United States: Transatlantic Merger Fever

As the IPO window for biotech companies opens and closes unsteadily for short periods of time, an alternative liquidity event - consolidation - has become attractive to biotech companies.

The traditional rationales for mergers and acquisitions, such as gaining critical mass to attract investor interest and taking advantage of technology synergies accompanied by cost-cutting, have become more compelling to biotech company shareholders. A growing number of these deals involve the acquisition of a U.S. biotech company by a European acquirer (e.g., CeNes/Cambridge Neuroscience, GPC/Mitotix, Elan/Liposome). Why is this?

Currently the relative valuations of biotech companies at a comparable stage of development are higher in Europe. Investor demand exceeds the supply of investment opportunities on local European stock markets such as the Neur Markt in Germany, the Copenhagen Stock Exchange, and the Swiss Stock Exchange, pushing up the valuations of public and private European biotech companies. U.S. biotechs appear cheap by comparison.

European stock exchanges are aggressively marketing themselves to biotech companies by negotiating new alliances among the various regional exchanges that will be finished during the next few months (including a tie-in with Nasdaq). Meanwhile, relatively higher levels of government funding for biotech companies are available in Europe, particularly in Germany, so a European biotech company can raise the capital needed to reach the public markets at an earlier stage than in the United States.

Most of these transatlantic deals involve a swap of the U.S. biotech company's stock for the stock of the European acquirer. These transactions can usually be accomplished on a tax-free basis, and favorable accounting treatment may be available. So what¹s not to like about selling your company to a European acquirer?

Although valuations are higher on the European markets, the liquidity and trading volume offered by these markets still cannot compare with Nasdaq. So, U.S. shareholders may be trading their stock for illiquid and possibly overvalued European securities. If the acquirer and the target are public companies, the relative valuations of the companies can change between the time the deal is announced and the date of the closing - not to mention the date when the U.S. target company shareholders are finally free, typically after a six-month lock-up period, to dispose of the stock of the European acquirer.

There are a variety of approaches for dealing with these issues, such as determining the exchange ratio between the two securities based on a 30-day or longer average of their respective prices prior to public announcement of the transaction. This should be reflective of the relative worth of the two companies.

Alternatively, the number of shares of the acquirer's stock tendered in the transaction can be fixed, so that target shareholders are not subjected to the uncertainty of a share number which floats based on market fluctuations.

These considerations are important because transatlantic acquisitions take a lot of time. Securities authorities in the acquirer's home country as well as the United States must approve the deal if both companies are publicly traded.

Estimating the timing of SEC review is hard these days, since the examiners require disclosure documents to be rewritten if they do not fit within their new "plain English" guidelines. The SEC's demeanor is akin to that of a cranky and unpredictable grade school grammar teacher, at times (but not always) losing its temper over the use of the passive voice, split infinitives, technical jargon and other peccadilloes.

Another complexity of transatlantic acquisitions involves stock incentives for the target company's employees. On the whole, stock options are far less prevalent in European companies, hence the target company must first convince its acquirer of their importance and the need to preserve the 15 to 20 percent ratio of stock options to outstanding shares typical of U.S. public companies.

Second, it is difficult to make stock options in a European company available to U.S. employees on the same tax advantaged basis as the "incentive stock options" (ISOs) which are granted by U.S. companies. Synthetic equivalents can be created to put the U.S. employee on the same footing as if he were employed by an U.S. company, but these are complex. Since the tax laws in Europe are not as employee-friendly when it comes to stock options, it is sometimes hard for a European acquirer to understand why ISOs are such an important part of employee compensation in the United States.

Then there are the usual issues that one must deal with in any merger of two companies. Will the target company's stockholders (a combination of venture capitalists and employees) be required to give detailed representations and warranties to the acquirer? Will a portion of the consideration payable in the merger be subject to a holdback via an escrow, and will there be indemnification for undisclosed or unknown liabilities? Will the closing of the deal be conditioned on a certain number of employees of the target company signing on?

Most importantly, despite the tense and extended negotiation process, will the cultures of the two companies begin to mesh, and can personality conflicts be overcome?

Although mergers are not for everyone, they are beginning to occur with increasing frequency in the biotech industry. M&A deals can be a preferred alternative to the launch of an IPO in uncertain securities markets. If structured properly, an acquisition can happen more quickly and with greater certainty than an IPO, and liquidity can be available to the target company stockholders on an expedited basis. While a cross-town consolidation may involve fewer logistics, as pharmaceutical and biotech enterprises become more international in scope, transatlantic mergers have become a less daunting prospect.

Reprinted with permission. All rights reserved. Mass High Tech - August 7-13, 2000.