On July 21, Elan CEO Kelly Martin kicked off his company's half-year earnings call with lots of good news, something rare for the Irish biotech in the past few years.
Particularly upbeat was the outlook for Tysabri (natalizumab), the multiple sclerosis treatment Elan markets with its partner Biogen Idec, with whom, Martin said, "We are working exceptionally well and closely." The mood took a decided down turn in a federal courtroom by early September.
Martin, for months in the crosshairs of dissident investors, had received rare praise for the firm's July 2 deal with Johnson & Johnson, a series of complex parts that would give debt-strapped Elan much-needed cash, including $1 billion in exchange for an 18 percent equity stake in Elan.
J&J also agreed to spend up to $500 million over five years on R&D supporting Elan's key Alzheimer's disease drug candidate, bapineuzumab, and several related assets - in essence saving Elan from an expense it would have been obligated to pay as part of a partnership it has with Wyeth. In return, J&J would take a controlling interest in a new venture set up to develop bapineuzumab and the other related Alzheimer's assets. Elan would get a minority position in that venture and Wyeth's role would be unchanged (1 'The Pink Sheet,' July 6, 2009).
In the July 21 conference call, however, information came to light that within a matter of weeks would cast the whole deal into doubt and turn the Biogen partnership sour.
Elan officials revealed that part of the deal with J&J gave the health care behemoth an option to help Elan finance a buy out of the rights to Tysabri if Biogen itself was bought. Under a change of control provision in their nine-year-old contract, Biogen and Elan agreed that if one partner gets bought, the other has an option to buy full rights to Tysabri at a "fair" price. The price tag of such a buyout would be between $1.5 billion and $2 billion, said Michael Yee of RBC Capital Markets -more than cash-strapped Elan could have afforded on its own. The scenario, as of late, is not pie in the sky; dissent shareholders, worried in part by Biogen's weak pipeline, have been pressuring the biotech's management to find a buyer.
But Elan, knowing Biogen investors (and particularly Carl Icahn) would listen hard to buyout offers, wanted to make sure it had the cash to take Tysabri in full, if that time ever came. Newly backed by J&J, Elan thought it had its bases covered.
Contract Breach Must Be Fixed By Sept. 26
Not so fast: A week later, Biogen told Elan it was in breach of contract, that by pulling in J&J as a possible financing partner it had transferred, or "assigned" rights without Biogen's consent. The case went to court, and on Sept. 3, Judge Deborah Batts, U.S. District Court for the Southern District of New York, ruled in favor of Biogen, letting stand its demand for a fix of the breach by Sept. 26 (2 'The Pink Sheet' DAILY, Sept. 3, 2009).
If Elan doesn't meet that deadline, it could lose its half of the Tysabri rights to Biogen. That's unlikely to happen, say analysts. Tysabri revenues, on track for nearly $1 billion in sales this year, are crucial to Elan's growth.
Elan wouldn't comment on its plans other than to say it respected the court's decision and would work to amend the J&J deal as soon as possible. J&J can walk away from the relationship on Sept. 15 if it's not happy with the outcome. "We expect Elan to rectify its partnership with J&J, prior to September 15, to accommodate the conditions in their Tysabri collaboration [with Biogen], as the risk of losing Tysabri revenue is significant," wrote Lazard Capital Partners biotech analyst Joel Sendek in a Sept. 4 research note.
If Elan eliminates J&J's role in the Tysabri financing altogether, it might have to "sweeten" the rest of its deal with J&J, analysts said.
"We believe J&J's primary interest is the [Alzheimer's] assets, so J&J is unlikely to terminate the $1 billion investment in Elan over a change in the Tysabri financing option agreement," wrote Cowen & Co.'s Ian Sanderson. "But if the Tysabri financing option agreement is eliminated, Elan may need to contribute other assets or product development rights to the J&J deal."
In a pre-hearing deposition, which Biogen's lawyers cited in court on Thursday, Elan CEO Martin said the larger J&J deal was not contingent upon the Tysabri financing component. Martin reportedly also said in his deposition that his company could find "29 other companies" to help with the financing if J&J's offer didn't work out.
Ruling Surprised Spectators, Not Just Elan
The ruling was a surprise. Several lawyers surveyed in the days leading up to the hearing said that Elan's deal with J&J - at least based on the parts that Elan had discussed in public - did not equal an assignment of rights. It was too conditional and contingent on several other triggers.
And until her ruling late in the day Sept. 3, Judge Batts gave no indication she felt differently. Through the hearing she constantly battled with Biogen's counsel Michael Gruenglas of Skadden Arps Slate Meagher & Flom, challenging his claim that Elan had assigned rights, presenting Elan's case and asking him, "What's wrong with this picture?" and at times showing great impatience. More than once she complained about his failure to communicate with her.
At the end of the day, though, she made Gruenglas smile. She ruled from the bench that a piece of Elan and J&J's contract, which to that point had been kept under seal (and still is, as of press time), gave her the ammunition to rule in Biogen's favor. In essence, she said, Elan had ceded too much control to J&J if and when Elan ever sat down to negotiate a buyout of Tysabri - a situation that would be triggered by a sale of Biogen Idec.
Elan had tried to argue J&J would simply act as a banker - a provider of cash. But Batts read the Elan-J&J contract as giving J&J the power to pull strings in a negotiation where, according to the original Biogen-Elan contract, the ultimate decision to acquire the assets is "at the sole discretion of the non-acquiring party."
Professor David Carlson of the Benjamin N. Cardozo School of Law in New York, who worked with Judge Batts at the law firm Cravath, Swaine & Moore, said before the hearing Thursday that assignment of rights isn't cut and dry. With real estate or other concrete property, any promise to transfer it - even in a speculative, conditional manner - is viewed as assignment. With intellectual property, however, there must be a more tangible transfer.
Carlson declined to comment on Batts' ruling without seeing the full transcript. But he said a good test whether rights were actually transferred is to ask if J&J would get injunctive relief, or merely damages, if it sued Elan for breach. (In its court filings, Elan warned J&J could take legal action if Elan were forced to amend or scrap the financing option.)
From Judge Batts' standpoint it seems J&J accrued too much control, no matter how contingent. "A right is owned by people who have the ability to control the right," said Geoffrey Parnass, a contract lawyer in New York who is not involved in the case.
J&J's ability to influence simply by owning a future option to a key piece of Biogen's assets was a main subtext to the case. How much J&J would have stepped in to dictate terms - or claim ownership of Tysabri - is unclear without seeing the contract language, which is still under seal. In the run-up to the hearing, however, Elan officials possibly undermined their own position by talking about a de facto collaboration with J&J.
The day the side deal was revealed, Elan Chief Financial Officer Shane Cooke talked of a "50-50" collaboration if J&J ever decided to help buy Tysabri. Spokesman Bob Purcell said in the scenario of Elan buying out Biogen, Elan would still need a partner, "and if J&J were providing the funding it's reasonable they would be the partner."
Elan banked on a firewall of contingencies to protect them against Biogen's breach claim. They banked wrong.
In hindsight the firm did itself no favors by keeping the side deal with J&J secret. Elan outside counsel Charles Gilman of Cahill Gordon & Reindel said in Thursday's hearing it was his decision to delay the disclosure because he didn't think it was material. It came to light three weeks after the companies announced their main deal, and Biogen only heard about it through media reports. Biogen wasted no time with its breach of contract accusation. Investors and analysts weren't pleased, either. "I think people were surprised it took that long to disclose," says Yee of RBC Capital Markets." Elan shareholders thought they paid a price for it."
- Alex Lash ( 3 a.lash@elsevier.com )
This article also appeared in "The Pink Sheet" – Sept 7, 2009
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