Increase in Health Care M&A
In a year where global M&A activity has boomed, the health care sector has emerged as one of the hottest industries for deal making, with over $400 billion in total announced deal value year-to-date through October (as an example, Actavis plc recently agreed to acquire Allergan Inc. for $66 billion, making it the third largest health care deal ever and the biggest acquisition across all industries in a year full of big deals). Virtually continuous deal making in the sector since the end of 2013 has been an essential part in driving up 2014’s overall M&A volume to the highest levels since 2007. Two of the largest withdrawn or terminated deals are in the health care space (Pfizer Inc.’s unsolicited bid of $118 billion for AstraZeneca plc and AbbVie Inc.’s announced $54 billion acquisition of Shire plc). Health care is one of the most targeted sectors for deals in U.S., with 2014 year-to-date deal values hitting $277.9 billion. Health care is also the most targeted sector for public acquisitions, with $261.5 billion in value for 2014 year-to-date, a more than 250% increase from 2013 year-to-date. Additionally, health care deals lead the sector ranking for U.S. domestic M&A, with $188.9 billion in deal value for 2014 year-to-date, a 23% increase compared to the same period last year.
Strategic considerations are the main impetus for the increase in health care M&A. The Affordable Care Act and other cost-related health care reforms have spurred many companies in the industry to consolidate. Some companies are engaging in deals to acquire products and services that complement their portfolios. Others are using the favorable market conditions to augment and refine their current operations. Others still, faced by expiring patents for their brand-name drugs and products, are engaging in deals to acquire the next successful drug. For example, AbbVie, Inc.’s proposed $54 billion merger with Shire plc was largely driven by the fact that AbbVie’s flagship drug Humira, which accounts for approximately 60% of the company’s sales, is set to lose its U.S. patent protection in 2016.
Many of the health care deals this year involve inversion transactions. In particular, the pharmaceutical space has emerged as an inversion hotspot, accounting for more than $114 billion in total health care M&A volume. Since M&A is essential to growth in the health care sector, it seems unlikely that the U.S. tax rules on inversions will stymie health care deals for long, even if the inversion rules will slow deals involving cross-border tax benefits. To date, the inversion regulations have sunk only two deals—the $2.7 billion deal between Salix Pharmaceuticals Ltd. and Italy-based Cosmo Pharmaceuticals SpA, and AbbVie Inc.’s $54 billion bid for Ireland-based Shire plc. Still, other companies engaging in inversion deals in the health care sector are proceeding with their plans, including Medtronic Inc.’s $46.8 billion acquisition of Ireland’s Covidien plc which is set to close by the end of 2014. Health care companies looking to engage in cross-border transactions may decide to restructure their transactions or may refocus their attention on domestic deals. Inversion transactions were discussed in greater detail in recent editions of The Deal Compass and in September’s Tax Alert.
Increased Use of Contingent Value Rights to Maximize Target Stockholder Upside
Recent deals in the health care sector have shown an increased use of contingent value rights (CVRs) as a way to bridge valuation gaps and provide target stockholders with additional upside. Valuation is the most fundamental issue in an M&A transaction, but it is difficult to find mechanisms to bridge valuation gaps between acquirers and targets in the public M&A context – CVRs are one mechanism to give target stockholders additional upside.
A CVR is an instrument that requires an acquirer to pay additional consideration to the stockholders of a target company upon the occurrence of specified payment triggers. Its primary use is to bridge valuation gaps relating to contingent and other uncertain events that would impact the target company’s value. There are two main types of CVRs: (1) price-protection CVRs, which are used in transactions that include publicly traded securities (usually the acquirer’s stock) as all or part of the consideration package and are meant to assure the target’s stockholders a floor for the value of the stock consideration post-closing; and (2) event-driven CVRs, which pay additional value to the target’s stockholders depending on the occurrence of specified events. Payment on a CVR is tied to one or more specific triggers. A CVR’s duration depends on the nature of the payment trigger and how soon after closing the contingency is expected to be resolved. It is not uncommon for CVRs to have multi-year durations.
CVRs offer many benefits in an M&A transaction. They can be used to bridge valuation gaps, increase deal certainty by allowing the parties to close a deal without resolving an outstanding contingency, provide deferred financing benefits by reducing the total consideration required at closing, and may improve market perceptions of the combined company’s future performance. However, CVRs are not without risks. Their main drawback is centered around their complex structure, which gives rise to a host of legal issues, including issues related to valuation, transferability, registration under federal securities laws and the ongoing disclosure and reporting requirements associated with such laws, as well as tax and accounting issues.
Historically, CVRs have been used in M&A transactions on a very limited basis due to their complexity and risks. Over the last 18 months, however, CVRs have been increasingly used by pharmaceutical companies, including:
- AstraZeneca’s acquisition of Omthera Pharmaceuticals, Inc. on May 27, 2013, for $323 million, plus contingent value rights of $120 million.
- Community Health Systems, Inc.’s acquisition of Health Management Associates, Inc. on July 29, 2013, for $7.6 billion, plus contingent value rights of $1.00 per share in cash (approximately $264 million).
- Cubist Pharmaceuticals, Inc.’s tender offer for Trius Therapeutics, Inc. on July 30, 2013, for $707 million, plus contingent value rights of $111 million.
- Cubist Pharmaceuticals, Inc.’s acquisition of Optimer Pharmaceuticals, Inc. on July 30, 2013, for $535 million, plus contingent value rights of $233 million.
- Forest Laboratories, Inc.’s acquisition of Furiex Pharmaceuticals, Inc. on April 27, 2014, for $1.1 billion, plus contingent value rights of $360 million.
- H. Lundbeck A/S’s tender offer for Chelsea Therapeutics International, Ltd. on May 7, 2014, for $530 million, plus contingent value rights of $128 million.
- Daiichi Sankyo Company, Ltd.’s tender offer for Ambit Biosciences Corporation on September 28, 2014, for $315 million, plus contingent value rights of $85 million.
- Actavis plc’s tender offer for Durata Therapeutics, Inc. on October 5, 2014, for $675 million, plus contingent value rights of $134 million (this transaction is discussed further below).
The prevalence of CVRs in pharmaceutical deals can be explained by the disproportionate impact that a single successful or failed drug could have on the valuation of a target. Also, the pharmaceutical industry is a natural context for CVRs as the development of any new drug is milestone driven based on regulatory approvals and sales thresholds for each individual drug. For this reason, many CVRs in pharmaceutical deals have payment triggers based on milestone achievements (such as Food and Drug Administration approval of new drugs) and financial performance metrics (such as drug sales).