Predators gaining power and increasingly able to hedge their bets


Several acquisitions announced recently containing complicated earn out agreements, such as Cephalon's offer for Ception Therapeutics, Endo Pharmaceuticals’ move on Indevus Pharmaceuticals and ViroPharma’s acquisition of Lev Pharmaceuticals, have made interesting reading and may signal a new trend in acquisition strategy.

Over time, deal structures will evolve, driven by a host of factors. Currently, it appears to be a lack of fundraising options, a strong aversion to risk and desire to conserve cash that is shaping transactions, and as the gloomy financial world shows no sign of cheering up, they are considerations that will remain at the forefront of negotiations. For the takeover targets, narrowing financing routes means their bargaining power is set to weaken. 

Takeover as licensing deal

The potential takeover of Ception has been structured largely like a typical licensing deal, with Cephalon buying an option to acquire the biotech for $100m. The specialty pharma group is interested in Ception’s lead product, reslizumab, a phase III monoclonal antibody which is in a phase IIb/III trial for the for the treatment of pediatric oeosinophilic oesophagitis, a severe inflammation of the oesophagus with symptoms that mimics severe gastro-oesophageal reflux disease.

Should the results be positive, Cephalon can chose to buy the whole business for a further $250m. With a market cap of $5.2bn, cash of more than $800m and debt of $1bn, profitable Cephalon would easily be able to finance the deal. Instead, they have hedged their bets.

Ception meanwhile has also been forced to take a risk, although admittedly even if the takeover does not happen they still have $100m in the bank. They could have refused to accept anything but a straight takeout, although a lower price would probably have been on the table. Lack of other funding options probably left them with little choice.

The private company last raised money in May 2007 in a series C financing of $14.7m, bringing the total equity raised over the year to $77m. Considering the group is running the phase IIb/III trial, and another phase II trial with the drug in asthma, funds are probably running pretty low.

So while the desire to reduce the risk of spending unnecessary cash would have driven Cephalon’s negotiations, limited financing options for Ception would have also influenced the outcome.

Get out clause

A similar situation of a company being able to hedge risk was seen with ViroPharma’s acquisition of Lev Pharmaceuticals in July last year, a few months before Lev was due to hear whether its only product had won approval from the FDA. The deal was heavily structured with further cash payable on the achievement of specific regulatory milestones (ViroPharma takes gamble with Lev acquisition, July 16, 2008).

Importantly, ViroPharma also retained the option to terminate the takeover should the FDA reject the product, or place restrictions diminishing its commercial potential. Although the company still has plenty of money, $668m at the end of September after paying almost $400m in cash for Lev, preserving it was clearly a key priority.

In fact, other than Abbott Laboratories’ acquisition of Advanced Medical Optics, every acquisition announced so far in January has future payments built in, linked to key product performance. As well as the Cephalon deal, Endo has offered Indevus $370m plus up to $267m in regulatory and sales milestones, whilst The Medicines Company plans to buy Targanta Therapeutics for $42m upfront, with a further $96m available in the future (Endo hits the acquisition trail, January 06, 2009; Medicines Company scoops up drowning Targanta, January 14, 2009).

This is not saying that these deals with earnout clauses, structured to hedge against risk, have not happened before. However, while cash remains king, keeping as much of it as possible is going to be even more important than in the past, particularly for mid-sized companies. With smaller biotechs weakened by falling share prices and limited debt options, deals can be negotiated to help achieve this, and all parties are likely to find themselves having much more complicated takeover talks than in the past.

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