DEALTALK-Milestone payments help bridge valuation gap

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* Milestone payments used often in biotech sector deals

* Payments help hedge the risk of products in development

PHILADELPHIA, July 20 (Reuters) - When biotechnology company Celgene Corp CELG.O agreed to buy Abraxis BioScience Inc ABII.O for $2.9 billion, it set aside $650 million in "milestone payments" if key drug Abraxane meets certain development goals -- a carrot held out to encourage the success of the merger.

Such milestone payments, or so-called earn-outs, have become popular in sectors such as pharmaceuticals and biotechnology as buyers seek to hedge their risk on products in development and sellers want a reward for any long-brewing successes.

“These structures are a great way for buyer and seller to share the risk that’s related to drug development,” said BMO Capital Markets’ head of healthcare mergers and acquisitions Brett Skolnik.

In the Abraxis case, the $650 million in milestone payments will be paid if specific development and sales goals are met, including approval of Abraxane to treat lung cancer and pancreatic cancer. [ID:nSGE65T0EQ]

At roughly 10 times Abraxane sales, the deal price is at the high end of biotech deals, which tend to range between four and 10 times sales, according to analysts.

Celgene’s Chief Executive Robert Hugin said the deal was an ideal move that transitions Celgene from being primarily a blood, or “liquid” cancer company, to one with a broad portfolio that encompasses solid tumors as well.


“They hedged their bet, somewhat, by putting about 20 percent of the value of the deal in the form of milestone payments. That’s some protection that keeps the overall valuation in moderation in case a goal fails to be met,” said one healthcare investment banker who declined to be named because he was not authorized to speak with the media.

So far this year, 70 deals in the U.S. have included earn-outs or milestone-type payments, up slightly from 61 deals in the same period last year, according to data from Thomson Reuters.

Since 2000, the biggest era for earn-outs hit in 2007, with 259 such deals, mirroring that year’s swell in M&A deals overall.

“The structure is coming up more frequently and earlier in deal discussions,” Skolnik said.

Similar milestone payments were used earlier this year in Medtronic Inc's MDT.N deal to buy Italy's Invatec, a provider of stents and angioplasty balloons. Medtronic plans to make an initial payment of $350 million to Invatec and additional payments of up to $150 million when the acquisition achieves certain milestones. [ID:nN25191331]

Although they are common in the health care sector, milestone payments can be used in any deal to acknowledge benchmarks of success, bankers said.

For example, boutique investment bank Greenhill & Co Inc GHL.N said in March it would buy Australia-based financial advisory firm Caliburn Partnership Pty Ltd for $91 million in stock plus milestone payments if certain revenue levels are achieved. [ID:nSGE62F0H9]

Just because the milestone payments get promised, they aren’t necessarily easy to get.

Earlier this month, GlaxoSmithkline GSK.L and Denmark's Genmab GEN.CO amended a licensing agreement for their Arzerra cancer drug. [ID:nLDE661020]

Under the altered plan, Genmab will receive an upfront payment of $134.4 million from GlaxoSmithkline but will see planned milestone payments cut or cancelled after recent clinical trial results have disappointed and Genmab had to make significant cost cuts.


Milestone payments also help bridge the gap in valuation expectations between buyers and sellers.

“It’s like sellers have selective amnesia when it comes to the negotiations process. They think they can command the same prices that existed back in 2007. Meanwhile, buyers are continuing to approach investing with an abundance of caution,” says Ed Hackert, a partner of Marcum LLP, a New York-based accounting firm that represents buyers in middle-market deals.

“Given the gap in valuation expectations and the general feeling of uncertainty in the economy that would otherwise would prevent deals from happening, this allows buyers to hedge against risk,” Hackert said.

Milestone payments also can encourage sellers to be more invested in the success of a merger over the long-term, as opposed to just getting to the deal closing date.

"It's a good tool to bridge the gap between perception and reality in terms of valuation, and it forces the seller to leave some skin in the game on the post-combination risk," Hackert said. (Reporting by Jessica Hall, editing by Bernard Orr) (For more M&A news and our DealZone blog, go to here)