Return of the CVR

A difficult environment for mergers and acquisitions is forcing prospective partners to dredge up once discarded techniques. Case in point: the contingent value right, which had its heyday during the late 1980s and early 1990s, then virtually disappeared from the M&A toolkit. Now the structure has reappeared in several recent pharmaceuticals transactions. "People are thinking about them more seriously than before," says Minh Van Ngo, a partner at New York law firm Cravath, Swaine & Moore LLP.

Contingent value rights, or CVRs, are rights held by targets that ensure them a boost in deal value if the merged company hits milestones. In essence, it's an extremely targeted option.

Ngo believes that the return of the CVR is just another symptom of the struggling economy. As he describes it, prospective sellers that are desperate might be more willing to push off potential gains into the future. Buyers, too, he says, might be willing to give up some potential upside because the deals they are seeing are so relatively cheap that surrendering some gains later won't matter as much. "You'll see CVRs if there's disagreement on valuation and price, and the CVR is the only way to bridge the gap," he says.

Indeed, the prospect of using CVRs came up in the contentious merger negotiations between Roche Holding AG and Genentech Inc. In the run-up to merger, which culminated in the March announcement of a deal where Roche agreed to buy Genentech for $47 billion, or $95 a share, analysts had thrown out the prospect that a CVR tied to uncertainty around the success of Genentech's cancer drug Avastin might nudge the deal to completion.

The deal was announced without CVRs, but the discussion of their use suggested the instrument is a viable option for merger candidates again.

And, in fact, there have been several recent transactions that have featured CVRs. In the $370 million merger between Chadds Ford, Pa.-based Endo Pharmaceuticals Inc. and Lexington, Mass.-based Indevus Pharmaceuticals Inc., which closed on March 24, Endo paid $4.50 a share in cash but also agreed to give Indevus shareholders an additional $3 a share. The CVR is contingent on U.S. Food and Drug Administration approval of two Indevus drugs in development.

In a much smaller deal, Parsippany, N.J., drugmaker Medicines Co. in January launched a $42 million offer to buy Targanta Therapeutics Corp. Under the terms, Targanta investors could get up to $95 million more if the Cambridge, Mass.-based target's lead drug Oritavancin comes to market in the U.S. and Europe.

Last year, German healthcare group Fresenius SE acquired APP Pharmaceuticals Inc. for $4.7 billion, promising a further $970 million if the company meets financial targets through 2010.

Today's CVRs are different in quality from earlier iterations. In the 1990s, CVRs were tied more closely to the stock price. Take, for example, Dow Chemical Co.'s acquisition in 1989 of Marion Laboratories. In 1991, Dow paid out some $1 billion to Marion shareholders because shares of the combined company failed to rise as much as expected. At the time, it was seen as an expensive penalty and created a shareholder backlash that effectively limited their use in following years.

In more recent deals, CVRs have been contingent not on performance of the share price, but on specific milestones, such as approval by the Food and Drug Administration. It's no surprise that they reappeared first in healthcare deals. Pharmas and biotechs have long used milestone payments in research collaborations to pay a set amount, for example, for a compound that completed animal testing or was accepted into an FDA approval pipeline.

"The structures are now going to be much more specific, with much more neutral financial terms," Ngo says. "You have built into the industry milestones that are certifiable by a legal entity," he says, noting that few other industries have a body such as the FDA that can definitively stamp its approval on new products. That limits debate about whether milestones have been met, giving more comfort to both parties that the CVRs' conditions are being satisfied.