On January 10, 2006 the managing director of Merrill Lynch’s Equity- Linked Capital markets Group, Dar Maanavi, was reviewing the final drafts of a proposal for a convertible debt offering by MoGen, Inc. As a leading biotechnology company in the United States, MoGen had become an important client for Merrill Lynch over the years. In fact, if this deal were to be approved by MoGen at $5billion, it would represent Merrill Lynch’s third financing for MoGen in four years with proceeds raised totaling $10 billion. Moreover, this “convert” would be the largest such single offering in history. The proceeds were earmarked to fund a variety of capital expenditures, research and development expenses, working capital needs, as well as a share repurchase program.
The Merrill Lynch team had been working with MoGen’s senior management to find the right tradeoff between the conversion feature and the coupon rate for the bond. Maanavi knew from experience that there was no “free lunch” when structuring the pricing of a convertible. Issuing companies wanted the conversion price to be as high as possible and the coupon rate to be as low as possible; whereas investors wanted the opposite: a low conversion price and a high coupon rate. Thus, the challenge was to structure the convert to make it attractive to the issuing company in terms of its cost of capital, while at the same time selling for full price in the market. Maanavi was confident that the right balance in the terms of the convert could be found, and he was also confident that the convert would serve MoGen’s financing needs better than a straight bond or equity issuance. But, he needed to make a decision about the final terms of the issue in the next few hours, as the meeting with MoGen was scheduled for early the next morning.
Founded in 1985 as MoGen (Molecular Genetics) the company was among the first in the biotechnology industry to deliver on the commercial promises of emerging sciences, such as recombinant DNA and molecular biology. After years of research, MoGen emerged with two of the first biologically derived human therapeutic drugs, RENGEN and MENGEN, both of which helped to offset the damaging effects from chemotherapy for cancer patients undergoing treatment. Those two MoGen products were among the first “blockbuster” drugs to emerge from the nascent biotechnology industry.
By 2006, MoGen was one of the leading biotech companies in an industry that included firms such as Genetech, Amgen, Gilead Sciences, Celgene, and Genzyme. The keys to success for all biotech companies were finding new drugs through research and then getting the drug approved by the U.S. Food and Drug Administration (FDA). MoGen’s strategy for drug development was to determine the best mode for attacking a patient’s issue and then focusing on creating solutions via that mode. Under that approach, MoGen had been able to produce drugs with the highest likelihood of both successfully treating the patient as well as making the company a competitive leader in drug quality. In January 2006, MoGen’s extensive R&D expenditures had resulted in a portfolio of five core products that focused on supportive cancer care. The success of that portfolio had been strong enough to offset other R&D write-offs so that MoGen was able to report $3.7 billion in profits in 2005 on $12.4 billion in sales. Sales had grown at an annual rate of 29% over the previous five years, and earnings per share had improved to $2.93 for 2005, compared with $1.81 and $1.69 for 2004 and 2003, respectively (Exhibits 1 and 2).
The FDA served as the regulating authority to safeguard the public from dangerous drugs and required extensive testing before it would allow a drug to enter the U.S. marketplace. The multiple hurdles and long lead-times required by the FDA created a constant tension with the biotech firms who wanted quick approval to maximize the return of their large investments in R&D. Moreover,...