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One of the rarest, and most interesting types of Special Situations out there...Contingent Value Rights

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April 16, 2011 – Comments (3) | RELATED TICKERS: SNY

In the world of investing, finding out about a new issuance of contingent value rights (CVRs) is sort of like seeing a shooting star or finding a four leaf clover.  There's no guarantee that one's wish on the star will come true or that clovers are actually lucky, but it's cool when you see one.  

Contingent value rights are one of the most interesting and unusual special situations that exist.  Essentially CVRs are essentially a tradable entity that entitle its holders to receive a cash payment or payments if certain events happen.  The new contingent value rights that I am talking about right now are the ones that were issued by Sanofi-Aventis (SNY) in its acquisition of Genzyme.  They confer the rights to potential profits from several of the latter's pipeline drugs.  Holders of these rights, which trade under the symbol GCVRZ, provide one-time cash payments to holders if three of Genzyme's drugs, Fabrazyme and Cerezyme, meet certain production targets and its MS drug Lemtrada is approved and hits certain sales targets. 

My problem with these CVRs, and the reason that I have not personally bought them yet, is that I am far from a biotech expert.  On my own I have absolutely no idea how much the CVRs are worth.  Closing on Friday at $2.63/share, they have a maximum value of $14/share, but I highly doubt that they'll hit that level.  

I was hoping that the contingent value rights would come under selling pressure from people who received them in the buyout, but don't want or don't understand them, or possibly from institutional investors that aren't allowed to hold them after they were issued. Alas, that was not the case. 

I have been very disappointed in the trading action that I have seen in this sort of situation lately. Spin-offs and other odd situations used to come under selling pressure all the time when investors who didn't want the shares that they were given sold them en masse. This was a major theme in Joel Greenblatt's classic book on investing in special situations, "You Can Be a Stock Market Genius." I guess that there's just too many hedge funds chasing this sort of investment nowadays for them to collapse in price. Oh well, this doesn't mean that opportunities aren't still found in this area. Spin-offs still align the interests of management with shareholders if they are incentivised properly with stock. They also can help to highlight the value of two very different businesses for investors when conglomerates break up. Still, I wish there was more irrational selling going on ;).

Even worse than the lack of selling pressure is the fact that cat's out of the bag. Michael Santoli mentioned the Contingent Value Rights that Sanofi-Aventis (SNY) gave Genzyme shareholders in its recent buyout of the company in his weekly Barron's column. Here's what he had to say about the CVRs:

One instrument of this description quietly hit the market this month, a "contingent value right" security whose value is tied strictly to the fortunes of one drug developed by Genzyme, the biotech company recently bought by Sanofi-Aventis (SNY). Sanofi paid $74 per share in cash, plus the CVR linked to the progress of Lemtrada, a drug being evaluated for its effect in treating multiple sclerosis. The CVR trades on the Nasdaq under ticker symbol GCVRZ and closed Friday at $2.63.

Some hedge-fund investors have been drawn to the CVRs as a "noncorrelated" investment with a definable probability-based estimated value, yet without the cash-burn and operational risks of a typical biotech stock. The CVR's ultimate cash value, between now and its maturity in 2020, is based on production and sales milestones for Lemtrada.

The maximum value is $14 per CVR, if every sales threshold is met on time. Of the 10 analysts who have ventured estimates of the likely payout, the average present value of the likely end value is around $3.30, or 25% above the current price. Comparisons with roughly similar "all or nothing" instruments place the present value closer to $4.

Who wants to bet that GCVRZ is up big on Monday?  Are there any biotech experts out there who have any insight about how much these CVRs might be worth.  

Deej

3 Comments – Post Your Own

#1) On April 16, 2011 at 10:20 PM, Momentum21 (91.02) wrote:

Interesting indeed...the valuations would seem to be contingent more upon exactly how those shares are structured for current shareholders (tax implications, perceived value of Genzyme shares, etc.) and like you say, one would think they would come under immediate selling pressure regardless of the potential upside over the 10 year window.

Have you found references to the actual thresholds?

Interesting piece here 

In addition, public company CVRs face a number of other unique challenges. These include the requirement that CVRs be, among other things, non-transferrable if the buyer wants to avoid registration of the instrument with the SEC, with associated timeline implications and post-closing reporting obligations. This non-transferrability, coupled with the extended timeframe for payout (usually one to three years) and potentially adverse tax treatment to target shareholders, leads targets and their shareholders to severely discount the potential value represented by the Contingency CVR. 

 

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#2) On April 23, 2011 at 11:17 AM, Momentum21 (91.02) wrote:

Charley Travers did a pretty good estimate of probabilities of hitting thresholds here

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#3) On April 24, 2011 at 7:30 PM, TMFDeej (99.42) wrote:

Thanks for the link Momentum.  Good article, though given what I have read about Lemtrada being basically a new application for an existing drug that Genzyme wants to charge ten times as much for I have a feeling that Charlie might be being a little generous in his sales forecast for it.

Deej 

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