Elans Defense

¹Copyright 2014 Thunderbird School of Global Management. All rights reserved. This case was prepared by Professor Michael H. Moffett for the purpose of classroom discussion only.

Elans 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 Elans 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 Elans stockholders questioning whether Elans 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 futureup to an additional $2.50 per shareif Tysabris future sales reached specific milestone targets. Royalty Pharmas 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 Elans 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. Elans 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 Pharmas synopsis of the sales debate, noting that Elans 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 conditionsall could change future global sales. That said, there were several more distinct factors of concern.

EXHIBIT A Forecasts of Tysabris Worldwide Sales

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 unrealisticalready.

EXHIBIT B Valuing Elan: Prospective Royalties on Tysabri Plus Cash

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-linetotal saleswas 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 Pharmas opinion, the post-patent period represented a significantly higher risk period for actual Tysabri sales. Market valuation. Despite the debate over Elans 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.) Elans share price history for 2013 is shown in Exhibit C. Elans management had made their case to shareholders. The collection of initiatives that Elans 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 [Elans 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. Elans current non-executive chairman then responded: I note that Elans share price has trebled since Mr. Schulers 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 decidequickly.

CASE QUESTIONS 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 shareholdersto approve managements proposals killing RPs offeror say no to the proposals, probably prompting the acceptance of RPs offer?