Elan and Royalty Pharma1
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. 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. The Players 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. But 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. 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 Defense Elan’s leadership was now under considerable pressure by shareholders 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. 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. But from the beginning that appeared difficult given public perception that the initiatives were purely defensive. 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. It 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. 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. For these and other reasons 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. Note that Royalty Pharma expressly decomposed its total valuation into three pieces: 1) the under patent period, 2) the post-patent period, and 3) the perpetuity value.
In Royalty Pharma’s opinion, the post-patent period represented a significantly higher risk period for actual Tysabri sales. Market Valuation. 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. Elan’s management had made their case to shareholders. 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.
1. 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?
2. What other considerations do you think should be included in the valuation of Elan?
3. 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?