Genzyme Corporation: Financing Strategy

1
Genzyme Corporation Financing Strategy
2
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)

3
Genzyme Businesses, 1992 (Exh. 3)

• Biotherapeutics
• Heavy RD
• Diagnostic Products
• Some sales, some RD
• Diagnostic Services
• All services sales
• Pharmaceuticals and Fine Chemicals
• All product sales

4
Genzyme Financing History

• 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 _at_ 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

5
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 RD?
• Why does Termeer pledge no proceeds from equity
  offerings spent on RD?
• Securities with Attached Options
• Can anything be gained by attaching options to
  ordinary securities (isnt whole sum of parts)?

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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

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Payoff Diagram Buying a Call with Exercise
Price E on a Stock

• Payoff at Expiration
• ST - E
• E Stock price at Expiration (ST)

8
Payoff Diagram Buying a Put with Exercise Price
E on a Stock

• Payoff at Expiration
• E
• E - ST
• E Stock price at Expiration (ST)

9
Options Associated with Corporate Investment

• RD 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

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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)

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Decomposing Puttable and Callable Bonds

• Payoff Buy Bond Payoff Buy Put Payoff Puttable
  Bond
• Value of Option-Free Bond (VOF)
  E VOF
  E VOF

• Payoff Buy Bond Payoff Sell Call Payoff
  Callable Bond
• E VOF
• Value of Option-Free Bond (VOF)
  E VOF

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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
• 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

Payoff Callable Bond E VOF
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When Are Convertibles a Good Idea?

• Bondholder suspicion of firms creditworthiness
• Bondholders nervous about shareholders ability
  to undermine their position
• Investor disagreement over firms true value
• High uncertainty ? higher option value

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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
15
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

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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)

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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

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Valuation of Partnership Interests

• Warrants worth 10 per underlying share
• Each warrant written on 1500 shares, so each
  units 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)

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After-the-Fact Partnership Rate of Return