Asset-like acquisitions

Transcription

1 Asset-like acquisitions Valuation considerations 17 March 2015

2 Asset-like acquisitions What do we mean by an Asset-like acquisition? An acquisition of a product or group of products that meets the definition of a business and recorded as a business combination pursuant to ASC 805.but, goodwill is NOT anticipated as the forecasts do not include revenue or earnings from unidentified future products How is the expectation of minimal/no goodwill achieved in an asset-like acquisition? Page 2

3 Asset-like acquisitions Taxable transaction (Asset deal) Buyer receives stepped-up tax basis on asset and presumably pays for this within the agreed upon price Book to tax differences are minimal as are potential deferred taxes Non-taxable transaction (Stock deal) Buyer does not receive a stepped-up tax basis and presumably pays less as no tax shield is available Book to tax differences are substantial as are potential deferred taxes Page 3

4 Asset-like acquisitions Example: Purchase of Developed technology for $50M Opening balance sheet - Taxable Transaction Opening balance sheet - Non-taxable Transaction Assets Assets Developed Technology 50 Developed Technology 50 Economic? Goodwill 0 Goodwill 15 Total Assets 50 Total Assets 65 Liabilities Liabilities DTL 0 DTL 15 Equity 50 Equity 50 Total Liabilities & Equity 50 Total Liabilities & Equity 65 Page 4

5 Day 2 issues & challenges Valuation considerations 17 March 2015

6 Day 2 issues & challenges Goodwill impairment Reporting unit versus IPR&D testing dates Interim testing procedures Cost structure in PPA versus cost structure in impairment analysis Allocation of corporate costs Changes to cash flows forecasts prior to initial test date Measurement period adjustment or potential impairment Discount rates Size and company specific risk premiums IPR&D impairment Testing based on therapeutic area, geography, launch date, etc. Change of indication for existing IPR&D product Milestones/royalties related to prior acquisitions versus licenses Cost structure in PPA versus cost structure in impairment analysis Capital asset charges post acquisition Page 6

7 Day 2 issues & challenges Sources of goodwill Future technology/customers Synergies not attributable to intangible assets Sale of a business operation (carve out) Allocation of existing goodwill Contingent consideration Methodology Discount rate Page 7

8 Tax synergies Purchase price allocation Tax structuring (e.g. NOLs, IP migration, inversions) has become a more common aspect of the deals in recent years. The benefits of the tax structuring are typically considered (i.e. modeled out) in deal models and become a new source of synergy. Tax synergies considerations in purchase price allocation Inversion deals or inverted companies - typically modeled out as the tax benefit resulting from shielding of the US profits (generally the buyer s profits) by an inter-company loan set up to finance the deal Typically considered market-participant assumption if explicitly included in the deal model (in other words, something the buyer paid for ) There is a debate whether tax synergies should be included in the intangible asset valuations when these are driven by the tax structure of the buyer as opposed to deal structure Page 8

9 Tax synergies Purchase price allocation In inversion deals, unlike operating synergies, tax synergies are not assumed to be part of the asset valuation as realization of these synergies would not be possible outside an inversion deal structure, which is a stock deal As a result, the value of tax synergies is typically carved out of the deal model and overall purchase price is split into the operating value and tax synergies Since the tax synergies assumptions are not included in the valuation of intangible assets, its value ends up in goodwill Page 9

10 Tax synergies Goodwill allocation and impairment test Initial goodwill allocation Because goodwill is assigned to the reporting units that are expected to benefit from the synergies of the combination, it is possible that the acquirer may assign a portion of the goodwill related to tax synergies to its own reporting units In the case of multiple reporting units, relative pre-tax profit or EBIT may be a reasonable allocation methodology Goodwill impairment test Incorporating tax synergies in Day 2 valuations of the reporting units present a modeling challenge Extending initial model assumptions (i.e., refinancing or incremental leverage assumptions) Assigning the benefit of future tax optimization strategies to the individual reporting unit models Page 10

11 Day 2 issues & challenges GAAP vs Non GAAP adjustments Amortization of inventory step up Stock-based compensation expense Impairment of goodwill and intangibles Acquisition, integration and restructuring expenses Amortization of intangible assets Upfront and development milestone costs Contingent consideration fair value adjustments Non-recurring expenses Legal expenses Impact of currency fluctuations Adjust tax expense to cash taxes Page 11

12 Inventory Valuation considerations 17 March 2015

13 Inventory introduction Inventory is comprised of several different categories: Ready to be sold in the normal course of business (finished goods) In production for future sale (work-in-process or WIP) Used in the production of goods to be sold (raw materials) Valuation classification may differ from accounting or balance sheet classification. In certain cases (e.g. outsourced manufacturing, API is classified as raw materials on the balance sheet but would be treated as work in process in the valuation and stepped-up because value has been added in the manufacturing of the API) Page 13

14 Inventory valuation introduction The fair values for work-in-process (WIP) and finished goods inventory acquired in a business combination are generally measured using a net realizable value computation. The net realizable value computation takes the expected sales price of the inventory reduced for all costs expected to be incurred in the completion and disposition of the inventory as well as a profit on those costs. Raw materials at current replacement cost The size of the inventory step up is directly correlated to the profitability of the business/product over the period over which the inventory is expected to be disposed of Page 14

15 Inventory valuation process Estimate selling price Gross up method versus bottom-up build up Estimate costs to complete and disposition costs Inclusion of indirect operating expenses or disposition costs (e.g. G&A to support manufacturing or sales functions) Inclusion of R&D expenses and royalties Estimate profit on the remaining costs Identification of expenses and efforts for which the seller is not generally entitled to a profit (e.g. 3 rd party royalties) Normalized profit versus profit over the expected period of inventory disposition Page 15

16 Inventory additional valuation considerations Pre-approval inventory in the life sciences industry, inventory acquired before a therapy is approved is often expensed to R&D. If the target is acquired shortly after the therapy has been approved, expensed inventory that is expected to be sold will need to be fair valued. Outsourced manufacturing while the book value of inventory for companies that outsource their manufacturing process may represent the arm s length price for the contract manufacturing services, it does not reflect the value of the intellectual property inherent in the product. Therefore, inventory manufactured by a contract manufacturer will typically be stepped-up to the extent any IP is relied upon in the manufacturing process/ resulting product. Page 16

17 Inventory additional valuation considerations Large amount of acquired inventory typical in large molecule/ biotechnology therapeutics where the amount of acquired inventory is expected to last several years after the acquisition, in extreme cases, throughout the expected life of the corresponding intangible asset. The inventory valuation in this case will look more akin to intangible asset valuation with expected profit attributable to the incurred costs to be discounted at rates close to intangible asset discount rate. Royalty charges technology royalty is applied in the WIP calculations to represent hypothetical royalty a third party would need to incur for access to the intellectual property in order to complete the inventory Page 17

18 Inventory step-up in intangible assets valuation When valuing intangible assets acquired in a business combination where there is also an inventory step-up, the profit included in the inventory step-up must be removed from the projected financial information of the intangible asset so that the profit is not recognized more than once. The full amount of the inventory step-up must be removed from the projections of the intangible asset over the time period in which the acquired inventory is expected to turn. Page 18

19 Inventory step-up in technology asset valuation - example Step-up adjustment included Remove total inventory stepup from gross profit over the expected period of inventory For the years ending 31 Dec disposition (USD in 000s) 2015E 2016E 2017E 2018E 2019E Revenue associated with technology 100, , , , ,410 Cost of goods sold (20,000) (22,000) (24,200) (26,620) (29,282) Inventory step up (10,000) (11,000) (12,100) (13,310) - Gross profit 70,000 77,000 84,700 93, ,128 SG&A (25,000) (27,500) (30,250) (33,275) (36,603) Research and development (8,000) (7,750) (1,314) (986) (986) EBITDA 37,000 41,750 53,136 58,909 79,540 Depreciation (tax) (40) (110) (185) (258) (341) Pretax income (loss) 36,960 41,640 52,952 58,651 79,199 Income tax expense (13,860) (15,615) (19,857) (21,994) (29,700) Net income (loss) 23,100 26,025 33,095 36,657 49,499 Add: Depreciation (tax) Less: Return of fixed assets (40) (110) (185) (258) (341) Less: Contributory assets' charge (357) (392) (431) (475) (1,044) After-tax cash flow 22,743 25,633 32,663 36,183 48,455 Present value factor 11.0% Present value of after-tax cash flow 21,214 21,539 24,727 24,677 29,772 Present value discrete cash flows 329,923 Remove expected inventory sales price from the revenue base used to calculate contributory asset charges Page 19

20 Inventory step-up in technology asset valuation - example Step-up adjustment excluded For the years ending 31 Dec (USD in 000s) 2015E 2016E 2017E 2018E 2019E Revenue associated with technology 100, , , , ,410 Cost of goods sold (20,000) (22,000) (24,200) (26,620) (29,282) Inventory step up Gross profit 80,000 88,000 96, , ,128 SG&A (25,000) (27,500) (30,250) (33,275) (36,603) Research and development (8,000) (7,750) (1,314) (986) (986) EBITDA 47,000 52,750 65,236 72,219 79,540 Depreciation (tax) (40) (110) (185) (258) (341) Pretax income (loss) 46,960 52,640 65,052 71,961 79,199 Income tax expense (17,610) (19,740) (24,394) (26,986) (29,700) Net income (loss) 29,350 32,900 40,657 44,976 49,499 Add: Depreciation (tax) Less: Return of fixed assets (40) (110) (185) (258) (341) Less: Contributory assets' charge (713) (784) (863) (949) (1,044) After-tax cash flow 28,637 32,115 39,794 44,027 48,455 Present value factor 11.0% Present value of after-tax cash flow 26,711 26,987 30,126 30,027 29,772 Present value discrete cash flows 351,616 Page 20