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Drug-linked payouts: complex fix for Pfizer's next Astra bid?

By Ben Hirschler and Anjuli Davies

LONDON (Reuters) - The world's biggest would-be drugs merger hit a wall last month but speculation about smart ways that Pfizer could yet seal a deal with AstraZeneca remains intense.

Even as talks fell apart last month, some in Pfizer's camp remained optimistic the transaction could be revived - and certain AstraZeneca advisers have not ruled out renewed talks. Under British takeover law, the UK firm can approach Pfizer at the end of August to discuss a sweetened bid, or Pfizer can try again in November.

While the most obvious method for Pfizer to win AstraZeneca around might seem to be more cash, some hedge funds think the U.S. firm could structure payouts by tying them to the performance of key AstraZeneca drugs.

A so-called contingent value right, or CVR, was a winning formula for Sanofi in its 2011 battle for Genzyme and the tradeable product - promising additional payouts once future benchmarks are hit - has been used in several other drug industry deals when the two sides could not agree on price.

"An enriched cash:equity mix as well as a CVR component to bridge the ... valuation gap between the two management teams may see the deal agreed upon on a friendly basis," said analysts at Jefferies this week, predicting an 80 percent probability of AstraZeneca inviting Pfizer back after an enforced cooling-off period ends in late August.

UNWIELDY OPTION?

Where CVRs have worked before, they have typically been tied to one particular drug upon which buyers and sellers could not agree a price - such as Genzyme's multiple sclerosis drug Lemtrada.

Applying a CVR to AstraZeneca, then, could be tough, given the number of new drugs in its pipeline and the time needed to prove their value: Debate about the UK company's valuation centres on a wide range of experimental drugs in cancer, respiratory disease and other areas, for which it has made sales forecasts stretching as far as 2023.

“Who wants to own a CVR for 10 years?" said Dan Mahony, a fund manager at Polar Capital, who built up his stake in AstraZeneca last year and doubts the idea would be attractive to investors.

“I’m not sure a CVR would necessarily work in this situation. You’d end up with something that is a really long-dated option - and anything that is illiquid and doesn’t really trade is always a bit of a pain in the neck."

In order to cover itself against the risk of a new drug not working out, Pfizer would have to construct any CVR around a number of very different assets ranging from new cancer drugs like MEDI4736 and AZD9291 to benralizumab for asthma to diabetes and heart drugs, suggested Mark Clark, an analyst at Deutsche Bank - a nice idea, but "probably too unwieldy."

"If Pfizer was cash-strapped then it might be a sensible way to work through the difficulties – but it’s not cash-strapped and it seems overly complex," Clark said.

MORE CASH

It would be far simpler for Pfizer instead to bump up the cash element in its 55 pounds-a-share offer - rejected as inadequate - and meet the 58.85 pounds that AstraZeneca has indicated is the minimum at which it might recommend a deal.

Many healthcare bankers not involved in the bid predict Pfizer will be back - not least because no other target both complements the U.S. company's product range and offers the same potential for tax and cost benefits.

Pfizer Chief Financial Officer Frank D'Amelio suggested as much this week - and pushed AstraZeneca shares higher - when he told a Goldman Sachs healthcare conference that talks about a deal had fallen down simply over price.

"In a word it was price," D’Amelio said. "Any other issues that were raised during the negotiations, during the conversations, I think we were able to adequately, effectively address those."

Since AstraZeneca also raised deep-seated concerns about execution risks and British politicians whipped up a storm over job cuts, D'Amelio's comments were taken as a sign that Pfizer sees such problems as manageable. D'Amelio stressed that he could not speculate on whether Pfizer would return or not.

UK takeover rules prohibit any re-engagement for three months from May 26 - and what happens after that will depend on how AstraZeneca's drug research fares in the meantime and what happens to its shares - a strong run on the stock could push it out of Pfizer's reach.

So far, the newsflow for AstraZeneca has been good, with promising data on new cancer drugs and no competition yet to its blockbuster heartburn medicine Nexium in the U.S. market due to problems at generic supplier Ranbaxy - a factor that could allow it to beat its current targets for 2014 earnings.

(Editing by Sophie Walker)

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