Elan – from buyer to target?

Elan Corporation PLC – Market Cap (as of 01/03/13) : $6.7bn

Royalty Management, LLC

On Monday, 25 February 2013, Royalty Pharma, the American private equity firm investing in acquiring drug royalties, made an indicative offer to acquire all the outstanding shares of Elan Corporation, the Irish biotech company listed in New York. Some of you may recall Elan from the case study presentation by Ondra Partners last term, where they presented us with the spin-off of Elan’s early stage operations. The company has continued with this divestment strategy and sold earlier this month its remaining 50% stake in its best-selling drug, Tysabri, to the biotech giant Biogen for $3.25bn. Effectively now Elan has become a shell company worth the value of its cash pile plus the discounted value of the royalty income stream from Tysabri.

Last Friday, 22 February, Elan announced it would be deploying its cash from the deal to acquire other pharma assets, pay down its debt and do a share buyback. In Kelly Martin’s (Elan’s CEO’s) words he plans to “go shopping” in the biotech industry. However, he has not expressed clear goals/objectives when announcing such an aggressive and expansionary approach. On the back of the uncertainty created by the absence of specific details of these plans and their potential impact on the company’s value, Royalty Pharma publicly announced on Monday that it submitted an “indicative offer” to Elan’s board on the 18th of February and was surprised that Elan did not mention at all its offer as a potential value-maximising route to its shareholders.

The offer values Elan at $6.6bn, which Royalty Pharma is planning to finance through cash and debt. The bid price was $11 per share in cash. The bid put forward by Royal Pharma represents a 6.3% premium on Elan’s closing price just before Elan’s management received the offer. The price represents an enterprise value multiple of 16x 2014e EBITDA which is twice the sector average, though it is in line with acquisition multiples in the sector.

As it currently stands there is not much happening. Elan’s management responded to the offer characterizing it as “highly opportunistic” and “heavily conditional”, given the list of requirements by Royalty Pharma before they would make this an actual offer. The bottom line though is that if the situation escalates and Royalty goes down the hostile takeover route, investors may be faced with a decision:

– are they better off remaining invested in Elan and bear the risks of its reinvestment strategy? This would require the company to pay potentially costly control premia to rebuild its portfolio or

-are they better off taking their money today and investing in other biotech companies directly, without paying any control premium?

For the time being, Royalty Pharma has set as one of its conditions the recommendation of the deal by Elan’s board so only a friendly transaction is on the table. This is understandable as this would be Royalty’s largest transaction and would allow for proper due diligence. Moreover, the fact that Royalty Pharma is making a bid for the whole company is peculiar as it has usually bought specific royalty rights to benefit from the cash flows they generate (though arguably, net of its cash pile, Elan is also now just a royalty stream…). Royalty Pharma must be taking the view that the royalties are worth well above what the market was pricing them based on recent trading, as apart from that there are no major(any?) synergies involved in owning royalties of different drugs.

So effectively investors have been told by this move that their royalties are more valuable, but they might end up worse off given the high risk of the management’s strategy. Tough call.

For the time being the share price has reacted quite strongly, rising +7% from last Friday on the back of the announcements, trading steadily above the $11 offered and approaching $11.50, suggesting investors expect a deal might happen at a higher price, despite the full multiple offered.

The advising banks of Royalty Pharma are JP Morgan Chase and Bank of America Merrill Lynch. We suspect Ondra Partners may be involved on the Elan side as one of the advisors.

Could this be part of a more general trend of increase M&A activity? Volume has increased in this quarter compared to last year and the talk of cash balances in corporate balance sheets can only lead to more such transactions.