In Mergers and Acquisitions (M&A), deal structures often need to be flexible to bridge gaps in valuation and address uncertainty. One such financial instrument used to reconcile differing views on a target company’s future performance is the Contingent Value Right (CVR).
Definition and Purpose
A Contingent Value Right (CVR) is a contractual agreement that grants shareholders of a target company the right to receive additional payments if certain predefined future events or performance milestones are achieved after the completion of an acquisition. CVRs are issued by the acquiring company as part of the consideration offered in a deal and can be cash-settled, share-settled, or tied to the performance of an asset or product.
In essence, CVRs serve as a risk-sharing mechanism. They allow sellers to benefit from future upside potential that might not be fully priced into the initial deal valuation, while allowing buyers to avoid overpaying upfront for uncertain outcomes.
Why Use CVRs in M&A Deals?
There are several reasons why CVRs are employed in M&A transactions:
- Valuation Disputes: When the buyer and seller disagree on the future prospects of a product, asset, or business line.
- Regulatory Uncertainty: When a company’s future value depends on regulatory approvals (e.g., drug approvals).
- Event-driven Outcomes: Where future milestones—like reaching a revenue threshold, closing another deal, or hitting product launch goals—are essential to the overall deal value.
- Alignment of Incentives: CVRs align the interests of sellers and buyers by tying compensation to actual results.
Types of CVRs
There are generally two types of CVRs:
- Event-driven CVRs: Payouts are contingent on specific events (e.g., FDA approval of a drug, successful litigation outcomes).
- Performance-based CVRs: Payouts depend on financial performance metrics like sales revenue, EBITDA, or share price targets.
Structure and Characteristics
- Non-transferable vs. Transferable: Some CVRs can be traded on secondary markets, while others are privately held and non-transferable.
- Expiration Period: CVRs usually come with an expiration date, often tied to the time expected to achieve the milestones.
- Payout Terms: Can be fixed or variable and are defined in detail in the merger agreement.
- Regulatory Oversight: CVRs may be subject to securities regulation, depending on how they’re structured.
Notable Real-World Examples
Let’s examine a few high-profile M&A deals where CVRs played a crucial role:
1. Bristol-Myers Squibb (BMS) and Celgene (2019)
- Deal Value: $74 billion
- CVR Component: Shareholders of Celgene received one CVR for each share, promising $9 per CVR if three of Celgene’s drugs (ozanimod, liso-cel, and ide-cel) were approved by specific deadlines.
- Outcome: The CVR expired worthless in 2021 when one of the drugs failed to receive FDA approval in time, highlighting the risk element involved.
2. Sanofi and Genzyme (2011)
- Deal Value: $20.1 billion
- CVR Component: Each Genzyme shareholder received a CVR tied to the performance of the multiple sclerosis drug Lemtrada and other production milestones.
- Outcome: Some CVR milestones were hit, and partial payments were made, demonstrating how CVRs can function as a middle ground in valuation disputes.
3. GlaxoSmithKline (GSK) and Human Genome Sciences (2012)
- Deal Value: $3 billion
- CVR Component: Shareholders received CVRs linked to sales milestones of the drug Benlysta.
- Outcome: Payouts were tied to the success of the drug in the marketplace, offering long-term potential rewards to shareholders.
Advantages and Disadvantages
Pros:
- Bridges valuation gaps between buyer and seller
- Allows sellers to retain some upside potential
- Helps buyers reduce upfront financial exposure
- Can facilitate deals that might otherwise fall through
Cons:
- Complex to structure and administer
- May lead to litigation if disputes arise over milestone achievement
- Often illiquid and may expire worthless
- Accounting and tax treatment can be complicated
Conclusion
Contingent Value Rights (CVRs) are powerful instruments in M&A transactions that allow both buyers and sellers to manage uncertainty. By tying additional compensation to future events or performance, they create a conditional layer of value that can unlock stalled negotiations and better align the interests of all stakeholders.
However, their complexity and risks require careful legal, financial, and regulatory consideration. For students of finance and business, understanding CVRs provides a deeper appreciation for the nuanced mechanics of modern deal-making, especially in sectors like pharmaceuticals, biotechnology, and technology, where future outcomes are particularly uncertain.