Friday, September 14, 2007

Genzyme Settles One

The Boston Globe just reported about some questionable tactics the biotechnology firm Genzyme used in the course of a merger and subsequent stock buy-back. Here is the background,

Like many large biotech firms, Genzyme has built its success as much by acquiring businesses and clever financing as by developing new drugs. The biosurgery division was a typical Genzyme creation.

The company set up Genzyme Biosurgery in December 2000 when it bought Biomatrix Inc., a New Jersey company. The attraction was Synvisc, a promising material that could be injected into arthritic knees to ease pain. Genzyme used tracking shares in the new division to pay for most of the transaction, worth about $860 million....

At the outset, the appeal for shareholders of Genzyme Biosurgery was that Synvisc and the division's other products had enormous growth potential that would allow the stock to rise faster than shares of Genzyme. Aside from the normal risks of owning stock, there was an additional one: Genzyme could at any time buy the tracking shares and absorb the division into the parent. The price was supposed to reflect the division's fair market value, but Genzyme had the right to choose the timing for the purchase.

Within six months of the acquisition, Genzyme soured on the arrangement. Company officials asked their investment bankers how to eliminate Biosurgery stock. A Feb. 27, 2002, Genzyme report on Project Eleanor described a timeline for buying the shares the following year.

'We are working towards reabsorbing' Genzyme Biosurgery, Peter Wirth, Genzyme's top lawyer, told Termeer in March 2002, an outline of the meeting said.

That August, Genzyme executives held a dinner discussion about the tracking stocks entitled 'Where Do We Go From Here?' The conclusion, according to company briefing materials, was that the biosurgery tracking stock had been a flop.

The issue was when to buy back the tracking stock. This is where things get complex.

But how quickly? The corporate charter said the parent firm could buy the tracking stock at any time, using cash or its own stock. The price would be the average of Genzyme Biosurgery's closing price over 20 trading days, plus a 30 percent premium. Genzyme preferred to use its stock rather than cash. But its stock had dropped by two-thirds between January and June of 2002 because of poor sales of the company's dialysis drug, Renagel. That meant Genzyme would have to use more of its own shares, making the deal more expensive.

Internally, Genzyme expected sales to improve, and its stock to bounce back. The company decided to wait, keeping Genzyme Biosurgery intact until that happened.

When the board met Oct. 3, 2002, directors discussed in detail eliminating Genzyme Biosurgery. Based on a company estimate, the division could be "rolled up" for only 60 percent of what Genzyme actually thought Biosurgery was worth. Shareholders would get $3.55 a share. Directors also discussed steps to protect themselves from lawsuits that might result from the buyback.

But Genzyme did not act immediately. Instead, according to shareholders' allegations, Genzyme tried to drive down the price of Biosurgery shares, to make the acquisition even cheaper.

In a lawsuit filed later, share-holders alleged that Genzyme used a variety of tactics to drive down the price of the tracking shares before the buy-back.

For instance, Genzyme disclosed bad news about the Biosurgery division while withholding good news.

In early 2003, Genzyme made public that the US distributor of Synvisc was lowering inventory levels - a sign of poor sales. The result was that Genzyme Biosurgery shares dropped to a record low, $1.17 a share. But according to the complaint, Genzyme had known about the inventory reduction since 2001.

Quinn, Genzyme's spokesman, said the company knew the distributor, Wyeth, was trying to reduce its inventory prior to the disclosure. 'We were trying to delay [the inventory reduction] for as long as possible and hoped we could avoid it entirely, particularly if sales rose to a point where it wouldn't be necessary,' he said. 'Ultimately, it was Wyeth's decision.'

Shareholders alleged that Genzyme also withheld information about a business within the biosurgery division that makes cardiothoracic surgical instruments. The division tried to sell the money-losing unit but the deal fell through in the summer 2002. In December 2002, Genzyme restarted the sales process, hiring J.P. Morgan Securities Inc. to identify prospective buyers. By March 2003, J.P. Morgan was guiding a group of prospective buyers through final steps prior to soliciting formal offers.

Genzyme kept secret its renewed effort to sell the instrument business. That news, shareholders claim, could have sent Genzyme Biosurgery shares up sharply, because the division would have immediately become profitable upon sale of the division. But Termeer did not tell shareholders until the May 8 conference call. It was too late: The price for the share buyback had already been set.

Genzyme also kept secret news that the Food and Drug Administration had given Biosurgery approval to conduct clinical trials on Synvisc's use in hip joints.

Quinn said Genzyme made 'all appropriate disclosures' regarding both developments. In particular, he said, the company's policy is not to disclose clinical trials until physicians begin giving doses to patients. That policy also applied to the Biosurgery division, he said, even though the start of the hip trial potentially might have had a major impact on prospects for the division.

Genzyme also commissioned an outside appraisal of the value of the tracking shares, but share-holders alleged that it was not accurate.

At a Feb. 27, 2003, meeting, Genzyme directors took a final look at the mechanics of the Biosurgery buyback. Once again, directors examined ways to minimize their legal exposure. They called for an outside valuation on the exchange price - known as a fairness opinion - to provide 'additional comfort' in the event of legal action disputing the deal.

The outside firm, Houlihan Lokey Howard & Zukin Capital, concluded that Biosurgery shares were worth $1.31 to $2.54. The purchase price of $1.77 was comfortably in that range. In court papers, shareholders characterized the report as a 'sham' that used arbitrary methodology to arrive at a predetermined price and provide cover for Genzyme's bargain price.

Genzyme disputed the share-holders' allegations, but just agreed to settle the case for $64 million. Documents released after that settlement formed the basis for the Globe's report.

In legal filings, Genzyme disputes the shareholders' interpretation of the events leading up to the buyback.

Last month, days before the case was to go to trial in New York City, Genzyme agreed to pay $64 million to settle the case.

Executives of pharmaceutical and biotechnology companies wonder why the public often does not trust their companies. (See posts here and here. )

A seemingly endless series of legal cases in which the companies end up settling allegations that they pushed the envelope of the truth to make more money may contribute to the public's impression that these companies' leadership often puts making money ahead ot being truthful.

If one cannot trust many of these companies' financial dealings, why should one believe what they say about their products, and why should one believe the research they sponsor, and their "educational" programs for doctors?

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