CVRs tied to the future performance of development-stage products.
Several recent transactions have featured CVRs with values tied to the
future performance of a target company's pipeline products.
In January, Endo Pharmaceuticals Inc. agreed to acquire
Indevus Pharmaceuticals Inc. for $4.50 per share plus a CVR entitling
the holder to receive up to an additional $3 per share. The value of
the CVR in this transaction is tied to Indevus obtaining certain
approvals from the U.S. Food and Drug Administration that will permit
it to market and sell two of its products -- Nebido, a
testosterone-based treatment for male hypogonadism, and an octreotide
implant for the treatment of acromegaly and carcinoid syndrome.
In July, ViroPharma Inc. agreed to acquire Lev
Pharmaceuticals Inc. ViroPharma's initial proposal to acquire Lev was
conditioned on Lev securing FDA approval and orphan drug exclusivity
for Cinryze. The introduction of a CVR allowed ViroPharma to drop this
condition. The CVR in this transaction entitles Lev shareholders to
receive two additional cash payments of 50 cents per CVR -- one upon
receipt of FDA approval and orphan drug exclusivity and another if
cumulative net sales reach at least $600 million within 10 years after
closing.
In September, Ligand Pharmaceuticals Inc. agreed to acquire
Pharmacopeia Inc. At the time, Pharmacopeia was struggling to raise
capital to finance its ongoing operations and was engaged in a review
of its strategic options, most of which appear to have centered around
developing Pharmacopeia's dual angiotensin and endothelin receptor
antagonist, or DARA program. The CVR in this transaction entitles
Pharmacopeia shareholders to receive under specified circumstances a
proportionate share of $15 million if Ligand enters into a license,
sale, development, marketing or option agreement with respect to the
DARA program.
CVRs tied to the future performance of an acquirer's stock or of an acquired business.
CVRs can be used to provide post-closing support to the value of an
acquirer's stock that is issued to a target company's shareholders in
connection with a transaction. Or they can serve to incentivize ongoing
performance of a target company's business, commonly known as an
earnout.
Where some or all of the consideration being paid in a transaction
consists of stock of the acquirer, CVRs can be used to protect the
target company's shareholders against downside risk associated with the
value of that stock. In this situation, CVRs are often structured such
that if the market price of the acquirer's stock over a pre-agreed
trading period falls below a specified value, then CVR holders become
entitled to receive the amount of any shortfall. The amount payable in
this event may consist of cash, stock of the acquirer or some
combination of both, and often is subject to a cap. This type of
structure can be particularly meaningful in volatile trading markets
and in cases where there may be significant downward pressure on a
stock due to short-selling, adverse market developments or otherwise.
This type of CVR was used in ViroLogic's (now Monogram Biosciences)
2004 all-stock acquisition of Aclara Biosciences. The parties created a
CVR that was used to guarantee the value of ViroLogic's stock for 18
months after closing. The value of each CVR was tied to the average
trading price of ViroLogic's stock over the 15 trading days immediately
prior to the end of the 18-month period, and the holder of a CVR at
that time was entitled to receive in cash the difference between the
average trading price and a guaranteed value of $2.90 per CVR, subject
to a cap of 88 cents per CVR. Only the first 50 cents of any payment
would be made in cash, and any amount above 50 cents could be paid in
any combination of stock and cash.
CVRs may also be structured as earnouts, which are arrangements that
require the acquirer to pay the target company's shareholders
additional consideration if the target business performs as agreed
after the closing. This type of CVR can be a particularly useful tool
where there is concern about future revenue growth of the target
business or a need to incentivize management of the target business to
perform. It also allows an acquirer to defer part of the purchase price
to a later date or, in some cases, indefinitely.
An earnout CVR is part of Fresenius SE's $4.6 billion
all-cash acquisition of APP Pharmaceuticals Inc. In that case, in
addition to cash consideration of $23 per share, each APP shareholder
also received one Securities and Exchange Commission-registered and
tradable CVR per share, which provide shareholders with an opportunity
to realize value above and beyond the cash consideration per share by
either trading the CVRs in the public markets or, if APP achieves
specified Ebitda financial performance objectives, receiving an
additional cash payment per CVR of up to $6.
Beyond their use and scope, it is important to understand the legal and technical issues associated with CVRs.
Securities Act of 1933/Securities Exchange Act of 1934. The
SEC repeatedly has taken no-action positions on the question of whether
the issuance of deferred payment rights, including CVRs, must be
registered under the Securities Act of 1933, and in that process has
developed a well-defined set of requirements to assist transaction
participants in answering that question. In general, CVRs that do not
confer on the holder an ownership position in the company that issued
them and are not assignable or certificated are deemed not to be
securities and therefore not subject to registration under the
Securities Act. By contrast, CVRs that do not meet these criteria (for
example, because they are listed on a securities exchange) are
securities and therefore potentially subject to registration. The SEC
registration process with respect to CVRs can be time-consuming and
expensive, and registration can subject the issuer of the CVR to
ongoing reporting and disclosure requirements imposed by the Securities
Exchange Act of 1934, which are particularly onerous for an acquirer
that is not already an SEC reporting company.
Trust Indenture Act of 1939. In some situations, CVRs may be
subject to the Trust Indenture Act of 1939, which governs the public
offering of notes, bonds and similar evidences of indebtedness. If the
TIA applies, a trustee will need to be appointed to look after the
interests of the CVR holders, and a written indenture setting out the
terms of the CVRs will need to be entered into by the issuer of the
CVRs (the acquirer in the M&A transaction) and the trustee.
U.S. Federal Income Tax Considerations. The Internal Revenue
Service generally takes the position that a seller must take into
account the value of a CVR received as of the closing date for purposes
of computing the seller's capital gain or loss on the sale of its
shares. There is contrary authority, however, that would permit a
seller to defer taking into account the value of a CVR unless and until
it receives a payment under the CVR. Under the latter approach, a
seller generally would treat a portion of any payment received as
interest income and the remainder of the payment as capital gain.
If CVRs are issued in connection with an M&A transaction that is
intended to qualify as a tax-free reorganization, the parties need to
carefully consider how CVRs will be treated under tax rules requiring
that the acquirer's stock comprise a minimum percentage of the total
consideration (40% to 100% depending on the nature of the transaction).
Depending on how the CVRs are structured, they might not be treated as
stock under these rules, and as a result cause the transaction to fail
to qualify as a tax-free reorganization.
Financial Accounting Statement 141R. Under newly-effective
accounting standards, earnouts and other forms of contingent
consideration used in M&A transactions, such as CVRs, are to be
recorded as liabilities at fair value on the closing date of the
transaction rather than at a later date when the contingency is finally
resolved. The fair value of contingent payments that are to be settled
with cash would then be subject to further adjustment in each
accounting period during the lifetime of the contingency. Contingent
payments that qualify under the rules to be classified as equity (that
is, they can be settled with shares of the issuer and certain other
requirements are met), however, would not be subject to further
adjustment.
CVRs can be a useful tool to assist buyers and sellers in public
company pharmaceutical/biotechnology deals to bridge valuation gaps
that might otherwise impede successful transactions. Because of the
technical issues associated with their use, care must be taken to
structure them properly. The extent to which CVRs recently have been
used in these types of transactions, however, shows that these
technical requirements most often can be addressed.
Benjamin K. Sibbett is a partner in the New York office of
Clifford Chance LLP, and Inderpal Singh is an assistant general counsel
in the New York office of Pfizer Inc.
Comments
If we want to acquire a better health care system, now is the time to use a computerized medical record system. Computerized medical records is a growing industry, probably soon to put a lot more people to work. Computerized medical records allow for physicians to link up and network in many ways, including no cross prescribing of medicines, which that will make it harder for addicts to keep popping pills. It can link up pharmacies with clinics so they know who has what prescribed for them. It's worth an installment loan for hospitals and clinics to get their records online, but secure – you can't twitter this kind of stuff. The electronic transcriptions business is going to grow over the next decade, and a good job in computerized medical records could mean some debt relief.