Friday, May 27, 2011

Pharma Deals, Contingent Value Rights & Activist Investors

The Contingent Value Right as Activist Goal

Ongoing consolidation of the biomedical and pharmaceutical industries, driven in large part by the tortuous nature of the research-to-market pipeline in those fields, has created a demand for tradeable Contingent Value Rights ("CVR").  These CVRs are very much on the minds of activist investors.

For example, in July 2008, ViroPharma Inc., (VPHM) a company perhaps best known for oral Vancocin, an antibiotic often used as a treatment of last resort for bacterial infections,  agreed to buy Lev Pharmaceuticals for $442.9 million, payable in the form of (a) $2.25 per share in cash, plus (b) $0.50 per share in VPHM stock, subject to a collar.  In addition, Lev Pharma stockholders would receive two $0.50 a share CVR payments in the event of either of two contingencies.

One CVR offered was the prospect that Lev’s leading drug candidate would receive a favorable FDA ruling. The other was the possibility that within ten years it would achieve cumulative net sales of at least $600 million. The net present value of the contingent consideration was valued around $174.6 million. 

Lev’s leading drug candidate was Cinryze, a treatment for hereditary angioedema.  The stockholders didn’t have long to wait before one of the expected contingencies came to pass. The FDA approved Cinryze that October. 

Also that October, a lawyer with Kaye Scholer, commenting on the Viro/Lev deal and others, suggested that CVRs “may be the leading edge of more deals … as industry players become more comfortable with the use of this type of consideration.” 

However, as useful as CVRs can be, especially in the Pharmaceutical industry, they do have their drawbacks.  Under certain circumstances, for example, they may be deemed securities subject to registration requirements under the Securities Act of 1933, an act which (if it does apply) can impose significant costs and disclosure requirements.  Other CVRs may be subject to the Trust Indenture Act of 1938, and if that is the case, there will have to be a trustee to look after the holders, and a written indenture between the issuer/acquirer on the one hand and the trustee on the other. 

Despite these sand traps, CVRs are popular as a way of assuring shareholders receive maximum value, important given the very speculative nature of any pharma-world merger, and they are becoming more so.   

Activist Investors Are Now Demanding CVRs  

In August 2010, the French pharma giant Sanofi launched a takeover bid for Genzyme at $69 a share.  It was at first met without enthusiasm from the Genzyme board and later recast as a hostile bid by October.   As investors made it clear that they thought this was a low-ball bid, Sanofi had to ante up CVRs in January 2011.  A deal closed in April 2011.

Meanwhile, in March 2011, Quest Diagnostics Inc. announced that it had agreed to acquire Celera Corp. through a simple all-cash offer, $8 a share, without either stock swapping or any CVR.  Again, the offer encountered resistance, and again stockholders in the target company proposed CVRs as a way of overcoming that resistance without increasing the up-front component of the consideration.  Activist investor Starboard Value & Opportunity Fund (formerly Ramius) focused especially on Celera ownership of a royalty associated with Odanacatib, a drug for the treatment of osteoporosis. 

“It does not appear that [Celera] fully evaluated opportunities to monetize the value of the Company’s royalty interest” in agreeing to the deal with Quest, Starboard said in a April 7, 2011 letter to Celera’s board

Mark Lampert, on behalf of his activist fund, Biotechnology Value Fund, was more direct in making the pro-CVR case.  Lampert wrote Quest on March 30, telling it that the drug royalties Celera owns, including Odanacatib, “are extraordinarily valuable, are not of strategic significance to Quest, and are not at all reflected in the purchase price.”   

(For more information on BVF's activist position in Celera you can read HFS's May 13, 2011 weekly activist investing report)

Despite such resistance, this deal went through.  On May 17 Quest announced that it had successfully completed its cash tender offer for all outstanding common shares of Celera Corp. through a wholly owned subsidiary.

Quest’s success without offering CVRs as an element of consideration seems at this time a one-off exception within a continuing trend: CVRs will recur, despite the regulatory pitfalls mentioned above, because they simply make too much sense, especially as a tie-breaker for a wavering investor.  And investors will learn that it makes sense to continue to ‘waver’ so long as CVRs are not yet on the table.   

Contributed by Christopher Faille

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