Week 7
mloi01
MC18_Eiteman_85652_14_MC18.pptxElan and Royalty Pharma
Chapter 18
Mini Case
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Mini-Case: Elan and Royalty Pharma
We lived a long time with Elan (ELN). We always appreciated its science and scientists, and, at times, we hated its former management, or whoever caused it to turn from ascending towards becoming a citadel of sciences, especially neurosciences, into an almost bankrupt firm with less everything valuable in it than what was necessary for its survival. What saved it at the time was the emergence of Tysabri, for multiple sclerosis, which we knew it was second to none in treatment of relapsing remitting multiple sclerosis. We were certain that this drug, like Aaron’s cane, would swallow up all magicians’ staffs.
—“Biogen Idec Pays Elan $3.25 Billion for Tysabri: Do We Leave, Or Stay?,” Seeking Alpha, February 6, 2013.
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Elan and Royalty Pharma: Case Questions
Using the sales forecasts for Tysabri presented in Exhibit A, and using the discounted cash flow model presented in Exhibit B, what do you think Elan is worth?
What other considerations do you think should be included in the valuation of Elan?
What would be your recommendation to shareholders— to approve management’s proposals killing RP’s offer—or say “no” to the proposals, probably prompting the acceptance of RP’s offer?
11-3
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Elan and Royalty Pharma
Elan’s shareholders (Elan Corporation, NYSE: ELN) were faced with a difficult choice. Elan’s management had made four proposals to shareholders in an attempt to defend itself against a hostile takeover from Royalty Pharma (U.S.), a privately held company.
If shareholders voted in favor of any of the four initiatives, it would kill Royalty Pharma’s offer. That would allow Elan to stay independent and remain under the control of a management team that had not sparked confidence in recent years. All votes had to be filed by midnight June 16, 2013.
Elan Corporation was a global biopharmaceutical company headquartered in Dublin, Ireland. Elan focused on the discovery, development and marketing of therapeutic products in neurology including Alzheimer’s disease and Parkinson’s disease and autoimmune diseases such as multiple sclerosis and Crohn’s disease.
Over time the company had spun-out, sold-off, or closed most of its business activities. By the spring of 2013, Elan was a company of only two assets: a large pile of cash and a perpetual royalty stream on a leading therapeutic for multiple sclerosis called Tysabri, which it had co-developed with Biogen.
The solution to Elan’s problem was the sale of its interest in Tysabri to its partner Biogen. In February 2013 Elan sold its 50% rights in Tysabri to Biogen in return for $3.29 billion in cash and a perpetual royalty stream on Tysabri.
Whereas previously Elan earned returns on only its 50% share of Tysabri, the royalty agreement was based on 100% of the asset. The royalty was a step-up rate structure on worldwide sales of 12% in year 1, 18% all subsequent years, plus 25% on all global sales above $2 billion.
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Royalty Pharma enters a bid ….
The ink had barely dried on Elan’s sale agreement in February 2013 when it was approached by a private U.S. firm, Royalty Pharma, about the possible purchase of Elan for $11 per share. Elan acknowledged the proposal publicly, and stated it would consider the proposal along with other strategic options.
Royalty Pharma (RP) is a privately held company (owned by private equity interests) that acquires royalty interests in marketed or late-stage pharmaceutical products.
Its business allows the owners of these intellectual products to monetize their interests in order to pursue additional business development opportunities. RP accepts the risk that the price they paid for the asset interest will actually accrue over time. RP owns royalty rights; it does not operate or market.
In March 2013, possibly tired of waiting, RP issued a statement directly to Elan shareholders to encourage them to vote for the proposed acquisition of Elan for $11 per share. At that time, Elan issued a response to RP’s statement that characterized the Royalty Pharma proposal as “conditional and opportunistic.”
Elan’s leadership was now under considerable pressure byshareholders to explain why shareholders should not tender their shares to Royalty Pharma. In May, Elan began to detail a collection of initiatives to redefine the company.
Going forward, Elan described a series of four complex strategic initiatives that it would pursue to grow and diversify the firm beyond its current two-asset portfolio.
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Because the company was currently in the offer period of a proposed acquisition, Irish securities laws required that all four of Elan’s proposals be approved by shareholders.
Royalty Pharma responded publicly with a letter to Elan’s stockholders questioning whether Elan’s leadership was really acting in the best interests of the shareholders.
RP then increased its tender offer to $12.50/share plus a Contingent Value Right (CVR). The CVR was a conditional element where all shareholders would receive an additional amount per share in the future—up to an additional $2.50 per share—if Tysabri’s future sales reached specific milestone targets.
Royalty Pharma’s CVR offer required Tysabri sales to hit $2.6 billion by 2015 and $3.1 billion by 2017.
Royalty Pharma also made it very clear that if shareholders were to approve any of the Elan’s four management proposals, the acquisition offer would lapse.
Royalty Pharma enters a bid ….
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Elan & Royalty Pharma: The Value Debate
Elan, as of May 2013, consisted of $1.787 billion in cash, the Tysabri royalty stream, a few remaining prospective pipeline products, and between $100 and $200 million in annual expenses associated with its management.
Elan’s management team wanted to use its cash and its annual royalty earnings to build a new business. Royalty Pharma just wanted to buy Elan, take the cash and royalty stream assets, and shut Elan down.
The valuation debate on Elan revolved around the value of the Tysabri royalty stream. That meant predicting what actual sales were likely to be in the coming decade.
Exhibit A presents Royalty Pharma’s synopsis of the sales debate, noting that Elan’s claims on value have been selectively high, while Royal Pharma has based its latest offer on the Street Consensus numbers.
Predicting royalty earnings on biotechnology products is not all that different than predicting the sales of any product. Pricing, competition, regulation, government policy, changing demographics and conditions—all could change future global sales.
That said, there were several more distinct factors of concern.
First, Tysabri was scheduled to go off-patent in 2020 (original patent filing was in 2000). The Street Consensus forecast, the one advocated by Royalty Pharma, predicted Tysabri global sales to peak in that year at $2.74 billion. Sales would slide, but continue, in the following years.
Second, competitive products were already entering the market.
In the spring, Biogen had finally received FDA approval on an oral treatment for relapsing-remitting forms of multiple sclerosis. It was only one of several new treatments coming to the market. Royalty Pharma had pointed to declining new patient adds over the past two quarters as evidence that aggressive future sales forecasts for Tysabri may be unrealistic—already.
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Exhibit A Forecasts of Tysabri’s Worldwide Sales
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Elan & Royalty Pharma: The Value Debate (continued)
Royalty Pharma had argued that a conservative sales forecast was critically important for investors to use when deciding whether or not to go with management or Royalty Pharma’s offer.
Royalty Pharma’s valuation, presented in Exhibit B, used this sales forecast for its baseline analysis. Royalty Pharma’s valuation of Elan was based on the following critical assumptions:
Tysabri’s worldwide sales, the top-line of the valuation, were based on the Street Consensus.
Elan’s operating expenses would remain relatively flat, rising at 1% to 2% per year, from $75 million in 2013.
Elan’s net operating losses and Irish incorporation would reduce effective taxes to 1% per year through 2017, rising to Ireland’s still relatively low corporate tax rate of 12.5% per year afterward.
The discount rate would be 7.5% per year up until going off-patent in 2017, rising to 10% after that.
Perpetuity value (terminal value) would be based on year 2024’s income, discounted at 12%, and assuming an annual growth rate of either -2% or -4% as Tysabri’s sales slide into the future.
Outstanding shares were 518 million shares as of May 29, 2013, according to Elan’s most recent communications.
Elan’s cash total was $1.787 billion, according to Elan’s most recent communications.
The result was a base valuation of $10.49 or $10.17 per share, depending on the terminal value decline assumption.
As typical of most valuations, the top-line—total sales—was the single largest driver for all future projected cash flows. The shares outstanding assumption, 518 million shares, reflected the results of a large share repurchase program which Elan had pursued right up to mid-May of 2013.
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Note that Royalty Pharma expressly decomposed its total valuation into three pieces:
the under patent period,
the post-patent period, and
the perpetuity value.
Exhibit B Valuing Elan: Prospective Royalties on Tysabri Plus Cash
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Elan & Royalty Pharma: The Value Debate (continued)
Despite the debate over Elan’s value, as a publicly traded company, the market made its opinion known every single trading day.
On the day prior to receiving the first indication of interest from Royalty Pharma, Elan was trading at $11 per share. (In the days that follow, the market is factoring in what it thinks the effective offer price is from a suitor like Royalty Pharma and the probability of the acquisition occurring.) Elan’s share price history for 2013 is shown in Exhibit C.
The collection of initiatives that Elan’s leadership wished to pursue had to be approved, however, by shareholders. The Extraordinary General Meeting (EGM) of shareholders would be held on Monday, June 17th. At that meeting the results of the shareholder vote (all votes were due by the previous Friday) would be announced.
In the days leading up to the EGM, the battle had become very public, and in the words of one journalist, “quite chippy.” In a Financial Times editorial, one former Elan board member, Jack Schuler, wrote:
“I have no confidence that Kelly Martin [Elan’s CEO] or the other Elan board members will act in the interests of shareholders. I hope the Elan shareholders realise that their only option is to sell the company to the highest bidder.”
Elan’s current non-executive chairman then responded:
“I note that Elan’s share price has trebled since Mr. Schuler’s departure. The board and management team remain wholly focused on continued value creation and will continue to act in the best interests of our shareholders.”
Shareholders had to decide—quickly.
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Exhibit C Elan’s Share Price (January 1–June 16, 2013)
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Elan and Royalty Pharma: Case Questions
Using the sales forecasts for Tysabri presented in Exhibit A, and using the discounted cash flow model presented in Exhibit B, what do you think Elan is worth?
Using the same DCF model, input the different sales forecasts for Tysabri and find the model’s estimate of firm value
Be careful to not change other valuation assumptions so that the differences found are clearly the result of only different sales, and not any other parameters
Once that is done, then vary other key parameters – such as the Perpetuity Growth Rate – to see how that interacts with the sales forecasts
11-13
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Elan and Royalty Pharma: Case Questions
What other considerations do you think should be included in the valuation of Elan?
Outside of the sales forecasts for Tysabri, one must also include the potential tax benefits of an Irish incorporation could provide
If RP did acquire Elan, they would essentially eliminate all costs related to general and administrative expenses; their ownership would be purely the rights to hold the case and own the right to receive royalties
11-14
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Elan and Royalty Pharma: Case Questions
What would be your recommendation to shareholders— to approve management’s proposals killing RP’s offer—or say “no” to the proposals, probably prompting the acceptance of RP’s offer?
Current Elan shareholders do not trust Elan’s management and leadership to create any additional value beyond the current two-asset portfolio, so its mostly a matter of deciding whether RP’s offer is as good as it is going to get.
It turns out – see the following slides on case outcome – there was indeed another company out there willing to offer even more ….
11-15
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Elan and Royalty Pharma: Outcome I
The extraordinary stockholder meeting was held at 10:00 am Irish time on Monday June 17, 2013 at the O’Callaghan Davenport Hotel, 8/10 Merrion Street Lower, Dublin 2.
In the week or so leading up to the EGM, it became increasingly clear according to surveys of shareholders that most of the proposals would be voted down, although the share repurchase program looked like a very close call.
When Royalty Pharma realized that the share repurchase proposal would possibly be approved and all others fail, it filed a request with the Irish takeover authorities to amend their tender offer to allow a single positive proposal vote, and not have a positive vote automatically terminate their offer. The Irish authorities refused.
Many critics of Royalty Pharma believe that this singular component of their tender offer was not well thought through and was a fatal error.
Vote outcomes: proposals 1-3 were rejected by shareholders, but proposal 4, the share repurchase program, was approved by the narrowest of margins, 50.1% (909,699 votes more For than Against). Because Royalty Pharma’s offer was contingent on all management proposals being voted down, Royalty Pharma’s offer ‘lapsed’.
Under Irish law RP cannot make another unsolicited offer in the next 12 months. By the time of the vote only 8% of Elan’s shareholders had tendered their shares to RP.
By voting down all of the management proposals involving strategy, but approving (narrowly) the share repurchase program, shareholders were essentially filing a no confidence vote in Elan’s management.
Following the announcement of the voting outcome, Elan’s share price actually rose to $13.65 in pre-opening trades, although it had been expected to fall by as much as 30%.
The day following the vote, Jefferies Securities raised its target price on Elan to $19/share from $13/share.
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
Elan and Royalty Pharma: Outcome
As votes were tallied over the week or so preceding the meeting, it became increasingly clear that most of the proposals would be voted down, but that the share repurchase program vote would be close. As a result, Elan’s management had on Friday June 14th essentially put the company up for sale to the newest higher bidder.
On July 29, 2013, Elan announced that it had agreed to the sale of the company to Pirrigo Company (NYSE: PRGO) for $16.50/share ($6.25 in cash and 0.07636 shares of New Perrigo for each Elan share), based on Pirrigo’s closing share price on July 26, 2013. This was an 11% premium over what Elan shares had closed at the previous trading day (Friday).
Elan would now be owned by a Dublin-based Holding Company owned by Pirrigo Company. The transaction was expected to be closed by the end of the calendar year 2013. “The combination is expected to result in more than $150 million of recurring after-tax annual operating expense and tax savings, and will include layoffs of redundant staff.”
Selling itself to Perrigo ends months of takeover speculation for Elan, which fended off a hostile takeover bid from British Royalty Pharma and then put itself up for sale. Elan CEO Kelly Martin, a ex-Merrill Lynch banker, has spun-off or sold most of the company's assets after an accounting scandal a decade ago, basically leaving nothing more than the Tysabri royalties. – “Prescription For Lower Taxes: U.S. Drugmaker Perrigo Buys Irish Biotech Elan For $8.6B,” Forbes, July 29, 2013
Elan’s shareholders had originally been offered $11/share in February 2013. They will now receive, per the July 29th sale announcement, $16.50/share.
So, in the end, did Elan’s management work in the best interests of shareholders?
© 2016 Pearson Education, Inc. All rights reserved.
18-‹#›
