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?
• The role of options in investment and financing
(Note: slides and spreadsheet available at
www2.bc.edu/~taggartr)
Genzyme Businesses, 1992 (Exh. 3)
1. Biotherapeutics
•
Heavy R&D
2. Diagnostic Products
•
Some sales, some R&D
3. Diagnostic Services
•
All services sales
4. Pharmaceuticals and Fine Chemicals
•
All product sales
Genzyme Financing History
• 1981: Venture Capital
(Round 1)
• 1987: GCP Units
– Net $8.65 mil
– $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)
• 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
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 price on (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)
Decomposing Puttable and Callable Bonds
Buy Bond
Payoff
Payoff
Buy Put
Payoff
+
=
Value of Option-Free Bond (VOF)
Payoff
Buy Bond
Puttable Bond
E
Payoff
+
Value of Option-Free Bond (VOF)
VOF
E
Sell Call
E
Payoff
VOF
VOF
Callable Bond
=
E
VOF
Genzyme Convertible Issue (Oct. 1991)
•
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
–
–
Payoff
Call option on stock
E
Payoff
Stock Price
Callable Bond
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
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
Genzyme
R& D fees (8.65 mil),
overhead
Potential
buyout
Potential warrant
exercise
GCP
losses
sale of units (8.65 mil)
Partnership Investors
GCP Units
4/87 – 5/87
Units sold
($50,000)
1/1/89
8/31/91
E = 18.15
8/31/94
E = 20.15
warrants
expire
How Can Place a Value on the Warrants?
The Black – Scholes Call Option Pricing Model
C  SN (d1 )  Ee RFT N (d 2 )


d1  ln( S / E )  ( RF   2 / 2)T /  2T
d 2  d1   2T
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:
2
 .0852 
R
1 
 e F 
2 

RF  ln (1  .0852 / 2)2  .083435


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)
After-the-Fact Partnership Rate of Return
35000(1  RB )
RB  54.6%
2.5
 104000 