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Apr 12, 2012

As Investors Eschew Risk, More M&A Deals Combine Cash with Milestone-Based Fees

Buyers can hedge their bets, and sellers can ask for more contingent on pipeline assets.

As Investors Eschew Risk, More M&A Deals Combine Cash with Milestone-Based Fees

Caption: Some firms are opting for M&A deals that pay less up front but hold the promise for more later. [Scott Maxwell - Fotolia.com]

  • When Merck & Co. bought Schering-Plough for $41 billion, Roche snapped up Genentech for $47 billion, and Pfizer acquired Wyeth for $62 billion, all three deals were closed with cash or cash-and-stock, nothing more. Those blockbuster takeovers were at the forefront of the biopharma megamerger mania of 2009–10.

    Fast forward to 2011, when Sanofi gave more than just cash to win over Genzyme, after roughly seven months of pursuing the company. The company paid $20.1 billion up front in cash, or $74 per share, but also agreed to contingent value rights (CVRs). Genzyme stakeholders would receive one CVR for each of their existing shares, with each CVR worth up to $14 in cash if certain regulatory and manufacturing milestones were met.

    On March 15 of this year Shire and FerroKin BioSciences came to terms on an acquisition deal where Shire agreed to pay the privately held company milestone payments totaling up to $225 million in addition to $100 million up front.

    Why the differences? CVRs are unlikely to come into play for commercial deals involving companies with product largely on the market, Sushant Kumar, Ph.D, partner at Mehta Partners, told GEN. Schering-Plough, Genentech, and Wyeth are commercial-stage firms unlike FerroKin. Genzyme does have marketed drugs but two of the five have seen significant setbacks since 2009 when contamination issues at its Allston Landing manufacturing plant impacted them. Investors view biopharma M&A with a sense of risk and are more interested in using a success-based fee structure like that afforded by CVRs among public companies and what are called earn-outs in private firms.

    “If there is any pipeline asset involved, then CVRs make a lot of sense,” Dr. Kumar noted. “Biotechs will argue for this, that you may value our company a certain way, but you should also take into account that if some of our pipeline programs are successful, that will add additional value, and you should figure out a way to pay for that. And it’s also good for the acquirer or the pharma company, because I don’t have to pay up front for something that may not be successful.”

    Had CVRs been used in Roche’s purchase of Genentech, Dr. Kumar pointed out, Roche might not have had to shell out as much as it did since the main object of Roche’s desires was Avastin. In December 2011, FDA revoked the drug’s metastatic breast cancer indication, and Avastin did not succeed in Phase III trials in early-stage colon cancer. Avastin did, however, gain approval for metastatic renal cancer and progressive glioblastoma.

  • Deal Structures

    M&A deals have become a combination of what buyers will pay for the cash flow their acquisitions will generate plus how much more they’re willing to pay if some of the pipeline programs get approved or achieve certain sales.

    “This is really a deal-by-deal point, negotiated in the context of the deal itself, as well as other dynamics such as the industry of the target business and the economic and timing desires of the seller,” Matthew Herman, head of Freshfields Bruckhaus Deringer’s U.S. corporate practice, told GEN. “Having said that, there are some deals that are particularly susceptible to lower up-front payments with follow-on milestone payments: healthcare M&A is a common example, where the ability to objectively set a milestone—for example around FDA approval of a new drug—can help lower execution risks and uncertainty around the milestone payment.”

    Herman and Paul Humphreys, an associate in Freshfields’ U.S. corporate practice, noted that deals with CVRs are more frequently discussed, both by commentators and deal parties, than actually implemented. For the past two years, they said, CVRs and earn-outs only accounted for about 3%–4% of total global M&A deal value; earn-outs are the private M&A counterparts of CVRs. The low estimate is in part because these payments can often be highly complex, difficult to negotiate, and difficult to value.

    CVR and earn-out structure can expose the buyer to potential suits from target shareholders over the level of efforts the buyer undertook to reach a milestone or other CVR trigger. Target shareholders, like earn-out sellers, are also subject to the risk that, as an unsecured obligation, the CVR will not be paid if the buyer files for bankruptcy.

    “As with the use of CVRs, the ratio of contingent consideration to overall deal value varies with the circumstances of a given deal, but in our experience, we see a range from 15% to 35% of the total deal value,” Herman explained.

  • Examples of Milestone-Based M&A

    In the case of Sanofi and Genzyme, the final value of each CVR depends mostly on development of Genzyme’s late-stage mAb therapeutic Lemtrada for multiple sclerosis but initially on reaching production volumes for the marketed enzyme-replacement therapies Cerezyme® and Fabrazyme® in 2011. This first milestone would have earned Genzyme shareholders $1 per CVR but was not met.

    Former Genzyme shareholders will receive $1 per CVR if Lemtrada is approved by the FDA before March 31, 2014; $2 per CVR if sales total $400 million during specified periods; $3 per CVR if sales total $1.8 billion during any four consecutive calendar quarters; $4 per CVR if sales total $2.3 billion during any four consecutive calendar quarters; and $3 per CVR if sales total $2.8 billion during any four consecutive calendar quarters. CVRs will be linked to net global sales, and any four quarters used to obtain one CVR cannot be used in future CVRs. If the second sales-related milestone is achieved despite not achieving the regulatory milestone, CVR holders will be entitled to receive an additional $1 per CVR.

    Even though investors of the former Genzyme missed out on earning their first CVR, linked to manufacturing milestones, they heard encouraging news from Sanofi in October and then November 2011, when the company trumpeted success with Lemtrada in two Phase III trials.

    Back then, Sanofi said it would apply during Q1 of this year for FDA and EU approvals for Lemtrada, which is already on the market as a leukemia drug, sold under the name Campath. The applications have yet to occur, as Sanofi is working to publish final late-stage results in April. One indication that a launch is still planned came March 10, 2012, when the company posted an opening for the new position of director-MS global marketing-Lemtrada.

    During their acquisition talks, Genzyme had projected peak Lemtrada sales of $3.5 billion a year, while Sanofi estimated about $700 million. The companies resolved their difference by agreeing to CVRs.

    Another example of an acquisition made with CVRs is Shire’s purchase of FerroKin. The deal was driven by FerroKin’s Phase II iron chelator, FBS0701. It is designed to treat iron overload following blood transfusions.

    The CVRs in Shire’s agreement with FerroKin were linked to clinical development, regulatory, and commercial milestones. FBS0701 has been granted orphan drug designation in the U.S. and Europe. FerroKin had projected first market launch of the drug could potentially be in 2016. Estimates suggest the global market for iron chelation is currently worth over $900 million and growing, according to Shire.

    The more products a company has on the market, the more buyers will pay to pick up that firm. But companies pursuing biopharma M&A deals are hammering out more than the price in cash or shares these days. Buyers and sellers also have to come to terms on the potential value of pipeline drugs.

    Investigational candidates further along in development will boost the purchase price up. But to hedge their risks, acquirers will also tie more milestone-based fees to their agreements. The financial markets will have to recover significantly to give early-stage companies, and their pursuers, more capital to spend more freely.


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