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Genzyme Corporation: Financing Strategy. Financing Strategy. Planning for an entire program of investments and financing (rather than isolated transactions) How does the nature of the business and the investments condition the types of financing instruments used?
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Financing Strategy • Planning for an entire program of investments and financing (rather than isolated transactions) • How does the nature of the business and the investments condition the types of financing instruments used? • The role of options in investment and financing (Note: slides and spreadsheet available at www2.bc.edu/~taggartr)
Genzyme Businesses, 1992 (Exh. 3) • Biotherapeutics • Heavy R&D • Diagnostic Products • Some sales, some R&D • Diagnostic Services • All services sales • Pharmaceuticals and Fine Chemicals • All product sales
1981: Venture Capital (Round 1) $3 mill – Oak Inv. Partners 1983: Venture Capital (Round 2) $3 mil – Oak – Termeer hired 1985: Venture Capital (Round 3) 1986: IPO 2.8 mil shares @ $10 (net $21.5 mil) 1987: GCP Units Net $8.65 mil 1989: GDP Units and SEO $30.5 mil from units SEO: $34.1 mil 1990: Neozyme I Units $43.5 mil 1991: SEO and 6.75% Convertibles SEO: $136.5 mil Converts: $97.25 mil Genzyme Financing History
Financing Growth Options • Pharmaceutical Company Partnership • Straight Debt • Why would Genzyme have difficulty raising straight debt? • Ordinary Equity • What problems does equity financing pose for a company that relies heavily on R&D? • Why does Termeer pledge no proceeds from equity offerings spent on R&D? • Securities with Attached Options • Can anything be gained by attaching options to ordinary securities (isn’t whole = sum of parts)?
A Brief Digression on Options Not obligation call put underlying asset An option is the right to buy (sell) a specified asset at a specified priceon (or before) a specified date strike (exercise) price European (American) maturity (expiration) date
Payoff Diagram: Buying a Call with Exercise Price E on a Stock Payoff at Expiration ST - E E Stock price at Expiration (ST)
Payoff Diagram: Buying a Put with Exercise Price E on a Stock Payoff at Expiration E E - ST E Stock price at Expiration (ST)
Options Associated with Corporate Investment • R&D expenditures or marketing research can create options to make future investments • Genzyme can be thought of as a portfolio of existing businesses plus growth options • An investment can be undertaken immediately but the firm also has the option to postpone it to a future date
Financing Instruments with Attached Options Corporations often issue securities with options attached: • Callable bonds (issuer has the right to buy the bonds back at a prespecified price) • Puttable bonds (holder has the right to sell the bonds back to the issuer) • Pay-in-Kind (PIK) bonds (issuer has the right to sell more bonds to holder in lieu of paying coupons in cash) • Convertible bonds (holder has the right to convert the bonds into a prespecified number of shares; issuer has the right to buy the bonds back at a prespecified price)
PayoffBuy BondPayoffBuy PutPayoffPuttable Bond + = Value of Option-Free Bond (VOF) E VOFEVOF PayoffBuy BondPayoff Sell CallPayoffCallable Bond + E VOF = Value of Option-Free Bond (VOF) EVOF Decomposing Puttable and Callable Bonds
10-year, 6.75% bonds convertible into common stock at option of holder Convertible at $52.875 each bond convertible into 1000/52.875 = 18.9125 shares Stock price at issue = $35 bonds callable at option of issuer First call date 10/93 (if GENZ sells at 150% of conversion price in previous 45 days) Initial call price = 104.821% of par (call price declines thereafter Payoff Call option on stock E Stock Price Genzyme Convertible Issue (Oct. 1991) Payoff Callable Bond E VOF
When Are Convertibles a Good Idea? • Bondholder suspicion of firm’s creditworthiness • Bondholders nervous about shareholders’ ability to undermine their position • Investor disagreement over firm’s true value • High uncertainty higher option value
Ceredase Financing R& D fees (8.65 mil), overhead Potential Potential warrant buyout exercise losses sale of units (8.65 mil) Genzyme GCP Partnership Investors
GCP Units 4/87 – 5/87 1/1/89 8/31/91 8/31/94 Units sold E = 18.15 E = 20.15 warrants ($50,000) expire
How Can Place a Value on the Warrants?The Black – Scholes Call Option Pricing Model S = current stock price E = exercise price RF = risk-free rate (continuous compounding) 2 = variance (per year) of stock price return T = time (years) to option expiration N(d) = probability of value ≤ d (std. normal distribution)
Warrant Valuation • S = $14.50 • E = $18.15 (4-yr warrants) or $20.15 (7-yr warrants) • T = 4 yrs (or 7 yrs) • = .70 (Exh. 5) • RF: 5-yr govt bond rate = 8.52% (Exh. 8). Continuously compounded equivalent can be found from:
Valuation of Partnership Interests • Warrants worth ~ $10 per underlying share • Each warrant written on 1500 shares, so each unit’s warrants worth ~ $15,000 • Investors pay $50,000 per unit, so each partnership interest worth about $35,000 • After the fact each of 200 partnership interests bought out by Genzyme in February, 1990 (~ 2.5 yrs) for total of $20.8 mil ($104,000 per interest)
