Hello, solving the Rhone Poulenc Rorer case implies usually the use of montecarlo smulation to valuate the CVR. However the professor said to use only Black and Scholes and Binomial combined. I know that the CVR, i.e. Contingent value right is equivalent toa longput with a strike price at the floor,and a short put with a strike price atthe limit of the protection. How should I proceed to calculate the value of the extendible option?

UV2318 Version 1.1 RHNE-POULENC RORER, INC. The interest with which industry analysts, the financial community, and our shareholders have responded to RPR has been encouraging. As evidenced in the strong performance of our stock during 1990 and the attendant decline in the CVR since issuance of the security by Rhne-Poulenc S.A. in August, many among our key audiences have moved from curiosity to confidence in RPR's ability to fulfill its ambitious sales and earnings goals for the future. Company, 1990 Annual Report . . . leadership requires, first, critical mass in order to compete effectively in research and marketing; second, a global presence to leverage these investments; and third, advantageous partnerships. . . . Company, 1989 Annual Report Dsormais, le succs dpend de notre talent et non plus de nos moyens. . . .1 In August 1991, a year had elapsed since the $3.2 billion merger that created a major multinational pharmaceutical company, Rhne-Poulenc Rorer (RPR). The merger, noted for its size, novel terms, and ambitiousness, provoked considerable comment and some skepticism about the projected synergies. Now, a year later, the company had shown rapid post-merger integration and initial synergy gains. The skeptics were not completely muzzled, however; some doubted that the growth and cost savings could be sustained. The expected performance of RPR was of crucial importance to at least one shareholder of the companyRhne-Poulenc S.A., the seventh largest chemical manufacturer in the world, which owned 68 percent of RPR's shares. In the merger, Rhne-Poulenc gave the minority shareholders a \"contingent value right\" (CVR) that, in effect, promised to pay them on July 31, 1993, any shortfall between $49.13 and the then prevailing stock price. At year-end 1990, Rhne-Poulenc carried this 1 \"Henceforth, success depends more on our talents than financing,\" a quotation of Igor Landau, president of the Health Sector at Rhne-Poulenc S.A. in Isabelle Chaperon, \"Affairs a Suivre,\" La Vie Francaise, June 7, 1991. This case was prepared by Robert F. Bruner, as a basis for classroom discussion, while he was a Citicorp Global Scholar and visiting professor at INSEAD in Fontainebleau, France. Copyright 1992 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to sales@dardenpublishing.com. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying, recording, or otherwisewithout the permission of the Darden School Foundation. Rev. 6/98. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -2- UV2318 contingent liability on its balance sheet at 4.96 billion French francs (about US$ 827 million). On August 1, RPR's shares closed at $45.75 and the CVRs closed at $2.50. The Company Rhne-Poulenc Rorer, Inc. (RPR), was created on July 31, 1990, in a merger between Rorer Group, Inc., and the Human Pharmaceutical Business (HPB) of Rhne-Poulenc S.A. As Exhibit 1 indicates, RPR reported sales of $2.9 billion for 1990, but if sales were annualized to include a full year of HPB's operations, RPR's sales would rise to $3.6 billion, ranking it as the 13th-largest pharmaceutical firm in the world. (See Exhibits 2 and 3 for comparisons of RPR with its key competitors.) Contenders in the field were numerous, and even the largest firms did not account for more than a 5 percent share of the market. Worldwide pharmaceutical sales were estimated to be $145 billion, having risen at a rate of 13 percent a year in recent years. The growth rate in worldwide pharmaceutical sales was expected to slow, however, to 9 percent per year.2 The largest markets were in the United States and Japan, which represented, respectively, sales of $44.5 and $31.3 billion in 1989. RPR's mission statement dedicated the company to becoming the best pharmaceutical company in the world. This statement had been revised somewhat from a version published in the 1988 annual report (see Exhibit 4 for the comparison). The company defined its products according to three categories. Strategic products involved those that already enjoyed a broad international market or were expected to do so. The merger positioned RPR as the leading seller in Europe of over-the-counter (OTC) drugs, with sales of $280 million (see Exhibit 5). These products were earmarked for heavy investment in marketing and were expected to grow at 19.2 percent per year through 1994. (One analyst assumed only 17.2 percent growth because of the maturity of the Maalox brand.)3 Specialty items were defined as products with clearly defined regional markets, or limited sales potential, because of either maturity or the narrowness of the market. These products were expected to grow at about 8.5 percent per year. Finally, RPR estimated that new products to be rolled out in the near future would produce sales of $715 million in 1994. Given the uncertainties associated with introducing these products, however, one outside analyst expected only $422 million.4 In its 1988 annual report, Rorer's chief executive officer, Robert Cawthorn, had celebrated this firm's sales level clearing $1 billion for the first time and reaffirmed the goal of producing growth in earnings of 15 percent or better. An important component of this growth strategy had been a program of acquisitions, because sales growth in the company's existing product lines was 2 P. Chandarana, \"Company ReportRhne-Poulenc Rorer,\" Elyses Bourse, October 2, 1990. Chandarana, \"Company Report,\" noted that Informations Mdicales et Statistiques predicted demand for antacids sold OTC to rise 6.3 percent per year by the year 2000, compared with a 1.3 percent annual fall in sales for prescription antacids. Also, competitors were known to be increasing their marketing efforts to sell OTC antacids. 4 Chandarana, \"Company Report.\" 3 This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -3- UV2318 characterized as \"mature.\" One observer described the Rorer strategy as \"playing offense in an effort to remain independent.\"5 Rhne-Poulenc S.A. (RP), the diversified chemicals manufacturer, owned 68 percent of RPR shares. In turn, the French government owned 100 percent of RP's voting common stock. RP had been nationalized in 1982 and had since struggled to modernize and attain its goal of a ranking among the five largest chemicals producers worldwide. With the French government under its own budgetary pressures, RP's growth had been financed internally and through an increasingly sophisticated series of financings in the corporate capital markets. As yet, RP had not met its stated goals. Analysts expected that RP would be privatized in 1993 after the next general assembly elections in France, when the conservatives were expected to be returned to power. Following the merger, Rorer's Robert Cawthorn continued as RPR's CEO, although the firm did assign a new chief financial officer and executive in charge of European operations and marketing. (These individuals are profiled in Exhibit 6.) The new senior executives came from Rhne-Poulenc. Outside observers believed that RP would slowly take over the company. Cawthorn, however, considered RPR to be a freestanding pharmaceutical operation with its own mission statement and Rhne-Poulenc S.A. to be merely an important shareholder.6 Some observers questioned RPR's claim to cultural integration and independence. The skeptics pointed to the predominantly American management team, an American-style mission statement, and a waning effort on the part of the American executives to learn French. The Merger Takeover rumors concerning Rorer had first appeared in the late 1980s, as the firm's relatively low cash balance and rising level of debt seemed to be handicapping its strategy of growth by acquisition. The final confirmation of this constraint surfaced in 1989, when Rorer bid for and lost the opportunity to take over the pharmaceutical business of A. H. Robins. Rorer thus surprised analysts with its announcement of a merger with the Human Pharmaceutical Business of RhnePoulenc. Later, the news emerged that several companies had expressed an interest in acquiring Rorer, including Hoffman-La Roche, Ciba-Geigy, Sandoz, Yamanouchi, Monsanto, and Du Pont. The $3.2 billion combination with Rhne-Poulenc coincided with a wave of mergers in the pharmaceutical industry, including Merrill-Dow buying Marion Laboratories, the $2.1 billion acquisition of Genentech by Hoffman-La Roche, SmithKline and Beecham, Bristol-Myers and Squibb, and major joint ventures between Sanofi and Sterling Drug and between Du Pont and Merck. One observer commented, \"Early evidence shows that the few mega-mergers that have been completed have been a stunning success, and we anticipate further duplication.\"7 5 Janet Novak, \"Please Pass the Maalox,\" Forbes, August 7, 1988. Mike Ward, \"RPR Takes the Global Stage,\" Financial Times, July 23, 1991. 7 Alan Archer, \"Alliances Offer a Model,\" Financial Times, July 23, 1991. 6 This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -4- UV2318 Prior to the RPR combination, Rhne-Poulenc's Human Pharmaceutical Business had virtually no position in the United States and Japan, although it was strong in some European Community markets. Moreover, its channels of distribution were not fully utilized. Rorer, on the other hand, lacked a position in Europe and the channels with which to access the market. After the combination, the company ranked among the top three in Europe and had improved its position in the United States. One goal of the company was to rank in the top 10 pharmaceutical companies worldwide. The merger was consummated in a three-stage transaction, by which Rhne-Poulenc obtained 68 percent of Rorer's common stock (91.6 million shares), which was enough to permit Rhne-Poulenc to consolidate Rorer's results for financial reporting.8 First, Rhne-Poulenc would tender for 50.1 percent (43.2 million shares) of Rorer's common stock for $36.50 cash per share. (Rhne-Poulenc, by borrowing the funds to finance the tender offer, increased its debt/capital ratio to 45 percent, well above competitors' capitalizations of 20-30 percent.) Second, Rorer assumed $265 million of RP debt (guaranteed by RP), made a $20 million cash payment to RP, and issued 48.4 million new common shares to RP in exchange for RP's HPB division.9 Observers believed that Rorer's bylaws would require at least 85 percent of all shares be voted in favor of the issuance of new shares and, more generally, of this entire transaction. Third, Rhne-Poulenc issued the 41.8 million CVRs to the remaining minority shareholders in Rorer. A CVR entitled the holder to the right at the end of three years, July 31, 1993 (or four years, at RP's option), to a cash payment of US$49.13 (or $53.06 if the payment were made at the end of four years) reduced by the higher of the value of the RPR share at that date or $26.00. Thus, if the value of the RPR share exceeded $49.13 (or $53.06), there would be no payment. The maximum amount of RP's liability on December 31, 1990, was FF4,960 million (FF5,165 million at the date of the issuance of the rights).10 The total market value of the rights on December 31, 1990, was FF844 million (FF1,306 million at the date of their issuance). The maximum amount of RP's liability at the date of issuance was hedged. Any changes in the value of the CVRs resulting from fluctuations in exchange rates, as well as the amortization of the cost of the hedge, were recorded directly into the consolidated equity of RP. The CVRs were quoted on the American Stock Exchange and traded independently of the shares of RPR, which were listed on the New York Stock Exchange (NYSE). 8 RPR split its common shares 2:1 on May 17, 1991. To avoid unnecessary confusion, all share numbers and prices reported in this case are given on a post-split basis. Actually, the acquisition terms involved half the number of shares and twice the share price reported here. 9 The transfer of RP's health sector excluded RP's business units in veterinary products, serums, and vaccines and the firm's minority interest in a French pharmaceutical concern, Roussel-Uclaf. 10 In general, the disclosure of contingent liabilities by a firm depended on whether the likelihood of realizing the liability was probable, possible, or remote. If the probability of realization was less than 50 percent, accounting conventions required that the liability be disclosed in the footnotes to the financial statements. The accounting rules contained no prescribed way, however, to estimate the magnitude of contingent liabilities. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -5- UV2318 Rorer and Rhne-Poulenc jointly announced that they believed that the package of CVR and minority share in RPR was worth $36.50 and thus equal to the price at which RP was tendering for shares of RPR. Rorer investors responded favorably to the announcement of an agreement in principle to merge. During the week of the announcement (January 12 -19, 1990), Rorer shares increased by $7.313 over the ex ante share price of $24.625, or 28 percent (net of the changes in the Standard & Poor's 500 Index over the week). This gain equaled about $632 million in new value. Meanwhile, RP's nonvoting common shares, traded on the Paris Bourse and the NYSE, lost 4.4 percent net of market during the announcement week, or about $175 million. On April 7, 1990, Warren Buffett, an American investor with an unusually successful money-management record, announced that he had acquired 8 million shares of Rorer (5.8 percent of the total) at an average price of $32.85. As of March 31, 1991, RPR's 8,175 minority common stockholders were dominated by large institutional investors, including 30 mutual funds (2.1 million shares), 61 investment advisors (22.1 million shares), 36 banks (2.77 million shares), and 8 insurance companies (4.4 million shares). The institutions accounted for 23 percent of the 137.4 million shares outstanding and 71 percent of the 44 million shares not held by RP. CVRs and Contingent Payments in Acquisitions Contingent payments tended to appear in acquisitions involving a large potential difference between the target transaction prices of buyers and sellers or when the sellers were seeking some protection for the remaining minority shareholders against unfair treatment by the acquirer. Acquisitions in the pharmaceutical industry featured some of the most innovative forms of these contingent-payment schemes; Exhibit 7 summarizes the terms of three other contingent deals and compares them with the RPR terms. CVRs had been used as merger vehicles since 1985, although they did not gain widespread recognition until used in 1989 in the takeover of Marion Laboratories by Merrill-Dow, the pharmaceutical subsidiary of Dow Chemical. The creation of Rhne-Poulenc Rorer was modeled on the Marion/Merrill-Dow deal. On September 13, 1991, Dow Chemical stunned the markets by announcing that it would redeem for cash the contingent value rights on Marion Merrill shares that were soon to mature. Analysts estimated that the payment per CVR would be about $10.00. Marion Merrill's share price plunged $8.125 to $29.50 on the announcement; the CVRs rose $4.875 to trade at $11.00. The announcement deflated investor expectations that Dow Chemical would extend the life of the CVRs for another year and make a bid for the 32 percent of Marion Merrill that it did not already own. Analysts pointed out that Marion Merrill's growth appeared to be slowing because of its failure to find new \"blockbuster\" drug products in the face of several imminent patent expirations. Indeed, analysts expected that Marion Merrill would not be able to market any new products for several years. Thus they speculated for Dow to redeem the rights now would be cheaper than to delay and redeem them in a year and cheaper than buying the remaining shares. Analysts also pointed out that Dow's earnings were under pressure. Dow's share price closed up $0.25 on September 13. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -6- UV2318 The Outlook CEO Cawthorn implemented an aggressive post-merger integration process at RPR that rationalized the merging manufacturing operations, reorganized the R&D function to heighten collaboration and foster the exchange of ideas, and sold nonstrategic assets.11 The successful postmerger integration permitted RPR to report that synergies and asset sales projected for 1990 were achieved. In its merger prospectus, the company had projected sales and earnings through 1994 (see Exhibit 8), and the results for 1990 and the first two quarters of 1991 were indeed consistent with these projections. Earnings and dividends per share for RPR showed the following trends: 1991 1988 Earnings per share (EPS) EPS (before restructuring charges) Dividends per share Return on equity 1989 $0.965 $1.215 $0.40 13.8% $0.41 14.7% 1990 Quarter 1 Quarter 2 $0.01 $0.39 $0.50 1.26 $0.42 20.8% $0.105 -- $0.11 -- Observers worried, however, about the sustainability of RPR's record. First, the cost of newproduct development in the industry was risingfrom an average $125 million per product in 1987 to $230 million in 1990. Industry R&D expenditures had been rising 15 percent per year since 1985, yet the number of new drug applications worldwide had fallen at the rate of 10 percent per year (also since 1985). Second, analysts predicted that governments would get tougher on the cost of drugs in an effort to slow down rapidly rising health costs. As a result, demand for drugs might shift from prescription remedies to OTC products. Other strategic risks included patent expiration and competition from low-priced generic drug manufacturers and decreasing product life cycles. On the positive side, analysts noted that computers and biotechnology were aiding new-product development, that the world population was aging, and that RPR was marketing harder than it had, which would boost the payback from its more aggressive R&D spending. The following table summarizes comments by securities analysts about RPR in early 1991. 11 RPR retained First Boston and Shearson Lehman to assist in the sale of certain assets. Asset sales were managed according to two key objectives: (1) to sell only if the net present value of future cash flows from retaining the assets would be less than the NPV of selling the assets and (2) to achieve earnings neutrality in the future. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -7- Analyst and Date J. P. Riccardo, Bear, Stearns & Co. May 10, 1991 Stock price = $41.00 R. C. Carryl, Value Line August 9, 1991 Expectations for RPR EPS 1991e $2.33 1992e $3.08 Gross margins will improve from 62.8% to 68% of sales. UV2318 Comments The company may struggle to achieve its sales target of $4,050 million in 1991. . . . While we remain concerned over the outlook for 1992, we believe that the Cawthorn-led team will pull off the right strategic moves to insure RPR's stated goals through 1994. On that basis, we would rate the stock a long-term buy. 1991e $2.25 1992e $2.40 Rhone-Poulenc Rorer appears to be entering a period of sustainable double-digit earnings growth . . . reflecting the shuttering of redundant facilities, a reduction in the employee head-count, and the cross-selling of each other's products. . . . Despite the positive long-term earnings outlook, investors looking for a drug stock would do well to consider other opportunities. . . . RPR's margin remains well below that of its industry counterparts, primarily reflecting a higher cost of goods sold/sales ratio. Furthermore, with overseas operations accounting for a whopping 75-80% of its total business, the drug maker's income stream is far more sensitive to foreign currency exchange swings than any of its peers. Investors skeptical of RPR's growth prospects might want to consider the contingent value rights (CVRs) which guarantee a cash payment. 1991e $2.15 1992e $3.15 We rate Rhne-Poulenc Rorer a BUY. Because of its dramatic profit margin expansion potential, [it] is expected to be the fastestgrowing company in our universe30% per year compared with 16% per year for our eight-company drug composite. . . . Few major Wall Street brokers actively follow the company; therefore, these strong fundamentals are not efficiently reflected in the stock price, in our opinion. . . . RPR's explosive EPS growth reflects dramatic margin expansion. . . RPR could trade around $46 per share in 12-18 months. S. Weisbrod, Merrill Lynch February 26, 1991 Stock price = $40.50 1991e $1.95 1992e $2.90 We recommend purchase . . . by long-term investors. We think the stock is fully valued near term. . . . The dramatic margin expansion gives us more confidence in our 1992 and 1993 projections. P. Chandarana, Elyses Bourse October 2, 1990 1991e $2.25 A possible long-term buy, but risks on earnings growth and dollar. . . . Our own more conservative projections call for sales to advance 12% a year and net 32%. . . . Trading at $30.50, the stock has little upward potential. . . . Investors could take an interest with an eye on the long term. Stock price = $46.00 Jami Rubin, Smith Barney February 12, 1991 Stock price = $37.50 Stock price = $30.50 Zack's Earnings Estimates March 30, 1991 Average over Eight Analysts 1991e $2.75 1992e $3.63 EPS growth rate next 5 years 21.1% Industry EPS growth 14.2% This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -8- UV2318 RPR's estimated beta was 1.1. The sigma (standard deviation of returns) on RPR shares was about .18 (see Exhibit 9) and compared with an average of .27 for 12 pharmaceutical companies.12 On August 28, 1990, an analyst for Bear Stearns had recommended that investors buy CVRs and RPR common shares at a ratio of 1.4 to 1. At the time, the CVRs were trading at $6.56 and RPR common at $31.50. In March 1991, he recommended that the ratio be adjusted to 1.8 CVRs per 1 share of RPR common; by then the stock price had risen to $40.625. He said, You will not lose money (from today's prices) unless RPR EPS falls below $2.50 per share at the CVR expiration in 1993; if RPR does not fall lower than $15 per share, your return will be greater than 10 percent to the CVR expiration.13 Exhibit 10 graphs the price movements of RPR's common shares and CVRs after the merger, and Exhibit 11 gives information regarding current capital-market conditions. Over the previous 18 months, the price/earnings ratio of the S&P 500 Index had varied between 18.07 and 14.21; the P/E ratio at the last market peak (August 25, 1987) was 16.3 times and at the last market trough (August 12, 1982) was 7.6 times. 12 Exhibit 9 estimates sigma over the prior 31 weekly closing prices. If sigma were estimated over the prior 52 weeks, its value would be .1875. Estimated over the 79 weeks since RPR shares began trading, the sigma was .266. 13 B. Cohen, Bear Stearns & Co., \"Rhne-Poulenc Rorer, Research Highlights,\" March 15, 1991. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -9- UV2318 Exhibit 1 RHNE-POULENC RORER, INC. RPR Selected Financial Data (dollars in thousands) 1988 Net sales Cost of products sold R&D expenses Net interest Restructuring costs (Gain) loss on asset sales Gain on contract termination fee Other expense Income taxes Minority interest Net income Capital expenditures New headquarters Other Depreciation Working capital Property, plant, and equipment Total assets Long-term debt Shareholders' equity Employees Sales per employee 1989 1990 $2,917,364 1,075,992 350,178 137,801 289,256 (78,835) 11,890 33,299 $1,182,152 428,626 121,806 41,608 9,981 (30,870) (19,949) 28,828 38,848 61,841 86,467 35,474 9,542 6,343 989 10,835 59,942 56,494 29,308 82,107 63,817 92,073 124,785 144,693 312,403 395,651 1,388,012 564,599 $ 414,171 436,922 488,167 1,791,716 882,525 $ 439,944 391,391 1,930,702 4,084,982 1,634,352 $ 693,454 8,394 132 8,527 140 23,454 150 $1,041,612 377,750 103,952 39,608 0 7,065 Source: Company 1990 annual report. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -10- UV2318 Exhibit 2 RHNE-POULENC RORER, INC. Data on Leading Pharmaceutical Companies Home Country Merck Bristol-Myers Squibb Glaxo SmithKline Beecham Hoechst Ciba-Geigy Johnson & Johnson American Home Products Sandoz Eli Lilly & Co. Bayer Pfizer Rhne-Poulenc Rorer Hoffman-La Roche Takeda Schering-Plough ICI Marion/Merrill-Dow Upjohn Wellcome U.S. U.S. U.K. U.K. Ger. Switz. U.S. U.S. Switz. U.S. Ger. U.S. U.S./France Switz. Japan U.S. U.K. U.S. U.S. U.K. 1990 Sales ($m) 6,425 5,980 5,286 5,001 4,628 4,592 4,200 4,022 4,005 3,720 3,720 3,684 3,613 3,471 2,670 2,652 2,474 2,438 2,420 2,260 1990/91 Growth (%) 9.4 8.0 9.2 0.0 18.2 11.7 12.4 -3.0 8.7 16.8 8.3 10.7 7.4 19.6 -23.9 6.4 8.6 3.0 3.8 15.5 Source: Alan Archer, \"Alliances Offer a Model,\" Financial Times, July 23, 1991. Sales reported in the article were given in pounds sterling and have been converted here to dollars at the rate of 1.78 to the pound. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -11- UV2318 Exhibit 3 RHNE-POULENC RORER, INC. Information on Comparable Firms in the Pharmaceutical Industry P/E Ratio American Home Products Bristol-Myers Squibb Eli Lilly & Co. Marion/Merrill-Dow Merck Pfizer Rhne-Poulenc Rorer Schering-Plough Upjohn Warner-Lambert 1 15.0 21.0 16.3 17.6 23.5 22.5 20.4 18.0 15.8 16.9 Beta LongTerm Sigma 1.00 1.00 1.10 n.a. 1.00 1.05 1.00 1.10 1.05 1.10 .25 .29 .23 n.a. .23 .28 .176 n.a. .25 .31 Expected DividendPayout Ratio Expected Growth of: Sales 7% 11 16 13 14 13 15 11 9 12% Profits 10.5% 15.0 19.5 16.0 17.5 14.0 27.5 17.5 12.5 17.0% Debt/Equity .124 .042 .053 .111 .031 .031 2.00 .087 .299 .220 55% 56 41 43 42 47 201 41 41 42% RPR's quarterly dividend had been raised to $.11 per share at the June 30 payment date, up from $.105 per share. Source: Value Line Investment Survey, August 9, 1991. The sigma for RPR was obtained from Exhibit 8 of this case. Sigmas on other firms were obtained from J. Cox and M. Rubinstein, Options Markets (Englewood Cliffs, N.J.: Prentice-Hall, 1985), pp. 34658. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. Mission Statement, 1988 Annual Report Source: Company annual reports. Generating consistently BETTER results than our competitors, through innovation and a total commitment to quality in everything we do. Being seen as the BEST place to work, attracting and retaining talented people at all levels by creating an environment that encourages them to develop their potential to the full; Operating with the HIGHEST professional and ethical standards in all our activities, building on the Rhne-Poulenc and Rorer heritage of integrity; Being BETTER AND FASTER than our competitors at discovering and bringing to market important new medicines in selected therapeutic areas; Being the BEST at satisfying the needs of everyone we serve, patients, health-care professionals, employees, communities, governments and shareholders; Being the best means: Our Mission is to become the BEST pharmaceutical company in the world by dedicating our resources, our talents, and our energies to help improve human health and the quality of life of people throughout the world. UVA-F-1015 That we are responsible to the communities in which we work and live. We will actively support civic improvement, better health, and education. That we must continually adapt and renew our business. We must encourage and reward innovation, experimentation, and change. That we must treat each other fairly, with trust and respect, in an environment that fosters involvement, open communication, and teamwork. That customer satisfaction is our first responsibility. To provide value for the people who benefit from our products and services, we must emphasize quality and integrity in everything we do. We believe: The Rorer Credo To improve human health while maximizing shareholder value by becoming a world-class pharmaceutical company, able to compete effectively with any other company in selected therapeutic areas in the major developed markets of the world. The Rorer Mission Mission Statement, 1990 Annual Report Mission Statement Exhibit 4 RHNE-POULENC RORER, INC. -12- -13- UVA-F-1015 Exhibit 5 RHNE-POULENC RORER, INC. Data on OTC Drug Sales A. World Drug Sales (in $ billions) Prescription OTC Total 120 90 25 20 145 110 1990 1986 B. OTC Drug Sales in Europe by Company (in $ millions) Country of Headquarters Rhne-Poulenc Rorer Bayer Sanofi SmithKline Beecham Procter & Gamble Boeringer Ingelheim Boots American Home Products Nicholas Laboratories Warner-Lambert Sterling Drug Hoffman-La Roche 1990 Sales U.S./France Germany France U.K. U.S. Germany U.K. U.S. U.S. U.S. U.S. Switzerland 280 210 180 170 170 150 150 140 120 110 100 100 Source: Clive Cookson, \"Roche Deal Puts Fizz in Drugs Race,\" Financial Times, June 4, 1991. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -14- UVA-F-1015 Exhibit 6 RHNE-POULENC RORER, INC. Profiles of Senior RPR Executives Robert E. Cawthorn (age 55) Chairman, president, and CEO. Joined Rorer in 1982 as executive vice president (EVP) and president of its international pharmaceutical subsidiary. President from February 1984; CEO from May 1985. Chairman from May 1986. Jean-Jacques Bertrand (age 51) EVP and group president [specifically in charge of Europe, Africa, the Middle East, South America, and Asia (excluding Japan and Korea)]. Served as president, Worldwide Pharmaceutical Operations of Rhne-Poulenc Sant from 1987 to 1990. From 1985 to 1987, served as president of various RP pharmaceutical operations. Ralph H. Thurman (age 41) EVP and group president, North America, Japan/Korea, Australia/New Zealand, and Worldwide Industrial Operations. Vice president, Personnel from 1985 to 1987. Senior vice president (SVP), Organization and Administration in 1988. EVP and president of U.S. subsidiary in 1989. Gilles D. Brisson (age 39) SVP, Corporate Development. 1989-90 area vice president of Northern Europe for RhnePoulenc. 1987-89 deputy SVP of Worldwide Pharmaceutical Operations of Rhne-Poulenc Sant. 1983-87 general manager of Theraplix. Patrick Langlois (age 45) SVP and chief financial officer. 1988-90 SVP, Corporate Finance and Acquisitions of Rhne-Poulenc. 1975-86 director of International Financings of Rhne-Poulenc and finance director. Source: Company merger proxy statement, 1990. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -15- UVA-F-1015 Exhibit 7 RHNE-POULENC RORER, INC. Landmark Acquisition Payment Structures in the Pharmaceutical/Biotechnology Industries Deal Eli Lilly and Company Buys 100% of Equity in Hybritech, Inc. Rhne-Poulenc Acquires 68% of Equity in Rorer Group, Inc. Dow Chemical Acquires 67% of Equity in Marion Laboratories Roche Holding Ltd. Acquires 60% of Equity in Genentech Date of closing February 1986 July 1990 July 1989 February 1990 $412.8 million $1,600 million $5,700 million $1,295 million Total estimated payment (US$) One-stage exchange per each Hybritech share: Three-stage transaction: Two-step transaction: Two-step transaction: (1) $22.00 cash or par value of 10-yr. conv. notes paying 6.75%. Conversion price $66.31 per share. (1) Cash tender offer for 50.1% of stock in Rorer. At $36.50 for 43.2 million shares, the initial cash outlay is $1,577 million. (1) Dow acquires 38.9% of Marion through a cash tender offer at $38 per share. (1) Roche purchases a 20% interest in Genentech through the purchase of newly issued shares at $22 per share. (2) 1.4 warrants to buy Lilly common stock at $75.98 per share. General structure (2) RP transfers its worldwide HPB to Rorer. Rorer pays RP $20 million and assumes $265 million of RP debt. Rorer issues 48.4 million new common shares to RP. (3) One contingentpayment unit (CPU) paying up to $22.00 in dividends over 10 years. (2) Dow contributes its pharmaceutical subsidiary, MerrillDow, and 92 million CVRs in exchange for new Marion shares. Following the transaction, public shareholders will own 40% of voting stock; Roche will own 60%. (3) RP issues 41.8 million CVRs (for terms of payment, see text of case). Contingent terms Annual dividend of CPU equal to: [6% of sales + 20% of gross profits - ($11 million * (1.35t)] divided by number of Hybritech shares. t = years since 1986. Sales and gross profits are for Hybritech. CVR entitles holders to receive from RP the amount by which $98.26 a share exceeds either a $52.00 floor price or the average market value of Rorer's share price 60 days before the rights' maturity date of July 31, 1993. Maximum payout $46.26 per share. RP has the right to extend maturity of CVRs for an additional year to July 31, 1994. In that event, the ceiling rises from $98.26 to $106.12. Maximum payout increased to $54.12. (2) All non-Roche common shares are exchanged for $18 cash and share of redeemable common stock. Similar to RP CVR: a \"put\" spread guarantees shareholder returns within a predetermined range of stock prices through 1992. Redeemable common stock entitles Roche to redeem the shares at predetermined prices until June 1995. Thereafter, these shares will automatically convert into an equal number of regular common shares. Redemption price starts at $38.00 at closing and rises $1.25 per quarter to the maximum of $60 per share in April-June 1995. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -16- UVA-F-1015 Exhibit 8 RHNE-POULENC RORER, INC. Five-Year Projected Financial Performance Forecasted by RPR1 (in millions of dollars except per-share data) 1990 1991 1992 1993 1994 $2,533 100 131 218 37 7 $4,053 176 165 -497 328 $4,657 168 173 -599 462 $5,276 137 186 -906 600 $5,906 107 197 -1,125 743 Earnings per share 0.065 2.43 3.42 4.45 5.50 Cash Total assets Debt (including current portion) Stockholders' equity 184 3,731 2,021 640 135 3,855 1,812 902 95 3,968 1,505 1,225 95 4,141 1,158 1,615 95 4,341 774 2,061 Capital expenditures Ratio of debt to debt plus equity Pretax interest-expense coverage, excluding restructuring costs $ 173 76% $ 208 67% $ 150 55% $ 157 42% $ 176 27% 3.4 3.7 5.0 7.3 10.8 Revenues Interest expense, net Depreciation Restructuring costs Income before tax Net income 1 The financial projections . . . were developed by the managements of Rhne-Poulenc and Rorer Group, Inc., over a period of several months. The projections . . . represent the \"base\" case in the view of senior management of both Rhne-Poulenc and Rorer Group, Inc. There are numerous assumptions and attendant uncertainties with respect to these projections which are set forth in more detail below. The 1990 data assume that the transactions are completed on June 30, 1990, and that the combined accounts include 12 months of results for Rorer Group, Inc., and 6 months of results for the Human Pharmaceutical Business as well as interest on the debt incurred in the restructuring from June 30, 1990. The projections also assume provisions of $218 million (before taxes) in 1990 for one-time costs related to the transactions. The financial projections reflect substantial benefits anticipated from the combination and assume, among other factors: (1) increases in sales of existing products and introduction of new products, receipt of regulatory approvals required for new products within the planned timeframes and achievement of marketing plans for both new and existing products; (2) reduction of sales in certain markets from overlapping products; (3) some disruption in sales from the business combination together with declines over time on products which will be less actively marketed by the combined company than previously; (4) exclusion of sales increases which may result from increased marketing emphasis on certain core products by the combined sales force; (5) price increases on existing products of both companies throughout the period on a basis generally consistent with historical experience; (6) improvement in operating margins, particularly in the first three years after the transactions, which improvement is expected to result from the consolidation of manufacturing operations, sales forces, marketing, distribution and administrative functions, and research and development activities. Source: Rorer Group, Inc., merger proxy statement, 1990. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -17- UVA-F-1015 Exhibit 9 RHNE-POULENC RORER, INC. Estimation of RPR Stock-Price Volatility across 31 Weeks, January 1991 to August 1991 Weekly Closing Stock Prices1 Jan. 11 Aug. 2 $34.69 33.75 34.00 34.56 35.00 36.13 38.79 39.56 40.75 40.69 41.44 40.44 40.50 39.31 39.75 39.44 39.56 39.38 41.99 41.25 41.19 41.13 41.88 42.00 42.50 41.50 41.63 41.75 42.38 41.50 43.38 $45.75 Price Relative 0.973 1.007 1.016 1.013 1.032 1.074 1.022 1.030 0.999 1.018 0.976 1.001 0.971 1.011 0.992 1.003 0.995 1.066 0.985 0.999 0.999 1.018 1.003 1.012 0.976 1.003 1.003 1.015 0.979 1.045 1.055 Sum Average Number of price relatives: Number of stock prices: Adjusted weekly variance: Annual variance: Annual std. deviation: Log of Price Relative Squared Error of Log of Price Relative -0.027 0.007 0.016 0.013 0.032 0.071 0.022 0.030 -0.001 0.018 -0.024 0.001 -0.030 0.011 -0.008 -0.003 -0.005 0.064 -0.015 -0.001 -0.001 0.018 -.003 0.012 -0.024 0.003 0.003 0.015 -0.021 0.044 0.053 0.0012 0.0000 0.0001 0.0000 0.0006 0.0041 0.0002 0.0005 0.0001 0.0001 0.0010 0.0000 0.0014 0.0000 0.0002 0.0000 0.0001 0.0033 0.0005 0.0001 0.0001 0.0001 0.0000 0.0000 0.0010 0.0000 0.0000 0.0001 0.0008 0.0014 0.0021 0.304 0.010 0.017998 0.000599 30 31 0.000620 0.032 0.180 = Sigma or volatility Comment: In this table, stock prices are converted into price relatives (which are simply the ratio of today's price to yesterday's price). Then the price relatives are transformed into logarithmic values (in order to normalize the distribution). In the right-hand column, the squared deviations of the logarithmic values are computed from their mean value (0.010). The weekly variance is computed by dividing the sum of the right-hand column (.018) by the number of price relatives (30) and then multiplying by a correction factor (30/29) to adjust for sampling bias. The annual variance is obtained by multiplying the weekly variance by 52. The standard deviation is the square root of annual variance. For a more detailed discussion of this estimation procedure, see J. Cox and M. Rubinstein, Options Markets (Englewood Cliffs, N.J.: Prentice-Hall, 1985), pp. 255-58. ___________________________ 1 These stock prices include dividend payments as of ex dividend dates. Source of stock prices: Datastream, Inc. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -18- UVA-F-1015 Exhibit 10 RHNE-POULENC RORER, INC. Graph of Prices of RPR Common Stock and CVRs since July 1990 (all values indexed to 1.00 from first day of trading) Security Prices July 2, 1990 RPR common stock RPR CVRs Standard & Poor's Index August 1, 1991 $ 36.88 $ 45.75 5.56 2.50 $196.23 $210.99 Source: Datastream, Inc. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016. -19- UVA-F-1015 Exhibit 11 RHNE-POULENC RORER, INC. Current Capital-Market Conditions, Early August 1991 August 9, 1991 Equity-market multiples Median price/earnings ratio Median dividend yield July 26, 1990 15.2 3.0% 13.3 3.7% 3,017.67 380.96 504.15 2,920.79 365.91 455.43 +5.3 +10.1 +17.6 +10.8 +4.1 -1.6 5.69 5.89 6.17 6.85 7.09 7.74 8.16 8.35 7.83 7.85 7.90 8.09 8.20 8.26 8.47 8.53 8.5 8.9 10.0 9.3 Other bond rates: A-rated corporates (25 yrs.) A-rated financials (10 yrs.) 9.6 9.15 9.67 NAv. Preferred stocks, dividend yield: A-rated utilities A-rated financials 8.99 9.37 NAv. NAv. Equity-market indexes Dow-Jones Industrial Average S&P 500 Index NASDAQ1 OTC Composite Index Change in equity-market indexes over past 12 months (%) Dow-Jones Industrial Average S&P 500 Index NASDAQ OTC Composite Index U.S. Treasury yield curve (yields by maturity, %) 3-month bills 6-month bills 1-year notes 2-year notes 3-year notes 5-year notes 10-year bonds 30-year bonds Benchmark corporate costs of funds (%) Prime rate Aaa corporate bond rate 1 National Association of Securities Dealers. Source: Value Line Investment Survey, August 9, 1991, and August 3, 1990. This document is authorized for use only in Financial Analysis and Management - 1143 by Jo?o Amaro Matos, FGV - EAESP from May 2016 to November 2016