Case #1 MoGen Inc

Advanced Corporate I|nance

IIN S342 Spr|ng 2011
rofessor 8||| Megg|nson

2

xecutive 5ummory
lounded ln 1983 MoCen lnc (Molecular CeneLlcs) qulckly became a leadlng bloLechnology
flrm 1he company's core focus was Lo dellver producLs creaLed Lhrough emerglng sclence Lyplcally
focuslng on advances ln recomblnanL unA and molecular blology MoCen qulckly produced Lwo of Lhe
flrsL blologlcally derlved human LherapeuLlc drugs LhaL showed slgnlflcanL success ln offseLLlng some of
Lhe harmful effecLs caused by Lhe use of chemoLherapy Lhe malnsLay ln Lhe LreaLmenL of cancer
As wlLh any flrm operaLlng ln Lhls space MoCen requlres a greaL deal of caplLal Lo be used ln
8esearch and uevelopmenL Lo develop new and effecLlve blockbusLer drugs ln order Lo recelve
approval Lo dlsLrlbuLe Lhese new drugs ln Lhe unlLed SLaLes LreaLmenLs musL be approved by Lhe uS
lood and urug AdmlnlsLraLlon (luA) 1hls approval process requlres exLenslve Lrlals LhaL Lake a
Lremendous amounL of Llme and can ofLen cosL hundreds of mllllons of dollars 1he payoff for Lhe
lnnovaLlve flrm ls LhaL once luA approval ls recelved Lhe company ls granLed an excluslve perlod of Llme
ln whlch Lhey are granLed an excluslve perlod of Llme Lo markeL and sell Lhe new drug durlng whlch
Llme Lhe company generally earns exLremely hlgh proflLs Powever once Lhe paLenL perlod runs ouL
compeLlng flrms can produce generlc alLernaLlves whlch severely llmlL Lhe flrm's ablllLy Lo malnLaln
premlum prlclng
MoCen esLlmaLes LhaL Lhey wlll need approxlmaLely $10 bllllon ln caplLal for Lhe upcomlng flscal
year 2006 ApproxlmaLely $3 bllllon of Lhls amounL wlll need Lo be ralsed exLernally and wlll supplemenL
Lhe roughly $3 bllllon Lhe company currenLly has on hand whlch Lhey had generaLed lnLernally 1he
company Lurned Lo Lhelr long Llme buslness parLner Merrlll Lynch Lo asslsL ln ralslng Lhe requlred funds
Merrlll Lynch prepared Lo embark on whaL would be Lhe largesL ever offerlng of a hybrld securlLy known
commonly as a converLlble bond ConverLlble debL offers lnvesLors a sLable dlvldend paymenL plus
3
poLenLlal upslde from Lhe converslon of Lhe debL lnsLrumenL lnLo shares of equlLy provlded Lhe
company's share prlce appreclaLes above a preseL prlce 8ecause of Lhe upslde offered by Lhe
converslon opLlon Lhe lssulng flrm ls able Lo offer Lhe lnsLrumenL wlLh a lower coupon paymenL Lhan
would Lyplcally be expecLed
AL Lhe Llme of Lhe case Merrlll Lynch and MoCen musL declde how Lo prlce such a large and
lmporLanL flnanclng 1he $3 bllllon offerlng would represenL Lhe largesL such offerlng ln hlsLory so lL ls
crlLlcal LhaL prlclng ls seL aL a level Lo generaLe sufflclenL demand for such large offerlng wlLhouL glvlng
Loo much away
,ens "1rue" copito/ kequirements
MoCen esLlmaLes LhaL Lhey wlll need $10 bllllon ln caplLal for 2006 of whlch $3 bllllon would
need Lo be ralsed exLernally 1he prlmary pro[ecLed uses of caplLal are
2006 Cap|ta| kequ|rements (5000)
xpand ManufacLurlng and lormulaLlon 1000000 $
xpand 8u and 1rlals 3300000 $
AcqulslLlon and Llcenslng 2000000 $
SLock 8epurchase rogram 3300000 $
1C1AL 10000000 $

1he flrsL Lhree uses of funds all make a loL of sense for a growlng flrm ln MoCen's poslLlon 1hey
are baslcally requlred lnvesLmenLs LhaL should help Lo drlve proflLablllLy ln fuLure years 1he fourLh use
of funds repurchase of company sLock ls a compleLely dlscreLlonary use of funds Whlle MoCen's
managemenL belleves Lhelr shares are undervalued lL ls our oplnlon LhaL Lhe company should defer
fuLure repurchases unLll Lhey are ln a poslLlon Lo fund Lhem wlLh lnLernally generaLed funds xcludlng
Lhese funds we esLlmaLe Lhe company's exLernal caplLal needs Lo be roughly $13 bllllon ln 2006
4
ssuonce cnvertib/e vs 1roditino/ uebt
As menLloned prevlously a converLlble bond ls a hybrld securlLy LhaL offers some feaLures LhaL
resemble debL and some feaLures LhaL resemble equlLy ConverLlble bonds offer advanLages and
dlsadvanLages Lo Lhe lnvesLors who buy Lhem and Lhe companles LhaL lssue Lhem
lnvesLors llke converLlbles because Lhey provlde Lhe securlLy of semlannual lnLeresL paymenLs
buL also offer poLenLlal upslde whlch occurs when Lhe company's sLock prlce exceeds a cerLaln LargeL
durlng Lhe Lenor of Lhe lnsLrumenL lssulng companles llke Lhem because converLlbles allow Lhe
company lssue debL wlLh a lower coupon raLe Lhan would normally be requlred Cnly lf Lhere ls
slgnlflcanL appreclaLlon ln Lhe company's equlLy share prlce do Lhey have Lo converL Lhe bonds lnLo
shares of sLock A converLlble debL offerlng also allows a company Lo ralse funds whlle delaylng or
avoldlng Lhe dlluLlon of ouLsLandlng shares assoclaLed wlLh a seasoned equlLy offerlng
MosL of Lhe dlsadvanLages assoclaLed wlLh converLlbles are Lo Lhe lssulng flrm versus Lhe
lnvesLor 1he mosL common dlsadvanLages clLed are (1) dlluLlon of Lhe company's S and poLenLlally
conLrol of Lhe company and (2) more resLrlcLlve covenanLs as compared Lo oLher flnanclng
arrangemenLs
8/ock5ch/es ,de/ os used t vo/ue cnvertib/e 8nds 5ee xhibit 1
1he 8lackScholes model ls used Lo esLlmaLe Lhe value of Lhe converslon opLlon wlLh a 23
premlum for one share of MoCen sLock 1he model ls used Lo calculaLe Lhe prlce of Lhe call opLlon 1he
currenL sLock prlce ls $7798 AfLer Laklng lnLo accounL Lhe converslon premlum Lhe exerclse prlce ls
$9748 (for 23 premlum) $10917 (for 40 premlum) and $8968 (for 13 premlum) 1he rlskfree
raLe 1reasury noLe 3year raLe of 446 (exhlblL 6 pg 14) Llme Lo maLurlLy as menLloned ln Lhe case Lo
be 3 years (pg 6) dlvldend yleld assumed Lo be 0 and annuallzed volaLlllLy of 23 (exhlblL 4 pg 12
3
volaLlllLy of call opLlon wlLh nearesL exerclse prlce and Llme Lo maLurlLy as compared Lo Lhe bond) as
glven ln Lhe case 1he converslon raLlo (for 23 premlum) ls found by dlvldlng bond face value $1000
wlLh Lhe converslon prlce ($7798*123$9748) whlch comes Lo be 102390 1he converslon raLlo of
102390 ls mulLlplled wlLh Lhe call opLlon value of $1382 Lo geL converslon opLlon value of $16230
t vo/ue the 8nds ot uierent cnversin Premiums 5ee xhibit 2
1he value of Lhe sLralghL bond componenL ls found Lo be $83770 Lhe converslon opLlon value
belng $16230 for 23 premlum maklng Lo LoLal converLlble bond value Lo be $1000 1he dlscounL raLe
should be 373 for Lhe converLlble bond Lo sell aL a face value of $1000 1he dlscounL raLe used Lo
value Lhe sLralghL bond componenL Lhus ls 373 (A grade bond yleld exhlblL 6 pg14 MoCen has A
bond credlL raLlng accordlng Lo Moody's (A+ accordlng Lo S raLlng comparable Lo a yleld of 379)
uslng Lhe above dlscounL raLe and uslng Lhe presenL value of sLralghL bond componenL $83770 Lhe
coupon raLe comes Lo be abouL 197 1o propose a 13 converslon Lhe coupon raLe would be 028
and for a 40 converslon raLe Lhe coupon raLe would be 309
vo/uotin ,erri//s Prpso/
We recognlze Merrlll Lynch as Lhe leadlng lnvesLmenL bank ln Lhe lssuance of hybrld securlLles
and appreclaLe our longsLandlng relaLlonshlp wlLh Lhem Merrlll appears Lo have done a good [ob of
adequaLely addresslng Lhe needs of boLh MoCen and Lhe poLenLlal lnvesLors of Lhls lssuance 1he 23
converslon premlum appears Lo be Lhe rlghL level as lL ls very lmporLanL Lo make Lhls lssuance aLLracLlve
Lo Lhe fundamenLal lnvesLors MoCen has expressed Lhelr deslre Lo sell Lhelr bonds Lo lnvesLors LhaL
Lake a longer Lerm vlew versus hedge fund lnvesLors who are llkely Lo Lrade ln and ouL of Lhe lssue
MoCen would probably have wanLed Lo seL Lhe bar a blL hlgher buL Lhey musL be reallsLlc ln LhaL Lhey
are looklng Lo ralse $3 bllllon and Lherefore musL offer lnvesLors an aLLracLlve proposlLlon Lo enLlce Lhem
Lo accepL Lhe very low coupon raLe LhaL MoCen wlll have Lo pay
6
|b|t 1 8|ackSco|es Mode| as Used to Va|ue Convert|b|e 8onds
CurrenL sLock prlce 7798 $
Converslon premlum 23
lace value of Lhe bonds 100000 $
Converslon raLlo 102390
Converslon prlce 9748 $
Converslon value of one bond 80000 $
Convers|on pr|ce ca|cu|at|on

Case1
CurrenL sLock rlce 7798 $
erc|se pr|ce 9748 5 calculaLed based on 23 converslon premlum
volaLlllLy 230
volaLlllLy of call opLlon wlLh nearesL exerclse prlce and Llme Lo
maLurlLy as compared Lo Lhe bond
8lskfree lnLeresL raLe 446 xhlblL 6 (3year 1reasury)
1lme Lo xplraLlon (years) 3 maLurlLy of bond lssue
ulvldend ?leld 00 company does noL pay dlvldends
Ca|cu|at|ons
rlce of call opLlon 1382 $
d1 02368687
n(d1) 06013399
d2 02374269
n(d2) 03984246
Convers|on opt|on va|ue 16230 5
Va|ue of stra|gt bond 83770 5

Case2
CurrenL sLock rlce 7798 $
erc|se pr|ce 10917 5 calculaLed based on 40 converslon premlum
volaLlllLy 230
volaLlllLy of call opLlon wlLh nearesL exerclse prlce and Llme Lo
maLurlLy as compared Lo Lhe bond
8lskfree lnLeresL raLe 446 xhlblL 6 (3year 1reasury)
1lme Lo xplraLlon (years) 3 maLurlLy of bond lssue
ulvldend ?leld 00 company does noL pay dlvldends
Ca|cu|at|ons
rlce of call opLlon 1249 $
d1 00363116
n(d1) 03143628
d2 0477784
n(d2) 0316402
Convers|on opt|on va|ue 11439 5
Va|ue of stra|gt bond 88S61 5

7
Case3
CurrenL sLock rlce 7798 $
erc|se pr|ce 8968 5 calculaLed based on 13 converslon premlum
volaLlllLy 270
volaLlllLy of call opLlon wlLh nearesL exerclse prlce and Llme Lo
maLurlLy as compared Lo Lhe bond
8lskfree lnLeresL raLe 446 xhlblL 6 (3year 1reasury)
1lme Lo xplraLlon (years) 3 maLurlLy of bond lssue
ulvldend ?leld 00 company does noL pay dlvldends
Ca|cu|at|ons
rlce of call opLlon 2104 $
d1 04397403
n(d1) 06699374
d2 01639981
n(d2) 04348663
Convers|on opt|on va|ue 23461 5
Va|ue of stra|gt bond 76S39 5
8
|b|t 2 now to Va|ue te 8onds at D|fferent Convers|on rem|ums
rem|um Ior 2S Ior 1S Ior 40
CurrenL sLock prlce 7798 7798 7798
Converslon premlum 023 013 04
lace value of Lhe bonds/ ConverLlble 8 100000 $ 100000 $ 100000 $
Converslon raLlo 1023904078 111311313 913983784
Converslon prlce 9748 $ 8968 $ 10917 $
Converslon opLlon value 16230 $ 23461 $ 11439 $
Stra|gt bond va|ue 83770 5 76S39 5 88S61 5
1M S7S S7S S7S
r 002873 002873 002873
1 3 3 3
Coupon aymenL (annually) 1969 $ 284 $ 3083 $
Coupn aymenL (semlannually) 984 $ 142 $ 1343 $
Coupon 8aLe 0019688747 000284314 003083133
Coupon kate () 197 028 309