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Sanofi-Aventis’ (SNY) use of contingent value rights (CVRs) in its Genzyme (GENZ) purchase is by no means the first time they have been used to settle a dispute over pipeline valuation in a biotechnology acquisition, but at $3.8bn it most likely is the highest value ever placed on them (Sanofi finally snags Genzyme with clever CVRs, February 16, 2011).
Evidence that risk is being hedged like never before can be seen across all types of transactions in life sciences – the increasing popularity of option-based licensing deals for example. Celgene (CELG), Fresenius (FMS) and ViroPharma (VPHM) have all turned to CVRs in recent years to seal a purchase, but their complexity and suitability for fairly specific situations means they are unlikely to become commonplace. Nevertheless, while investors refuse to assign substantial value to pipelines, CVRs will remain a useful tool to resolve valuation disputes that have the potential to derail a takeout.
Milestones
CVRs are a tool for building performance milestones into an M&A deal; in the case of Genzyme, $14 worth of potential payouts per share depending mostly on the performance of MS treatment Lemtrada in the clinic, at the regulator and in the market. To a certain extent it acknowledges that Genzyme had the weaker negotiating position on the matter of Lemtrada’s value.
In earlier eras of high R&D productivity, it might have been easier for Genzyme to have won the day on Lemtrada’s potential, reckoned at peak sales of $800m by Deutsche Bank, one of the few banks to assign any tangible value to the product at this stage (Event – Lemtrada’s real value will start to emerge soon enough, February 18, 2011).
As it is, Sanofi played hardball about the level of risk they were being asked to take on – a strategy that, had Merck & Co (MRK) applied it in 2009, might have paid off when trials for Schering-Plough (SGP) derived anticoagulant vorapaxar bombed out, for example (Hopes fading for Merck’s anticoagulant, January 14, 2010).
Uncommon tool
Still, CVRs are not likely to be used in a majority of big M&A deals; they are most likely to be seen when a company is being purchased for a lead candidate.
The Celgene-Abraxis and ViroPharma-Lev deals looked and felt like licensing deals because they were struck essentially for one product – Abraxane and Cinryze, respectively.
What set the Sanofi-Genzyme CVR apart is that the acquisition was not completed for Lemtrada, but instead for Genzyme’s portfolio of marketed products treating orphan diseases. Clearly, the deal had the potential to break down on the high-risk proposition that Lemtrada represented, and the CVR was a means of resolving that issue.
Performance
While Lemtrada's potential is questionable at best, a look at the relative value of some of the more recent tradeable CVRs does not necessarily bode well.
The Celgene CVRs premiered at $5.55, almost 43% of the total CVR value of $13, a decent debut compared to the $1.34 implied value of each Genzyme CVR today, just 10% of their total potential of $14. However, a big dip for the Celgene CVRs on January 10, caused by data indicating that Abraxane did not demonstrate a statistically significant improvement in progression-free survival in non-small-cell lung cancer, means the CVRs currently trade at around $2.40.
Fresenius-Kabi Pharma Holding, the CVR for Fresenius’ purchase of APP Pharmaceuticals, was trading at just 12 cents Friday morning, nearly 88% lower than its debut at 99 cents in 2008, which was way off its potential value of $6 per share. The CVR was an all-or-nothing proposition that three years worth of APP earnings would exceed a certain threshold, which investors clearly had little confidence in ever being breached.
With hindsight, the acquiring companies were certainly wise to have agreed to CVRs, which would also support investor's skepticism over the value of pipeline opportunities.
As long as investors do not value pipelines, buyouts - particularly of one-product companies - are likely to continue to include CVRs in order to create some value for the seller, while limiting the risk for the purchaser - much the same way as licensing deals do.
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