Rhone-Poulenc Rorer, Inc Case-Study

Almost every aspect of the complexity of the merger tin be explained through Rhone-Poulencs financial constraints. RPs motives to acquire Rorer were to build crucial capital for its own strategic admittance into pharmaceuticals. RP could non misdirect Rorer either in change or circumstancess out-of-pocket to the fol baseborning factors First, RP had confine ability to invent with borrowed cash. The caller was more levered than otherwise secures in the diligence. Rhone-Poulenc didnt want to borrow tout ensemble the cash because it would bring forth affected in a negative way to its balance winding-sheet despite the fact that it borrowed for the cash portion of the bear.Second, Rhone-Poulenc couldnt yield with internally generated cash because, during the resolve snip, RP was a net cash user in connection with its peachy capital sp final stageing containments and the recession felling on chemicals markets. Third, RP could non pay with debt securities. It is analytic that if the company was overly highly levered to borrow and pay in cash, it was too highly levered to swap debt securities for sh atomic number 18s. Fourth, Rhone-Poulenc could non pay with RP parkland lucks or with cash raised from selling blondness.A train based on dish outs would not realise been approved by old shareholders because the deal would start diluted the shelter of individual shares and it would arrive at not been profitable because the RPs worry believed the companys share terms was under care ford. Rhone-Poulenc could not stretch meter ordinary stock because it didnt run through any, so it had to oblation and nonvoting certificate of investment as a state-owned company as it was.2. In model of Rhone-Poulenc Rorer, Inc, the shareholders of Rorer received a CVR that enabled them to receive additional gains from the potential shortfall of the future stock price and to persuade the Rorer shareholders to continue as the minority equity investo rs in the Rhone-Poulenc Rorer, Inc. Rhone-Poulenc could not pay with RP gross shares or with cash raised from selling equity. A deal based on shares would not give up been approved by old shareholders because the deal would have diluted the rate of individual shares and it would have not been profitable because the RPs management believed the companys share price was under valuated.Rhone-Poulenc could not allege standard common stock because it didnt have any, so it had to poke out only nonvoting certificate of investment as a state-owned company as it was. 3. The assumption is that RP is not going to use its right to anesthetise the adulthood of the CVRs, and they are frankincense expiring in July 31, 1993. We have apply the binomial tree diagram to survey the CVRs as a put option. The harbor of a CVR is indeed $5. 54, and the aggregate value is $231. 64 gazillion. Secondly, we have calculated the value of the CVRs in marvellous 1991, assuming this is the date when th e case was written.In addition, I am as yet assuming that RP isnt going to extend the adulthood. Ive use nigh the same method as in the previous calculation and the value of a CVR is $2. 78, and the aggregate value is thus $116. 34 million. 4. The investor can cypher the twistinging quite attractive. This is referable to the fact that they now have extra their checkmateside risks with the put option. This means the minority have an effective hedge against the chance of failure of the upcoming merger. Rhone-Poulenc managed to entice all the shareholders of the acquired Rorer with its somewhat complicated three-stage transaction.The sign sociable draw out and giving the rights to control RPs HPB was attractive bountiful for Rorer to play the deal. The Contingent Value Rights gave the minority shareholders the rights they thought were valuable affluent to airless the deal. Rorer believed that the whole portion was indeed worth of $36. 50 per share. Rorer benefited from the resolve of this deal and gained squiffy $632 million in new value. However, RPs non-voting common shares fall 4. 4 percent, or $175 million, in value. The fact is, all in all, that RP has a huge obligation due to the CVRs.In the worst case scenario, the share price falls below $26. 00 and the liability would thus be ($49. 13 $26. 00) * 41. 8 million = $966. 83 million, which is the level best amount of RPs liability. The maximum liability was perfectly hedged, providing RP a delta neutral position. Extra. RP would prefer the share price to stay high than $49. 13 until 1993, and $53. 06 until 1994. This is because in these cases RP would not be obliged to pay CVR-holders the cash payments. Thus if the share price would be higher than $49. 13 in the expiry date of the CVRs, RP would not extend the maturity of the Contingent Value RightsIntroduction A merger between Rorer Group, Inc and the human Pharmaceutical Business (HPB) of Rhone-Poulenc (RP) S. A. generated a major multinational pharmaceutical company, Rhone-Poulenc Rorer (RPR) on July 31, 1990. The expectations concerning undertakeover of Rorer had aroused in the late 1980s when the considerably low cash balance and rising level of debt let onmed to slow down its system of growth by acquisitions. The rumors had reassurance in 1989 when Rorer make a bid to take over the pharmaceutical business of A. H. Robins and lost the opportunity.Just a short time after this, the $3. 2 billion merger of Rorer and RP was announced. A year subsequently the company had shown rapid post-merger integproportionn and initial synergy gains. RP had practically no position in the linked States and Japan, unless on the other baseball glove it had a strong market share in some European Community markets. Thanks to Rorers U. S. connections, the new company ranked among the concealment three in Europe and had improved its position in the United States. Rorers Robert Cawthorn continued as RPRs CEO and almost al l the new senior executives came from Rhone-Poulenc.The markets expected RP to slowly take over the company because it owned 68% of RPRs shares. The French government owned one hundred% of Rhone-Poulencs voting common stock. RP was the seventh largest chemical manufacturer in the world and it gave the minority shareholders a contingent value right (CVR) that promised to pay them on July 31, 1993, any shortfall between $49. 13 and the then normal stock price. Rorer Goup, Incs main factor in its growth dodging had been a program of acquisitions, because sales growth in the companys existing product lines was characterized as mature.As usual, in that location were several skeptics associated to this merger. They were worried more or less the cultural integ proportionalityn and independence. The skeptics pointed out the company is French, yet the management group is mainly American, they have a American-style mission statement (Our Mission is to puzzle the BEST pharmaceutical com pany in the world by dedicating our resources, our talents, and our energies to economic aid improve human health and the quality of feel of people throughout the world) and the lack of interest of the American executives to learn French. The market brainpower for the industry wasnt respectable for the company.The cost of new-product development in the industry was rising and yet the number of new drug applications worldwide had fallen. It was in any case predicted that the governments would get tougher on the cost of drugs in an effort to slow down rapidly rising health costs. Other risks to consider were patent expiration and competition from low-priced generic drug manufacturers and decreasing product life cycles. In turn, the world population was aging, analysts noted that computers and biotechnology were aiding new-product development and diverse analysts recommended to obtain the RPRs stock on the long term. . The $3. 2 billion merger was consummated in a three-stage tr ansaction, by which Rhone-Poulenc obtained 68% of Rorers common stock (91. 6 shares), which was enough to permit Rhone-Poulenc to consolidate Rorers results for financial reporting. First, Rhone-Poulenc would tender for 50. 1% (43. 2 million shares) of Rorers common stock for $36. 50 cash per share. Rhone-Poulenc increased its debt/capital ratio to 45% by borrowing the funds to finance the tender offer. The debt/capital ratio was considerably high compared to its competitors ratio of 20-30%.Second, Rorer assumed $265 million of RP debt (guaranteed by RP), do a $20 million cash payment to RP, and issued 48. 4 million new common shares to RP in alter for RPs HPB division. Analysts believed that Rorers bylaws would require at least 85% of all shares be voted in favor of the issuance of new shares and, more generally, of this entire transaction. Third, Rhone-Poulenc issued the 41. 8 million CVRs to the be 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 RPs option, to a cash payment of US$49. 13 (or $53. 6 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. Thus, if the value of the RPR share come abouted $49. 13 (or $53. 06), there would be no payment. The maximum amount of RPs liability on December 31, 1990, was 5 165 million French francs at the date of the issuance of the rights. The maximum amount of RPs 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 straightaway into the consolidated equity of RP.The CVRs were quoted on the American Stock Exchange and traded respectively of the shares of EPE, which were listed on the New York Stock Exchange. Rorer and RP jointly released its own estimate of the package value of CRV and minority share in RPR to be worth $36. 50 and thus equal to the price at which RP was offering for shares of RPR. Rorers investors responded positively to the merger arrangements. Rorer shares increased by 28% net of the changes in the measurement & Poors 500 index over the week during the week of the announcement. This gain equaled about $632 million in new value.Simultaneously, RPs nonvoting common shares lost 4. 4% net of market during the announcement week, or about $175 million. Almost every aspect of the complexity of the merger can be explained through Rhone-Poulencs financial constraints. RPs motives to acquire Rorer were to create crucial capital for its own strategic entry into pharmaceuticals. RP could not buy Rorer either in cash or shares due to the following factors First, RP had frontiered ability to pay with borrowed cash. The company was more levered than other firms in the industry.Rhone-Poulenc didnt want to borrow all the cash because it would have affected in a negative way to its balance sh eet despite the fact that it borrowed for the cash portion of the deal. Second, Rhone-Poulenc couldnt pay with internally generated cash because, during the announcement time, RP was a net cash user in connection with its great capital spending requirements and the recession felling on chemicals markets. Third, RP could not pay with debt securities. It is logical that if the company was too highly levered to borrow and pay in cash, it was too highly levered to swap debt securities for shares.Fourth, Rhone-Poulenc could not pay with RP common shares or with cash raised from selling equity. A deal based on shares would not have been approved by old shareholders because the deal would have diluted the value of individual shares and it would have not been profitable because the RPs management believed the companys share price was undervalued. Rhone-Poulenc could not offer standard common stock because it didnt have any, so it had to offer only nonvoting certificate of investment as a st ate-owned company as it was.The play of the deal solved Rhone-Poulencs financial problems and it made mathematical for the firm to generate capital for its human pharmaceutical business and raise equity via obtaining Rorers shareholders to remain as minority equity investors in the Rhone-Poulenc Rorer, Inc. It would be natural to RP to want to issue equity for part of the deal that for the reasons mentioned above, it could not do so. 2. Contingent Value Right (CVR) is a compositors case of right given to shareholders of an acquired company that ensures them to receive additional benefit if a specified event occurs.CVRs are handy tools that may help deal makers surmount challenging deal design problems. The use of CVRs is relatively rare, but they are useful when the seller company is seeking protection for the remain minority shareholders who might be vulnerable to unfair treatment by the acquirer, the sellers board may be concerned the buyers share price may not retain its val ue if the deals projected synergies are not achieved, the integration is not smooth, or the buyers legacy business does not set as expected.In case of Rhone-Poulenc Rorer, Inc, the shareholders of Rorer received a CVR that enabled them to receive additional gains from the executable shortfall of the future stock price and to persuade the Rorer shareholders to continue as the minority equity investors in the Rhone-Poulenc Rorer, Inc. Rhone-Poulenc could not pay with RP common shares or with cash raised from selling equity. A deal based on shares would not have been approved by old shareholders because the deal would have diluted the value of individual shares and it would have not been profitable because the RPs management believed the companys share price was undervalued.Rhone-Poulenc could not offer standard common stock because it didnt have any, so it had to offer only nonvoting certificate of investment as a state-owned company as it was. Shareholders selling their Rorer share s to Rhone-Poulenc were paid in three forms. They received totaling $1. 7 billion, shares in Rhone-Poulenc Rorer and CVRs. If, at the end of three years, the RPR share price did not exceed $98, Rhone-Poulenc had to pay CVR holders the difference between the share price and $98, to an upper position of $46 per CVR.If the RPR share price was below $52 on August 1, 1993, RP would have to pay the CVR holders $1 billion (in FRF over 5 billion). By the end of 1991, the price of the CVR had fallen by 4/5 of its value. Its close at under $1 reflected the good performance of the group. RP took the opportunity to buy all the CVRs it had been offered. During the first year after issue, the group gathered in 20. 7 million CVRs, half the total number issued. 3. The assumption is that RP is not going to use its right to extend the maturity of the CVRs, and they are thus expiring in July 31, 1993.We have used the binomial tree (Exhibit A) to value the CVRs as a put option. The value of a CVR is t hus $5. 54, and the aggregate value is $231. 64 million. I have assumed risk-free rate of 8. 20 percent, which is the yield of a 3-year U. S. exchequer note. The standard deviation was given, 18 percent, and we have used it to calculate u and d enabling me to calculate p also. We have used $36. 50 as S(0). Secondly, we have calculated the value of the CVRs in August 1991, assuming this is the date when the case was written. In addition, we are still assuming that RP isnt going to extend the maturity.We have used almost the same method as above (Exhibit B) and the value of a CVR is $2. 78, and the aggregate value is thus $116. 34 million. Only difference is that we used 0. 172 (=0,18*(SQRT(11/12)) as standard deviation, since there is not full year until maturity. We have used 8. 09 percent as the risk-free rate, which is the yield of a 2-year Treasury note. The share price in August 1, 1991 was $45. 75, which is the value of S(0) in my calculations. As we can see, the value of the C VR is considerably smaller in the latter case, due to the decrease in the time value of the put option. 4. The investor can see the offering quite attractive.This is due to the fact that they now have expressage their downside risks with the put option. This means the minority have an effective hedge against the orifice of failure of the upcoming merger. The investors are receiving a cash payment of $49. 13 (or $53. 06 in the case of RP extending the maturity) minus the then prevailing share price or $26. 00. In one hand their shares can gain possible extra value and in the other they have a limit for the possible losses. Rhone-Poulenc managed to entice all the shareholders of the acquired Rorer with its somewhat complicated three-stage transaction.The initial tender offer and giving the rights to control RPs HPB was attractive enough for Rorer to accept the deal. The Contingent Value Rights gave the minority shareholders the rights they thought were valuable enough to close the de al. Rorer believed that the whole package was indeed worth of $36. 50 per share. Rorer benefited from the announcement of this deal and gained about $632 million in new value. However, RPs non-voting common shares decreased 4. 4 percent, or $175 million, in value. The fact is, all in all, that RP has a huge liability due to the CVRs.In the worst case scenario, the share price falls below $26. 00 and the liability would thus be ($49. 13 $26. 00) * 41. 8 million = $966. 83 million, which is the maximum amount of RPs liability. The maximum liability was perfectly hedged, providing RP a delta neutral position. This is possible through adjusting the ratio of CVRs and RPR equity, in the case of price changes of these CVRs. Extra question RP would prefer the share price to stay higher than $49. 13 until 1993, and $53. 06 until 1994. This is because in these cases RP would not be obliged to pay CVR-holders the cash payments.Thus if the share price would be higher than $49. 13 in the expira tion date of the CVRs, RP would not extend the maturity of the Contingent Value Rights. I have calculated the value of the CVRs in case the maturity is extended until 1994. The calculations are in the Exhibit C, and the value of a CVR is thus $5. 57 and the aggregate value is $232. 89 million. In 1993, if the share price is S(uud) = $43. 70, the CVRs maturity might be extended, because now there would be a possibility of the share price to increase to $52. 32 and the extension would have been preferable.