According to an Internal Revenue Service ruling, former shareholders of Hybritech Inc. realized $40.71 per share in March, 1986, when Eli Lilly & Co. acquired the San Diego-based biotechnology firm in a deal valued at $485 million.
But the market value of the deal has mushroomed to about $90 for savvy Hybritech shareholders who picked--and held onto--the right combination of warrants, convertible notes and deferred cash payments that Lilly offered in exchange for Hybritech's common stock.
Most of that increased market value has come from the warrants and notes, which are linked to the price of Lilly's common stock. Lilly common, which traded in the mid-50s when the deal was concluded in March, 1986, closed down $1.25 Monday at $91.875.
The warrants that began trading on the New York Stock Exchange at $10 when the deal was concluded have since enjoyed a fourfold increase in value. They have traded at a high of $41 and closed down 75 cents at $35.625 on Monday.
10-Year Notes Up 50%
As part of the deal, Lilly also offered $22 in cash or a like amount of 10-year, 6.75% notes convertible into Lilly stock at $66.31. Lilly's stock surge has increased their value to $33, or 50% above their $22 face value.
"I don't think anyone anticipated that kind of rapid growth" in the price of Lilly's common stock, said former Hybritech Chairman Howard E. (Ted) Greene, who helped negotiate the sale. Greene left Hybritech last year and now is a principal at Biovest Partners, a San Diego venture capital firm.
Lilly initially agreed to issue warrants for seven-tenths of Lilly common for each share of Hybritech. However, the agreement later was modified and the warrant total jumped to 1.4 warrants per share of Hybritech stock.
"That added about 8 million warrants for Hybritech shareholders," according to Tim Knepp, a San Diego-based financial analyst who has studied the complex payment package won by Hybritech shareholders. "It turned out to be a real coup for Hybritech."
The increased value of Lilly's common hasn't helped those Hybritech shareholders who passed on the notes offered by Lilly and instead accepted $22 in cash.
It is difficult to determine just how valuable the convertible notes and warrants have grown for Hybritech shareholders because Lilly has not said how many shareholders took cash in lieu of the notes. And some shareholders immediately traded away their warrants.
Value Would Top $1 Billion
However, had every Hybritech shareholder kept the notes, warrants and deferred cash payments, the value of Lilly's acquisition of Hybritech would be more than $1 billion today, according to Greene. That estimate includes the assumption that the notes would be converted into Lilly stock at the current market price and the warrants would be exercised or sold on the open market.
The deal's value would be further increased if Hybritech were to hit sales goals that trigger a series of novel deferred cash payments. Unlike the notes and warrants, the value of the so-called "contingent payment units" is dictated by Hybritech's performance, not Lilly's stock price.
The CPUs will begin if Hybritech, now a wholly owned subsidiary of Lilly, turns several research and development projects into viable therapeutic products.
A total of $22 in CPUs, or deferred cash payments, will be paid through 1996 if Hybritech can reach goals determined by a complex equation that is based on Hybritech's annual sales and gross profit margins.
Lilly made no CPU payments in 1986 because Hybritech fell short of its goals, but some biotechnology industry analysts expect the CPUs to generate a slight payment during coming years, according to Knepp.
On Friday, Lilly reported that Hybritech generated an $11.5-million gross profit and $26.3 million in sales. According to the CPU payment formula, Hybritech must generate $93 million in sales and a 50% gross profit margin in order to trigger the 1987 CPU payment.
Unlike the warrants, which have increased in market value, the CPUs that rose to about $5 shortly after opening trading on the American Stock Exchange at $4 have since dipped to $2.50, as of Monday's close.
Greene remains optimistic, however: "If Hybritech hits on some therapeutic products, then there will be a payoff. But only time will tell. If they do pay off . . . it's icing on the cake."
Most Content to Wait
Given the dismal trading record of the CPUs, most shareholders seem content to "put them away in their safe deposit boxes and wait," according to Greene.
Greene continues to describe the sale of Hybritech to Lilly as a "no-lose situation" for Hybritech shareholders. That optimism is driven by the rapid increase in the value of warrants and notes, as well as an expectation that the CPUs eventually will contribute to the value of the deal.
But even if Hybritech fails to push projects out of R&D laboratories, analysts have suggested that Hybritech shareholders realized solid gains through the sale to Lilly.
"Given the general market for biotechnology companies since 1986, Hybritech shareholders have done well," Knepp said.