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What ownership levels should PS2 assume for each option?

Read the case study located on page 310 of the section titled Case Studies in your textbook and prepare a 4-6-page report in Microsoft, based on the following situation: Entrepreneurial firm, PS2, has been presented with two opportunities to significantly expand their business in China. Paul Antle, President and CEO of PS2, has come to you asking for your advice regarding these opportunities. Review the information available to you in the case and write a response to Mr. Antle’s questions: •Should PS2 enter the Chinese market? •Which opportunity should PS2 pursue? •Could PS2 pursue both opportunities? Should they? •Did PS2 possess the required resources and capabilities to pursue an equity-based entry? •What ownership levels should PS2 assume for each option? As you respond to each question, be sure that you explain the major issues that need to be considered. For example, what should be considered when thinking about entering the Chinese market? Support your responses with examples. Don’t forget to add a conclusion to paper. Cite any sources in APA format. Attached below is the Case Study. Phase Separation Solutions (PS2): The China Question In early 2008, Paul Antle, president and chief executive officer (CEO) of Phase Separation Solutions (PS2), received a call from the State Environmental Protection Agency of China, expressing interest in PS2’s Thermal Phase Separation (TPS) technology. PS2 was a small, Saskatchewan-based environmental solutions company that had grown, under Antle’s entrepreneurial direction, to become a North American leader in the treatment of soil, sludge and debris impacted with various organic contaminants. The company specialized in the cleanup of two waste streams using its TPS technology. The first was the remediation of soil contaminated with persistent organic pollutants (POPs), such as pesticides and poly-chlorinated biphenyls (PCBs). The second was recovering usable oil from industrial sludge generated in various industries, such as the oil and gas industry. Despite Antle’s initial concerns that the call had been a scam, he soon visited China to learn more about the market in China and to build relationships. The Chinese inquiries were sincere. By mid-2010, nearly one and a half years after Antle’s first visit, potential cooperative opportunities had emerged with two separate Chinese organizations: one in soil remediation, and the other in oil recovery from oil sludge. The two potential opportunities were attractive to PS2. The international geographic diversification would transform PS2 from a domestic player to an international player, and in so doing, would significantly improve its growth potential. The PS2 management team was no stranger to international markets. The TPS technology had been successfully employed in 14 countries in the past 15 years. However, the modes of international involvement had been on a non-equity basis, in the forms of equipment exporting, licensing and service contracts. Although the cooperative opportunities in China would bring PS2 to a higher level of internationalization, the decision was not to be taken lightly. A series of questions needed to be answered. Should PS2 enter the Chinese market? Which of the two opportunities should it pursue? Would it be feasible to pursue both? Did PS2 possess the required resources and capabilities to pursue an equity-based entry? What ownership levels should PS2 assume for each option? How would PS2 staff its Chinese operation(s) if PS2 decided to pursue the opportunities in China? Company Overview PS2 was founded in 2004 by a group of Canadian entrepreneurs who believed that the key to the safe management of environmental liability was the proper application of advanced clean technology, such as their TPS technology. By combining their extensive experience in the fields of hazardous waste management, remedial technology development and environmental engineering, they created PS2 to take advantage of the new opportunities in the Canadian environmental market. In the Government 310311of Canada’s 2004 budget, it had pledged $3.5 billion2 over the following 10 years for environmental cleanup. In 2005, after securing an investment of $3 million from Golden Opportunities Fund Inc.3 in the form of senior secured debentures, the company constructed a fixed soil reclamation facility in Wolseley, Saskatchewan. This facility was capable of treating a wide variety of soil contaminated with POPs, industrial sludge and waste Pharmaceuticals. The location was chosen so that PS2 could target the markets in both Eastern and Western Canada, and in the United States. The facility, which had a capacity of 20,000 tons per year, was permitted to treat a wide variety of pollutants. It was one of only three fixed facilities in Canada permitted to treat PCB and dioxin/furan-impacted soil. In late 2005, the facility became operational and started generating revenue. It was fully commissioned in early 2006. PS2 generated revenue by securing service “contracts” for the treatment of contaminated soil or on a “fee-for-service basis,” wherein small quantities of contaminated soil were accepted from customers. Its customer base comprised environmental service companies, utility companies and general industry. The number and size of contracts obtained each year for contaminated soil varied and depended on the funding that customers had budgeted for remedial projects. PS2 went public in 2007 through a reverse merger with West Mountain Capital Corporation (WMT), a capital pool company (see more information in a later section). The reverse merger brought PS2 to an advanced level of growth by introducing more funds and professional management expertise. In early 2008, PS2 diversified into pharmaceutical waste management by acquiring an Ontario firm. Later that year, however, PS2 decided to divest it to focus its resources on the Wolseley facility, in response to the contaminated soil market that had opened up significantly since the acquisition. The soil treatment market in Canada received a big boost in late 2008 when the federal government introduced new regulations that established deadlines for ending the use and long-term storage of both PCBs and products containing PCBs. The new regulations also required that these products be sent for destruction by the end of 2009 (later extended to 2011). Such a policy change resulted in a strong demand for PS2’s TPS technology; subsequent to this announcement, PS2 secured contracts for 2009 and into 2010, utilizing 80 percent of its capacity at its Wolseley facility. As a result of the new regulations in 2008, PS2 posted record revenues of $5.88 million and net profits of $2.51 million in 2009 (see Exhibits 1, 2 and 3 for PS2’s 311312financial statements). In 2010, PS2 was expected to fulfill the contracts it had secured in 2008 and 2009. However, PS2’s ability to secure new contracts and source new business for its unused treatment capacity in 2010 and future years could be affected by the economic climate of the day. For example, if the economy was poor, potential customers might need to suspend their remedial projects, which could lead to delays in securing revenue.4 In addition, recent regulatory changes with regard to PCBs would provide PS2 with only a short-term momentum as PCB treatment was a declining market. Exhibit 1: Phase Separation Solutions Income Statements (in Canadian Dollars) Assets 2007 2008 2009 2010E 2011E Revenue 255,633 – 5,884,361 4,900,000 7,233,333 Cost of goods sold 257,473 103,323 2,009,746 1,760,000 2,893,333 Gross profit expenses (1,840) (103,323) 3,874,615 3,140,000 4,340,000 General & administrative 415,567 608,493 886,620 822,312 904,543 Stock-based compensation 19,488 91,555 71,244 98,000 144,667 EBITDA (436,895) (803,371) 2,916,751 2,219,688 3,290,790 Amortization 335,609 393,091 420,941 407,448 361,331 EBIT (772,504) (1,196,462) 2,495,810 1,812,240 2,926,042 Interest & bank charges 31,783 17,682 9,745 8,980 3,417 Earnings from operations (804,287) (1,214,144) 2,486,065 1,803,259 2,926,042 Interest income 5,661 21,386 – – – Interest on long-term debt (368,161) (44,484) (106,948) – – EBT (1,166,787) (1,237,242) 2,379,117 1,803,259 2,926,042 Discontinued operations, net of income taxes (345,983) (193,516) 129,030 – – Taxes – – – – 907,073 Net earnings for the period (1,512,770) (1,430,758) 2,508,147 1,803,259 2,018,969 Exhibit 2: Phase Separation Solutions Balance Sheets (in Canadian Dollars) Assets 2007 2008 2009 2010E 2011E Cash and cash equivalents 1,253,446 783,993 3,255,003 5,072,250 7,432,087 Accounts receivable 117,725 155,344 681,075 696,499 1,028,166 Income tax receivable – 177,861 – – – Assets related to discontinued operations – 141,988 – – – Prepaid expenses and deposits 2,750 12,094 9,144 8,843 13,053 Current assets 1,373,921 1,271,280 3,945,222 5,777,592 8,473,306 Restricted cash 145,301 167,383 217,394 217,394 217,394 Capital assets 2,970,732 2,982,937 2,716,322 2,408,874 2,147,543 Other assets 51,216 46,096 41,904 41,904 41,904 Total assets 4,541,170 4,467,696 6,920,842 8,445,763 10,880,146 Liabilities & shareholders’ equity Bank loan – 107,000 – – – Accounts payable & accrued liabilities 296,207 299,658 864,972 509,952 838,331 Deferred revenue 184,409 393,798 – – – Convertible debentures – – 474,203 – – Liabilities related to discontinued operations – 184,903 38,732 38,732 38,732 Current portion of Obligations under capital lease 5,570 56,412 61,318 97,631 – Current liabilities 486,186 1,041,771 1,439,225 646,315 877,063 Obligations under capital lease – 158,652 97,631 – – Convertible debentures – 464,274 – – – Shareholders’loans – – – – – Long-term debt – – – – – Asset retirement obligations 93,431 102,775 113,052 153,052 193,052 Shareholders’ equity Share capital 6,915,817 6,935,817 6,935,817 7,459,213 7,459,213 Contributed surplus 90,141 181,696 252,940 350,940 495,607 Equity component of convertible debentures – 57,874 49,193 – – Deficit (3,044,405) (4,475,163) (1,967,016) (163,757) 1,855,212 Total liabilities & shareholders’ equity 4,541,170 4,467,696 6,920,842 8,445,763 10,880,146 Exhibit 3: Phase Separation Solutions Statements of Cash Flows (in Canadian Dollars) 2008 2009 2010E 2011E Operating activities Net earnings for the period (1,430,758) 2,508,147 1,803,259 2,018,969 Discontinued operations, net of income taxes 193,516 (129,030) – – Items not involving cash Asset retirement obligations 18,992 48,868 40,000 40,000 Amortization 390,017 410,664 407,448 361,331 Gain on settlement of debentures – (5,621) – – Stock-based compensation 91,555 71,244 98,000 144,667 (736,678) 2,904,272 2,348,708 2,564,967 Changes in non-cash operating working capital 168,894 (173,404) (370,143) (7,499) Cash from (used in) operating activities – discontinued operations (630,629) 24,847 – – Cash from (used in) operations (1,198,413) 2,755,715 1,978,565 2,557,468 Financing activities Cash acquired on reverse takeover – – – – Repayment of long-term debt – – – – Proceeds from bank loan 107,000 – – – Repayment of bank loan – (107,000) – – Payment of capital lease obligations (48,483) (56,115) – – Proceeds (repayment) of debentures – net 500,000 (31,722) – – Proceeds from issuance of common share & exercise of stock options 20,000 – – – Cash provided by (used in) financing activities 578,517 (194,837) – – Investing activities Increase in restricted cash (22,082) (50,011) – – Purchase of capital assets (322,076) (139,857) (61,318) (97,631) Capital expenditures – – (100,000) (100,000) Cash provided by investing activities – discontinued operations 494,601 100,000 – – Cash provided by (used in) investing activities 150,443 (89,868) (161,318) (197,631) Increase (decrease) in cash (469,453) 2,471,010 1,817,247 2,359,837 Cash beginning of period 1,253,446 783,993 3,255,003 5,072,250 Cash end of period 783,993 3,255,003 5,072,250 7,432,087 By mid 2010, the management team comprised Antle, Stephen Clarke as vice-president of Business Development and Paul Coombs as chief financial officer (see Exhibit 4 for a biography of Antle). The company had 15 employees. Exhibit 4: Paul Antle, the Serial Entrepreneur: A Biography Paul G. Antle, B.Sc., M. Eng., CCEP, was the president and chief executive officer of Phase Separation Solutions, Inc. A recognized leader in the Canadian environmental and waste management industries, he had over 25 years of experience and had started, operated, grown and sold numerous businesses. Antle was born in St. John’s, Newfoundland and Labrador. He graduated from Memorial University in 1985 with a B.Sc. degree in Chemistry. With no desire to do research or teach, he went on to the University of New Brunswick (UNB) to pursue a master’s degree in Chemical Engineering, with an aim to apply his chemistry background in a practical application. Antle graduated from UNB with a master’s degree at the age of 22 in 1987. With resumés in hand and an eagerness for work, he journeyed to Toronto, Ontario. However, he was not successful in landing a job he wanted. Antle returned to Newfoundland, empty handed but not discouraged. Two months later, Antle was hired to kick-start a newly opened waste management division for a local construction company that had encountered PCBs at its construction site. After working for the company for nine months and achieving all his goals, Antle determined that it was time for a new challenge. Armed with a bank loan and helped by some friends, he hung out his own shingle as an entrepreneur on July 14, 1988, when he founded the SCC Environmental Group (SCC) in Newfoundland and Labrador. From its meager beginnings, SCC grew during the first half of the 1990s to become known for its advanced site remediation and integrated hazardous waste management. The company employed 150 Newfoundlanders and worked on four continents. In 1994, SCC launched the TPS Technology. The reputation of SCC grew to such a point that Stratos Global Corp., a satellite communications company, purchased SCC in September 1996 for $3.2 million. Stratos Global invested in the TPS technology and financed the promotion of it to the international oil and gas sector. SCC soon started dealing in international contracts. During 1997/98, however, Stratos Global refocused its business and decided to divest any interests that were not related to telecommunications. Antle decided to buy the company back, and the transaction was completed on July 13, 1998. He then sold it to MI Drilling Fluids of Houston, Texas, on December 14, 1999, for $10.0 million. MI Drilling Fluids used the TPS technology for the treatment of drilling mud and cuttings generated by the oil and gas industry. Antle served as the president and CEO of SCC from 1988 to 1999, as vice president of Stratos Global Corporation from 1996 to 1998, and as vice president of Thermal Operations at MI Drilling Fluids from 1999 to 2001. In 1995, Antle founded Island Waste Management Inc., which he sold for $5.6 million in August 2006. He joined PS2’s management/ownership team in 2005 to oversee its growth into a public company and its diversification into pharmaceutical waste management. Antle holds a majority equity interest in PS2 and runs it as president and CEO. Antle was inducted into the Academy of Entrepreneurs in September 1995; was a finalist for Atlantic Canada’s Entrepreneur of the Year Award in 1995; received a World Young Business Achiever Award in 1997; was recognized for his contribution to the Newfoundland and Labrador Environmental Industry in 2002; in August 2002 was part of Canada’s official delegation to the United Nations World Summit on Sustainable Development held in Johannesburg, South Africa; in May 2003 was named one of Canada’s Top 40 Under 40™; and in November 2003 was named Alumnus of the Year for Gonzaga High School. The Thermal Phase Separation (TPS) Technology5 The TPS technology is an indirectly heated thermal desorption process that adopts a closed-loop system 312313using non-incineration engineering principles. The mechanism of the technology is akin to a household clothes dryer, which is indirectly heated, vaporizing the water from laundry. In a TPS unit, the contaminated soil is indirectly heated to boil off the hazardous contaminants, which are subsequently captured as a vapor. The vapor is then re-condensed into a liquid so the contaminants don’t escape to the environment. The TPS technology was the only technology capable of extracting up to 90 percent of oil (by volume) from industrial sludge. It was also capable of separating hydrocarbons with boiling points up to 550°C. The technology had been internationally proven and was recognized as being world-class for its performance, lack of harmful air emissions, mobility and reliability. The technology had been used to treat hundreds of thousands of tons of contaminated material worldwide at many high-profile projects, such as the Sydney, Australia’s 2000 Olympic Games Site Restoration Project. The technology had been used or was permitted to be used in more than 10 countries. 313314 TPS technology was originally developed as a mobile, onsite remedial technology. However, because of its modular design, it could be easily deployed at a fixed facility if required due to cost considerations (e.g., to take advantage of economies of scale or to avoid prohibitive transportation costs). Compared with the traditional means of treating contaminated soil and industrial sludge, such as incineration or land filling, TPS technology had a series of advantages. First, the TPS process produced safe soil with an 85 percent decrease in volume that could be returned to the environment. This process was a better alternative to burying contaminated soil in landfills, which was only a temporary solution, as it did not destroy or remove contaminants. Second, the TPS process not only enabled the recovery of oil and other hydrocarbons for reuse or resale but also generated its own fuel source to fire the system. Third, compared with incineration and land filling, TPS technology produced no harmful air emissions and no land and water pollutants. Fourth, compared with incineration, the TPS process produces significantly fewer greenhouse gas emissions. Although the TPS technology had significant advantages over the traditional technologies, the TPS technology could compete only in applications and regions where it was cost-competitive compared with the traditional technology, or where government regulations required the proper treatment of waste. The PS2 management team launched the Thermal Phase Separation (TPS) technology in 1994 from the firm they had founded. The technology and company were sold to Stratos Global Corp. in 1996 and bought back again in 1998, only to be resold to MI Drilling Fluids of Houston, Texas, in 1999. Since the acquisition, MI Drilling Fluids had used the TPS technology exclusively for the treatment of drilling mud and cuttings generated by the oil and gas industry. In 2002, the founders of PS2 licensed the technology from MI Drilling Fluids, wherein PS2 received exclusive rights to use the technology, in Canada and the 314315United States, for the decontamination treatment of all types of hazardous waste streams, until 2012. In return, PS2 paid an initial licensing fee of $61,460 and agreed to start paying a royalty of US$10 per ton of material processed, after the first 15,000 tons. PS2 also agreed to pay US$0.10 million for each TPS unit installed subsequent to the first unit. Although the company had yet to reach its first 15,000 tons of production, PS2 had started paying royalties in October 2008, after the license was renegotiated to extend the expiration date to 2019. In 2009, MI Drilling Fluids granted PS2 the exclusive rights to use the technology in China. All the patents associated with the TPS technology were set to expire in 2019, after which the company would not need to renew its license. This patent deadline implied that competition would increase after 2019, when potential competitors would be able to more easily adopt the TPS technology. The Market for Persistent Organic Pollutants and Industrial Sludge in Canada6 PCB Market Due to their fire resistance and chemical stability, PCBs had been primarily used as insulating fluids and coolants in electrical equipment and machinery since the early 1900s.7 However, PCB production had been banned in North America since the 1970s, due to their harmful effects on humans and the environment. Despite the ban on production, PCBs still persist in the environment due to their resistance to environmental degradation. According to the United Nation’s 2001 Stockholm Convention on Persistent Organic Pollutants (POPs), PCBs were considered one of the 12 most persistent organic pollutants. Even though the TPS technology could be used to treat oil sludge and a variety of POPs and other organic contaminants, the main focus of PS2 was the PCB-contaminated soil treatment market in Canada. The PCB market was believed to have high entry barriers due to high start-up costs, difficulty in sourcing and securing friendly locations for facilities and a minimum of two to three years of environmental assessment and regulatory evaluation.8 In addition, this market was a niche market that needed special expertise that could only be developed through many years of immersion in the industry. PCB soil remediation in North America was a declining market because PCB production had been banned since the 1970s. PS2’s Wolseley facility was one of only three plants in Canada with the environmental certification to service the PCB market. Although PS2 also had the exclusive rights to use the technology in the United States, it was banned from transporting PCB-contaminated soil from the United States to Canada. All other types of contaminated soil, however, were allowed to be transported to Canada for treatment. Because the U.S. market for contaminated soil was highly competitive, PS2 did not have any immediate plans to establish a fixed facility there. However, an entry through licensing by granting the use of the TPS technology to an American company might be considered. Market Size. In 2008, the known amount of PCB-contaminated soil in Canada was only approximately 200,000 tons. Even though many believed that several additional sites potentially contained unknown amounts of PCB-contaminated soil, the future prospects for the industry were not good. In addition to limited sustainable future revenue, past revenues for the industry in Canada had been highly volatile. Competitors and Strategies. The Canadian PCB market was an oligopoly, with PS2 and Bennett Environmental (BEV) as the main competitors. BEV provided solutions for soil contamination problems throughout Canada and the United States, using a technology called thermal oxidation, essentially an incineration technology.9 BEV had a market capitalization of $81 million. Compared with PS2, BEV was the major player with a capacity of 80,000 tons, four times the capacity of PS2’s 20,000 tons. Because both PS2 and BEV had similar cost structures, they competed on the basis of the locations of their facilities relative to project sites because transportation costs played a significant role in the economics of such projects. PS2’s facility was located in Saskatchewan, whereas BEV’s facility was located in Quebec. As such, BEV had an advantage in Quebec, and in most of Ontario, whereas PS2 clearly had an advantage in Western Canada. The majority of PCB-contaminated soil was located in Ontario and Quebec, with British Columbia a distant third. Although BEV had recently entered into a contract to remove and treat approximately 10,500 tons of PCB-contaminated soil located in southern Ontario (which was estimated to be worth $7 million to $9 million), the remaining amount of PCB-contaminated soil available for removal and treatment was in decline.10 Due to limited growth potential in the PCB treatment market (i.e., the “known” amounts of PCB-contaminated soil in Canada was only approximately 200,000 tons, or approximately two years of production at PS2 and BEV’s combined capacity), BEV had been seeking opportunities 315316for geographical diversification and product diversification to reduce volatility in revenues and improve efficiency through continuous operations. It had diversified into the treatment of contaminated construction debris. Industrial Sludge Market in Canada Industrial sludge referred to the residual, semi-solid waste generated as a result of an industrial production process. Although industrial sludge could be of different types, PS2’s target was hydrocarbon-based sludge with more than 50 percent hydrocarbons. Conventionally, such sludge either ended up in man-made lagoons or landfills, or was incinerated. Landfills and incineration were much less expensive than PS2’s TPS technology; however, such methods created environmental liabilities due to their potential impacts on subsoil, groundwater and air. As a result of the general public’s ever-increasing environmental awareness, the conventional disposal method of using landfills was under siege. For example, in September 2008, the Ontario government had initiated regulatory changes to its Land Disposal Restrictions (LDR), which required proper pre-release treatment of industrial sludge. Under the new regulations, land disposal of untreated hazardous wastes was prohibited, and treated wastes were required to meet specific treatment standards before being disposed of. Such treatment requirements were specified as either concentration-based numerical levels or as specified treatment methods. Such regulatory changes created demand for technologies that could meet the environmental regulation, such as PS2’s TPS technology. One potential target identified by PS2 in the industrial sludge sector was paint sludge. According to data from Stewardship Ontario,11 the collection target of Ontario for paint and coatings contents and containers was 10,573 tons per year, or 47 percent of available for collection. Based on PS2 management’s estimation that the paint sludge market represented about 7 percent to 10 percent of the industrial sludge market, the 2009 industrial sludge market in Ontario was, at most, approximately 150,000 tons. Assuming that Ontario’s GDP was 40 percent of Canada’s GDP, and that paint waste generation would be proportional to GDP, the total industrial sludge in Canada was estimated to be at 375,000 tons in 2009. Despite the potential size of this market appearing to be of a decent size for small firms such as PS2, the market was still at an emerging stage. The prohibition against dumping sludge into landfills might simply create more opportunities for other conventional disposal methods, such as incineration. The real market potential for firms such as PS2 would largely depend on their comparative cost advantages over other conventional disposal methods, and on future regulatory evolution, which was a slow process. The potential of this market for PS2 was also limited due to the distance between Ontario and PS2’s facility in Saskatchewan. PS2 had yet to break into the industrial sludge market in Canada. PS2 Strategic Moves The vision of PS2 was to become a fully integrated environmental service company.12 As such, the company was always seeking opportunities to expand both organically and through acquisition for the purpose of transforming itself into a more integrated and more diversified waste management company. On the domestic front, PS2 had gone through the following strategic moves. Diversification into Pharmaceutical Waste Management13 Given the limited growth potential in soil remediation and oil recovery from industrial sludge, PS2 was searching for growth opportunities. It ventured into the pharmaceutical waste treatment market by acquiring a pharmaceutical waste-processing firm, Pharma Processing, on March 17, 2008. Pharma Processing was a well-known pharmaceutical waste management service provider that processed hazardous and non-hazardous pharmaceutical waste at its facility in Brampton, Ontario. Pharma Processing had been in operation since 1994. The acquisition was completed on July 23, 2008. The rationale behind the acquisition included geographic diversification, product diversification and scope economies.14 The pharmaceutical waste stream was 49.6 percent plastic packaging comingled with pharmaceuticals. Because of the co-mingling, the plastic in this waste stream was not readily recyclable. Thus, pharmaceutical wastes were typically incinerated. Using a modified version of its TPS technology, PS2 patented a process to depolymerize the plastic and deactivate the pharmaceutical ingredients. Using this process, PS2 was able to generate up to 44 litres of No. 2 fuel oil and up to 20 cubic meters of “synthetic” natural gas from 1 cubic meter of pharmaceutical waste, while producing only 60 kilograms (kg) of carbon dioxide per metric ton (CO2/mT). In comparison, incineration not only cost more but also produced more than 300 kg CO2/mT of waste without offering any recovery value. Despite PS2 having succeeded in developing and commercializing its pharmaceutical waste business unit, the company decided, in October 2008, to exit this 316317business to free capacity at the Wolseley facility for the soil market, which had increased since the acquisition. The decision was made as a result of the slower than projected growth rates and the higher per-unit transportation costs of pharmaceutical waste, which typically had a much lower density than contaminated soil. On December 12, 2008, the unit was acquired by an undisclosed firm. The pharmaceutical waste unit was sold at a profit, and the patent resulting from this business remained the property of PS2. Thus, the door was left open for PS2 to enter the business in the future. Going Public through Reverse Acquisition of West Mountain Capital Corp. Because PS2 was a small growth company, it needed to raise money to fund the various growth strategies required to realize its vision. In the absence of further venture capital financing, going public was a necessary strategy. However, an initial public offering (IPO) in its own name might not be appropriate for several reasons. First, the IPO market was not strong enough during a time of recession. Second, the company was at too early a stage for a broadly distributed regular IPO. Third, and most importantly, a traditional IPO might not allow the company founders to retain higher ownership levels, whereas at the company’s current stage of development, the technical expertise of the strong founder-manager team was critical. PS2 resorted to TSX Venture Exchange (TSXV), the public venture capital marketplace in Canada, which provided growth companies with access to capital and offered investors a venture investment market. TSXV offered a unique listing vehicle, the Capital Pool Company* (CPC)15 program, which provided an alternative, two-step introduction to the capital markets that would meet PS2’s requirements. The CPC program identified entrepreneurs whose development and growth-stage companies required capital and public company management expertise and introduced them to investors who had financial market experience. Unlike a traditional IPO, the CPC program enabled seasoned directors and officers to form a CPC with no assets other than cash and no significant commercial operations. They could then list the CPC on TSXV and raise a pool of capital. The CPC then used these funds to seek out an investment opportunity in a growing business. Once the CPC had completed its “qualifying transaction” and acquired an operating company that met TSXV’s listing requirements, its shares continued trading as a regular listing on the TSX Venture Exchange. Alternatively, an existing operating company could reverse acquire the CPC. The use of CPCs not only provided a going-public process that had more certainty, greater flexibility and allowed for greater control by the operating company but also removed the company’s risk from the going-public process. PS2 reverse acquired West Mountain Capital (TSXV: WMT), a CPC that was incorporated in 2005 with its headquarters in Calgary, Canada.16 As a CPC, it did not have commercial operations. It intended to identify and evaluate entrepreneurial companies with a view to completing a “qualifying transaction” to become integrated with an existing company satisfactory to its evaluation. In December 2007, based on the strength of PS2’s technology and the recognized expertise of its executive team, WMT decided to be taken over by PS2 in a reverse takeover. In so doing, PS2 went public on the TSXV and, by April 2010, had grown to a market capitalization of $12.67 million. In the newly integrated corporate structure, PS2 became the only wholly owned subsidiary of WMT, the parent firm. The new vision and mandate of West Mountain Capital was to evaluate and seek complementary acquisition in the environmental services industry with a view to building a fully integrated environmental services firm focused in Western Canada.17 Other Potential Future Moves Consistent with its vision of building a fully integrated and diversified environmental services firm, WMT also had plans for geographical diversification. Its Wolseley facility had an annual treatment capacity of 20,000 tons (which could be expanded to 60,000 tons, subject to regulatory approval, at a relatively low capital expenditure of $2 million). However, because the Wolseley facility was a fixed facility, and all the contaminated material needed to be transported there, transportation costs played a huge role in the viability of the company’s business model. The company could establish a second facility in Ontario (the largest market in Canada) if and when demand exceeded the current plant capacity of 20,000 tons. The Chinese Market China has seen rapid economic development since its opening up to the outside world three decades earlier. Real GDP per capita rose from $220 in 1980 to $2,883 in 2010,18 or an annual growth rate of approximately 9 percent from 1980 to 2010. However, this economic achievement had been made at the cost of the environment. Residents in big cities rarely saw a clear sky due to ubiquitous smog resulting from industrial pollution, coal-based power generation, and transportation exhaust. 317318 Environmental pollution was becoming a big issue in China due to its many negative consequences. Smog affected worker attendance and productivity rates in many cities. Various types of pollution also placed a big burden on the country’s medical system. An estimated 410,000 Chinese people died each year as a result of pollution.19 Environmental pollution had also become a social issue. For example, in recent years, the number of mass protests caused by environmental issues had grown by an annual rate of 29 percent. The social pressure became even more urgent after the 2008 Beijing Olympics. To prepare for the games, the Chinese government had taken a series of measures to reduce pollution in the participating Chinese cities, including restricting vehicle use, reducing coal combustion and closing some pollution-emitting factories. As a result of these measures, city dwellers saw a clear sky for the first time in decades. The 2008 Beijing Olympic Games not only provided China with an opportunity to showcase its beauty, history and power but also presented the Chinese people with a new perspective on the relationship between economic development and environmental protection. A consensus emerged in China that environmental protection needed to become a priority in the country’s agenda. The Chinese government now regarded environmental protection as a “basic state policy.” Since 2008, the Chinese government had stepped up its involvement and commitment in environmental protection. In 2009, the environmental expenditure by the Chinese State Environmental Protection Agency was at $162.5 billion, up from $75 billion in 2005.20 The government had also sped up its implementation of the Stockholm Convention on Persistent Organic Pollutants (POPs), an international environmental treaty that aimed to eliminate or restrict the production and use of POPs for their damage to human health and the environment. POPs Market in China PCB Market Size. PCB production had been banned in China since the 1980s. Prior to the ban, approximately 10,000 tons of PCBs had been produced, some of which were released into the environment. The total amount of high-density PCB waste (>500 parts per million [ppm]) in China was estimated to be 50,000 tons, and the total amount of low-density wastes (50–500 ppm) was estimated to be 500,000 tons.21 This amount was three times the Canadian PCB market size. Assuming a treatment cost of ¥3,000,22 the Chinese PCB market was ¥1.65 billion, or approximately $255 million. The PCB-contaminated soil was spread in numerous PCB-contaminated sites, which were difficult to identify. Zhejiang and Liaoning provinces alone had 83 sealed PCB-contaminated sites. Based on the distribution of PCB use in China, China might have as many as 800 PCB-contaminated sites.23 POPs Market Size in General. In addition to the 550,000 tons of soil contaminated with PCBs (which was one of many POPs), an additional 1 million tons of soil was contaminated with other POPs.24 Assuming a similar treatment cost to that of PCBs, of ¥3,000,25 the POPs market size was estimated to be ¥3.00 billion, equivalent to approximately $470 million. Experts estimated that China might have as many as 300,000 to 600,000 sites contaminated with POPs.26 Because PS2’s technology could be applied regardless of the types of POPs to be treated, it would compete in a market of $725 million. Even this number may have been conservative and would probably rise as the Chinese government improved its environmental protection measures. Furthermore, the ongoing rapid industrialization and urbanization in the country would probably continue to generate POP wastes. Current Market Situation. The Chinese government was strongly committed to the Stockholm Convention on Persistent Organic Pollutants. It also had a strong resolve to tackle the issue of POP contamination. In 2010, the Chinese government announced that it would invest more than US$3 billion in soil investigation and soil remediation over the next five years, beginning in 2011. Compared with developed countries, the management of POP-contaminated soil in China was still at an early stage. China lagged behind with respect to research capabilities, policies, procedures and techniques for safely managing and disposing of its enormous POPs contamination. As such, in 2006, the Chinese government embarked on the China PCBs Management and Disposal Demonstration Project, which was jointly funded by the Global Environment Facility Trust Fund (through the World Bank). The project was to be implemented in Jiangsu and Liaoning provinces, with the specific objective to help China establish and strengthen its policies, regulations and standards for PCB management and disposal. It also aimed to establish and enhance China’s capability in PCB waste monitoring, treatment and disposal.27 The successful PCB management and disposal experience from this project would then be disseminated across the country.28 Launched in 2006, the project had been progressing well. In 2009, a successful trial run was conducted on the Shenyang PCBs High Temperature Incineration Facility in Liaoning Province. 318319 Under the same demonstration project, an indirect Thermal Desorption Unit (TDU) was to be procured to dispose of PCB-contaminated soil and to carry out the cleanup, treatment and disposal of PCB equipment storage sites in the two demonstration provinces. After following the World Bank’s international competitive bidding procedures, the consortium of Beaudin Consulting (U.S.), BRISEA Group, Inc. (U.S.) and Beijing Construction Engineering Group won the bid in early 2009 at the price of $3,732,453. The TDU would take up an area of about 5,000 square meters and would have a daily capacity of treating 70 tons of soil contaminated with PCBs up to 20,000 ppm. Contaminated soil would be transported to the TDU facility for treatment. After treatment, the PCB level in treated soil would be less than 1.0 ppm. The TDU unit had been delivered to Jiangsu Province in China after its fabrication in the United States. However, no information was available about whether the TDU unit worked to specification and expectations. PS2’s Advantage. Even though a TDU unit had been procured from another contractor for the PCB demonstration project, PS2 and its TPS technology would provide the Chinese market with a competitive alternative for the Chinese market for several reasons. First, the TPS technology had originally been developed as a mobile, onsite remedial technology. This attribute would prove to be attractive to the Chinese market, which had numerous small contaminated sites. PS2’s TPS-PS model had a handling capacity of 50 kg per hour, whereas the smallest model from Beaudin Consulting, which had been used in the demonstration project, was in the range of 2 to 3 tons per hour.29 Although the TDU unit also claimed to be capable of being easily installed and dismantled,30 the TPS technology had higher mobility. Second, PS2 had been seriously considering China, as was demonstrated by its involvement with the Chinese market in the past one and a half years of relationship building and market research. Many other environmental firms were still locked in the mentality of creating an entry mode through equipment export and service contracts. PS2’s TPS technology was likely to be embraced in a market such as China, where hundreds of thousands of contaminated sites were widely dispersed across the country. In the demonstration project, the contaminated soil would need to be transported to the TDU for treatment, and the desorbed POPs would need to be further transported to a high-temperature incineration facility. This approach might not be sustainable in the longer run for several reasons. First, soils contaminated with POPs could not be easily transported because of their bulk. Second, new laws and regulations were expected to ban the importation of waste containing POPs from province to province, in response to public pressure. Oil Sludge Market in China Three to five percent of crude oil becomes sludge, which is unusable if not further treated.31 When sludge is transported in oil tankers or stored in storage tanks, it settles to the container bottom, where it cannot be drained but must be removed and hauled away at considerable expense. Oil sludge is caused by oil solidifying or gelling in a storage tank, often as a result of an excess of water in the oil.32 Sludge can cause major problems in oil storage tanks if not cleaned regularly. Typical crude oil tank bottoms contain more than 50 percent by weight oil, 30 to 45 percent water and 5 to 20 percent solids.33 The Chinese petrochemical industry generated approximately 5.67 million tons of oil sludge each year, based on its processing of domestic production.34 Chinas oil import dependence ratio surpassed 55 percent in early 2010 and was forecasted to reach 60 percent in 2015. Thus, more sludge would likely be generated from oil imports. China imported 4.08 million barrels of crude oil per day (BPD), or 1.49 billion barrels on a yearly basis in 2009.35 Based on a BPD to tons per year conversion ratio of 49.8,36 China imported 203.2 million tons of oil in 2009. Assuming a conservative ratio of 3 percent of oil sludge to oil, China would need to treat 6.1 million or more tons of oil sludge as a result of its annual oil imports. Much of the huge amount of oil sludge would need to be treated at facilities close to coastal oil terminals or oil reserve bases in China. Traditionally, oil sludge in China had been dumped directly into the environment (e.g., into unlined, earthen pits), buried without treatment or incinerated. This situation could not be continued as new regulations in some provinces enforced proper treatment, in response to the environmental awareness of the general public. As such, an emerging industry was oil sludge treatment. However, the industry was still in its infancy, and the market was very fragmented. This fragmentation was in part because of the spread of oil sludge generation in many oil fields and port facilities. Pharmaceutical Waste Market In 2006, China produced 570,000 tons of pharmaceutical waste, most of which were incinerated, generating up to 1176.3 grams of toxic equivalents (g TEQ) of dioxins, or 11 percent of total dioxin release in China.37 The amount of pharmaceutical waste would continue to increase 319320because of an aging Chinese population that would lead to greater future spending on health care. The Chinese government had decided to offer basic medical care to farmers in rural areas. Although the pharmaceutical waste market was not a priority for PS2, compared with the other two waste streams of POP-contaminated soil and oil sludge, PS2 could still consider it as a market to diversify into in the future, especially when considering the absolute size of the pharmaceutical waste market and PS2’s past experience in pharmaceutical waste management in Canada. The Options in China for PS2 Option 1: Remediation of POP-Contaminated Soil The first option required the cooperation of the Nanjing Institute of Environmental Sciences (NIES) of the State Environmental Protection Agency, Ministry of Environmental Protection for the People’s Republic of China. Located in Nanjing, the capital city of Jiangsu Province, NIES was a key technical provider for policies, legislation, action plans and technical guidelines on biodiversity conservation in China. Its research areas included rural environmental protection, nature conservation and biodiversity protection. NIES employed more than 200 scientific and technical staff, who carried out research on rural ecology, nature conservation, pollution prevention of township and village enterprises, and agriculture chemicals. NIES undertook key national research programs and scientific research projects on the rural environment. It also provided the scientific basis and technical support for the management of rural environments and nature and of ecological conservation while assisting in the formulation and implementation of relevant action plans. In the NIES option, a joint venture (JV) would be established between PS2 and NIES on a mutually beneficial date. In addition, NIES would act as an agent for PS2’s TPS technology in China. The JV would construct a mobile TPS unit in China and use it in a demonstration project for the treatment of 2,000 to 3,000 tons of POP-contaminated soil. (The TPS unit had a capacity to treat approximately 30,000 tons of soil per year). This task would cause no concern to PS2 because its TPS technology had originally been a mobile, onsite remedial technology. PS2 also had extensive experience in applying its mobile technology on numerous contaminated sites around the world. After the success of the demonstration project, the JV would subsequently use its TPS technology to design, plan, launch, bid for, operate and participate in various remediation projects throughout China. To use its technology in this way, the JV would need to design, engineer, manufacture and market TPS units in China for use in various parts of China. The JV was also proposed to provide solutions and consulting services for environmental remediation issues. The JV would need an investment of approximately $3.0 million. This option offered several attractive advantages. First, NIES was a government agency, which significantly reduced the risk of the project. Second, NIES had extensive remedial experience and expertise. Third, NIES had identified and inventoried more than 300 sites in just three provinces. The sites ranged in size from 3,000 tons to 2,000,000 tons of contaminated soil. Fourth, the project was a demonstration project, which not only had a lower risk level but also acted as a free advertising campaign for PS2’s technology. Being involved in a demonstration project also implied that PS2 was an early entrant into the emerging environmental market in China and would most likely enjoy certain first-mover advantages. Option 2: Oil Recovery from Oil Sludge The second option was to cooperate with Zhoushan Nahai Solid Waste Central Disposal Co. Ltd. (Nahai) in Zhejiang Province. Established in September 2009, Nahai was a private company and was the largest and only solid waste management company in the Zhoushan area of Zhejiang. It covered a land area of 33,700 square meters, and the investment was ¥62.35 million (approximately Cdn$9.8 million).38 Despite Nahai’s short history, it had become a leader in the management of hazardous waste and oil sludge in the Zhoushan area. The company had an excellent infrastructure, including an oil storage facility (capacity of 2,500,000 tons), a waste oil recovery facility (capacity of 1,000,000 tons per year), bilge water treatment process (capacity of 20,000 tons per day) and a solid waste destruction facility (capacity of 20 tons per day). Nahai possessed the only waste management processing permit in Zhoushan. Zhoushan comprised a group of islands located at the opening of the Yangtze River, just south of Shanghai. It was in the center of the world’s largest four fisheries and had been ranked as the ninth largest harbor among Chinese coastal harbors and the biggest commercial petroleum transit base in China. Many oil storage facilities were located in this region due to its accessibility to the traditional shipping lanes. For example, Zhoushan was home to the Aoshan Oil Terminal, China’s largest oil transshipment base, and Zhoushan National Oil Reserve 320321Base Co., Ltd. (one of China’s 12 state strategic crude oil reserve bases). The cooperation with Nahai would be in the form of a JV. The JV was proposed to establish a fixed facility in Zhoushan, which would be capable of processing 10,000 tons of oily sludge per year and expandable to 100,000 tons per year. The facility would process and recover oil from the oily sludge waste generated from oil storage operations and oil tanker cleaning activities in the region. PS2’s management team was well suited for this task due to their global experience. The JV would also further define and develop other technologies to complement the oily sludge treatment process, provide solutions and consulting services with respect to oil recovery issues, and explore opportunities of applying the oily sludge treatment technology to other parts of China. The JV would need an investment of approximately $3.0 million. This option was attractive for several reasons. First, Nahai’s owner was an accomplished entrepreneur, similar to Paul Antle. The two entrepreneurs had identified with each other from the beginning. Throughout their interactions, a solid trust had been developed. Second, Nahai had solid assets and had obtained a wide range of permits. Third, Nahai was located in a region that generated approximately 180,000 tons of oily sludge waste per year.39 This amount was about 3 percent of the total amount of oil sludge China generated in 2009 (6.1 million tons as previously shown) from its oil imports. The Decision The environmental market in China presented PS2 with both challenges and opportunities. For a small entrepreneurial firm such as PS2, the cooperative opportunities with NIES and Nahai in such a large market would not only affect the metrics of the company but would also strain corporate resources and the organizational structure. The China entry would also mark an important stage along its internationalization path. Although the entrepreneurial leadership at PS2 had been successful in the past and was eager to achieve even higher goals, this situation differed from its past projects in the international market, which had been based on the export of equipment and service contracts. After careful deliberation, PS2 had arrived at a point where a series of decisions needed to be made. Any delay might open opportunities for competitors. Should PS2 enter the Chinese market? Should PS2 pursue the NIES option or the Nahai option? Would it be feasible to pursue both? What ownership levels should PS2 assume for each option? How would PS2’staff its Chinese operation(s)? Antle needed to use a thorough analysis of market situation and PS2’s resources and technical and organizational capabilities to arrive at some answers.