How can a suitor offering $1 billion see eye-to-eye with a seller asking for $2 billion? It’s the billion-dollar deal question as higher interest rates persistently rattle valuations.
In pharmaceuticals, there’s an old stand-by to bridge such divides: tack on extra payments, with strings attached. Such contingent value rights, or CVRs, are a way to get around the inherent uncertainty of an unproven drug. The approach is fraught with discord, but under the circumstances probably will hold greater appeal.
These takeover sweeteners, or pre-agreed payments based on the achievement of certain milestones, first gained prominence in the 1980s with transactions such as Dow Chemical’s acquisition of a majority stake in Marion Laboratories. They typically help mitigate risk associated with pending lawsuits, as when chemicals manufacturer LyondellBasell Industries (LYB.N) bought A. Schulman in 2018, or government approval of new medical treatments.
Indeed, biotechnology is the area where this form of creative financing is most commonly used. Between 2018 and April 2023, there were 37 deals involving publicly traded companies that leaned on CVRs, 84% of which were in life sciences, according to law firm Sidley. They are also becoming more popular. In the year to April, about three out of every 10 deals in the sector added contingent payouts, versus 17% over the longer period back to 2018.
Bristol Myers Squibb’s (BMY.N)latest deal, unveiled earlier this month, is a prime example. The drug-making giant is paying $5 billion in cash for Mirati Therapeutics (MRTX.O), whose prescription medicine Krazati is used to treat a particular kind of lung cancer. Mirati shareholders also will receive a CVR that pays out an extra $1 billion if another early-stage therapy under development is filed for approval with U.S. regulators within seven years.
The Mirati transaction is effectively being split into two pieces. Krazati sales should max out at around $1.3 billion in the 2030s, according to JPMorgan analysts, and a general rule of thumb is that drugs change hands for about 5 times peak sales. Discount the estimate back five years at a rate of 10%, and Krazati is worth about $4 billion today, a little more than the upfront deal price, after accounting for Mirati’s cash. The CVR values the company’s most obvious remaining potential.
ADVERSE REACTIONS
Serial acquirer Bristol Myers is no stranger to CVRs, or to having them go awry. Its $74 billion takeover of Celgene in 2019 included a $6.4 billion payout dependent on a trio of drug approvals. Importantly, the rights could be traded separately from Celgene’s stock, dangling catnip to hedge fund managers. Unmet deadlines rendered the CVRs worthless, leading some investors to cry foul. They accused Bristol Myers of slow-rolling the process. Lawsuits followed.
It was not the first time that controversy infected CVRs either. Sanofi (SASY.PA)agreed to a $315 million settlement over ones related to its $20 billion acquisition of Genzyme in 2011. Again, the CVR was tradable, a feature largely reserved for the biggest deals. Considering their proclivity for attracting unruly and pushy investors, however, transferable CVRs are probably on the way out. Only 8% of them were allowed to change hands, based on Sidley’s findings.
The stringency with which a buyer is held to doing its best to complete a drug’s development is a key part of negotiations. “Reasonable efforts” standards can be benchmarked either to the buyer’s internal norms or the tighter standard of prevailing market practices. Such negotiations are often tense, with competitive deals able to win more exacting protections, while sellers in a weaker position may only be able to extract lighter-touch concessions, according to Andrew Weisenfeld, managing partner at investment bank MTS Health Partners.
UNCERTAIN TIMES
Industry valuations are hurting following the sharp rise in interest rates, which hit the most speculative stocks the hardest. The Nasdaq Biotechnology Index (.NBI) is down 6% this year, versus a 13% rise in the S&P 500 Index (.SPX). A CVR provides one workaround for acquirers to avoid paying ludicrous-looking premiums while allowing sellers to lock in some compensation if their products pan out.
Inhospitable equity markets also weaken a takeover target’s bargaining position. Many companies that are developing cutting-edge therapies go public while burning cash, issuing stock to raise money to fund research. A rocky environment cuts off this option. There have been only 27 biotech market debuts this year, raising $2.2 billion, according to LSEG data. By the same time two years ago, 122 IPOs had raised nearly 10 times as much.
A company “may have fundamental value, but the cost of raising capital becomes prohibitive,” said Dan Lepanto, the head of biopharma M&A for financial advisory firm Leerink Partners. A buyer using its balance sheet to help foster drug development has a stronger hand in deal talks, clearing the path to make more payments contingent.
All of this can lead to lopsided outcomes for fledgling companies. Eli Lilly’s (LLY.N)deal for preclinical-stage Sigilon Therapeutics in June included a mere $14.92 a share in cash at closing; the attached CVR is worth as much as $111.64.
STRETCH GOALS
Sigilon shares closed their last day of trading in August at $22.47, reflecting confidence that some of its CVR-related milestones would be hit. They start with an initial payout for the first dose given in a human trial, but most of the rest is gated behind achieving full regulatory approval, practically a lifetime away for investors weighing up the value of such early-stage development.
Deeply discounting longer-term goals makes sense. They are achieved far less frequently, according to SRS Acquiom, which helps facilitate private transactions. Payouts tied to preclinical events are triggered 43% of the time; those conditioned on commercial success, only 8%. In total, only about a fifth of milestones in private deals were successfully met in 2023, SRS estimates. Unsurprisingly, more than a quarter of private deals with milestone payments are disputed.
Public-company CVR terms tend to be simpler, but advisers structuring them say the rates of success are similarly low. Given the nagging fissures in valuation perspectives, however, more dealmakers are apt to try this risky M&A therapy.
(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)
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CONTEXT NEWS
Drugmaker Bristol Myers Squibb said on Oct. 8 that it had agreed to buy Mirati Therapeutics, which is developing oncology treatments, for $4.8 billion, excluding the seller’s net cash.
The deal includes a further $1 billion in payments tied to a contingent value right, or CVR, which will pay out $12 per share if the U.S. Food and Drug Administration accepts a new drug application for Mirati’s non-small cell lung cancer therapy within seven years after the closing of the deal.
