activities throughout India.”  Semiconductor developer Intellon Corp. uses joint ventures to “broaden” the market acceptance of its products, yet the company claims these agreements can bring development costs, cutting into profit margins.  Medical equipment maker Stereotaxis, Inc. stresses the importance of its strategic alliances to “leverage the sales forces” of the respective partners and co-market its products globally.  The global nature of such ventures can have drawbacks, however.  Cytori Therapeutics stressed the need to overcome “cultural” as well as “contractual barriers” that come along with its developmental joint venture.

Joint ventures are a common form of business agreements, but their disclosures must not be taken for granted.   Whether for IP protection, marketing, or risk mitigation, the formation of joint ventures can serve to boost a company’s bottom line, yet also burst a collective investor group’s bubble should the venture fail to materialize.  This 10-K season should see no exception to the quantity and quality of disclosures of JVs –whether via substantial marketing alliances, or simply as the implementation of cost saving measures.

Published:  March 17, 2009