What Is a Contingent Value Right?
A contingent value right, or CVR, is a type of derivative whose value is based on some future event. If the event occurs by a specified date, then the CVR distributes a pre-determined payout, often in cash. If the event doesn’t occur by then, the CVR expires worthless, making CVRs similar to an option. They’re perhaps the rarest security on a stock exchange, even though they often are borne out of high-profile mergers. Here’s everything you need to know about contingent value rights.
How do contingent value rights come into existence?
Contingent value rights usually spring into existence as part of a merger agreement. They’re especially prevalent in the biotech and pharmaceuticals industries because they allow the merging companies to negotiate differences in the value of yet-to-be-commercialized — and therefore very risky — drugs. But in theory they can be used wherever a significantly different perception of value exists.
Imagine a scenario in which the acquiring company doesn’t want to pay much, if anything, for a drug (or another product) that might not work, has a limited market, or might need significant investment. On the other side, the acquired company wants to get full value for its assets and wants to be able to show shareholders that it’s maximized value for them.
The contingent value right helps bridge this negotiation, making the payout dependent on hitting certain goals. For example, a CVR’s payout often depends on a future drug being approved or a fledgling drug hitting a sales milestone within a certain time frame, often years in the future. It’s not all that unusual for a CVR to have multiple milestones, especially if a drug is very early in its development.
While they’re still rare, contingent value rights have become more prevalent since the global financial crisis, and they’ve been part of high-profile deals with AstraZeneca and Sanofi-Aventis (NYSE:SNY), among others. In the case of Sanofi-Aventis’s 2011 takeover of Genzyme, Sanofi paid $74 per share and gave Genzyme shareholders one CVR per share. Those CVRs could be worth as much as $14 more, if all milestones were met. Sanofi’s recent takeover of Bioverativ offered no such CVR provision, however.
How can shareholders profit on contingent value rights?
When an acquiring company decides to issue contingent value rights as part of a merger or other transaction, it can issue them in two ways. CVRs can be either non-transferrable or traded on a stock exchange. The latter are much more interesting for investors, but less for companies in the deal. Unfortunately, most contingent value rights are non-transferrable, because the issuer does not want the hassle, increased cost, and disclosure requirements associated with them trading on an exchange.
To receive nontransferrable CVRs, investors must own stock in the acquired company when its stock is delisted from the exchange as part of the takeover. Those CVRs are paid out as part of the merger consideration (along with cash, stock, or whatever else was agreed on) and then held in the investor’s brokerage account but may not be sold. If the payout milestones are met by the deadline, the payout will be deposited in the account. But, as noted, that might be years down the road.
Transferrable contingent value rights are much more interesting because investors don’t have to own the acquired company when the merger closes. Investors can purchase this kind of CVR right up until it expires and is delisted from the exchange. Like stocks and other securities, the price of contingent value rights will fluctuate based on investors’ expectations and whether the milestone is surpassed.
Transferrable CVRs allow investors to price the security separately from what the merging companies say it’s worth. Those who believe the right is worth more can negotiate with those who see otherwise.
In Sanofi’s takeover of Genzyme, the contingent value rights were traded on the exchange.
What else do investors need to know about contingent value rights?
While they share the name contingent value right, each series of CVR is completely different and bespoke for the deal under which it was created. Each has different milestones, different payout schemes, different expiration dates, and on and on. In some cases, CVRs offer multiple payments over a period of years based on the commercialization of a new product. All the details are in the filing. In Sanofi’s case, the CVR had six separate milestones that could be reached, depending largely on the approval of a drug and various sales levels thereafter.
So that’s why it’s absolutely critical that any investor thinking about buying CVRs read thoroughly any Securities and Exchange Commission filings associated with them and understand the risks in owning CVRs. Like options, CVRs can expire worthless, leaving their owner with nothing.
Finally, contingent value rights rely on the good faith of the acquiring company to pursue a course of action that could actually allow the CVR to become profitable. While CVR contracts specify that an acquirer must use good faith in conducting its business, the potential payout creates a conflict of interest, especially if the company has to invest even more cash to develop a speculative product it doesn’t see as worthwhile and perhaps only agreed to in order to consummate a deal.