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OT- Interesting article on investment banks, bio-tech, and buy-outs.
Dealpolitik: Filing by Illumina Highlights Complex Relationship With Goldman



The news from Illumina’s filing on Tuesday afternoon is not about Illumina at all. Of course, Illumina rejected the Roche $44.50 cash offer as grossly inadequate, etc. We were expecting that.

The interesting news is about Goldman (click here for a news story by Deal Journal colleague Gina Chon). The bank was hired as one of two financial advisers to Illumina despite having an enormous derivative position in Illumina stock that dwarfs the size of its advisory fee. The filing Tuesday shows that Illumina’s management and its board, in deciding whether to retain Illumina to advise it on Roche’s offer, considered Goldman’s interest in its stock at least four different times, including when Goldman proactively raised it on December 14 on its first call on the deal.

The board asked Bank of America Merrill Lynch to advise it (without Goldman present) on the nature of Goldman’s interest. After all of this, Goldman was retained, for among other reasons, its familiarity with Illumina, its work on the Illumina IPO and other transactions and its prior work in defending Roche hostile offers, according to Illumina’s filing.

In addition, Illumina also retained BofA to advise the board as well.

So what’s the story on the derivative position that generated this concern?

The transaction arose as a hedge to reduce potential dilution to Illumina’s stockholders of the convertiability feature of a 2007 note sale, the filing says.

In 2007, long before anyone was thinking takeover, Illumina issued a convertible note through Goldman and another bank with a conversion price of $21.83 per share. A convertible note is a loan that eventually can convert to an equity stake. Through a series of derivative transactions (and payments) with Goldman, Illumina was able effectively to increase that conversion price to $31.44 per share, a move that would reduce the number of shares it would have to issue were the price to rise. The convertible notes themselves have almost all been converted and that transaction is old and cold. But the derivative transactions with Goldman remain very much alive and kicking and a deal with Roche at the current offer would have a significant impact on who owes what to whom.

If Roche were successful with its current offer of $44.50 per share, Illumina says it would be required to pay Goldman $272.8 million for the cancellation of warrants issued in the transaction, the filing shows. To hedge its risk in the derivative transaction, Goldman sold short approximately 10.2 million shares of Illumina which would cost Goldman $454 million to close out if Roche closed its current deal. All this said, Goldman isn’t necessarily vested in a lower stock price for Illumina. Illumina does not disclose how a change in price would affect the payments.

Also, presumably the difference in payments was baked into the initial fees for the transaction of $139 million, Goldman of course received the proceeds from selling the shares short and Goldman may have had some other profits (or losses) over the years in connection with managing this hedged transaction.

And these payments are an acceleration of payments that would be due anyway when the transaction matures in 2014 if there is no Roche deal.

But whatever the payments, they appear to be sensitive to the price of Illumina stock. The numbers are large, and one can be very sure that the traders at Goldman understand exactly what effect the Roche deal has on their positions.

And this isn’t just some old deal now dormant. Illumina’s filing says Goldman is going to “continue to engage, in hedging and other market transactions with respect to its position.” In other words, Goldman can implement strategies in its trading to try to advantage itself as the deal develops.

In fairness, the filing indicates that Goldman, as is typical, “maintains customary institutional information barriers,” to ensure that those trading do not have access to the information that investment bankers at Goldman have. There is one other interesting feature of the retention of Goldman. In addition to getting paid a percentage (0.42%) of the transaction if there is a deal, and a fixed dollar amount ($17.7 million) if Roche is chased away from its current deal, all of which is typical, Goldman gets extra fees (up to an extra $2.3 million) if Roche bumps its offer but does not close. But BofA Merrill Lynch? It gets paid less across the board and gets no bonus if Roche bumps, but doesn’t close.

What’s the significance of all of this? The Goldman derivative interest is a bit embarrassing for Goldman and Illumina, but substantively I don’t think it would affect Goldman’s advice on Roche to the board. And BofA Merrill Lynch has been brought in to keep an eye on things even if there were to be an issue.

But here is where it could make a difference: Roche’s strategy to get its takeover done includes seeking to replace a majority of the Illumina directors. The amounts involved in the Goldman derivative position are so eye-popping that they could make great fodder for a proxy fight. Roche could try to make the case that Illumina’s directors are not being guided by disinterested judgment but by Goldman’s clouded judgment. Roche could try to create doubt among shareholders as to whether the incumbents can make the right decisions.

That proxy fight was going to be nasty anyway. Now Illumina seems to have handed Roche quite a nice issue on a silver platter. Illumina may still be able to convince shareholders that their directors are the best custodians for a sale process, but the Goldman issue will at least create a lot of smoke.

http://blogs.wsj.com/deals/2012/02/08/dealpolitik-filing-by-illumina-highlights-complex-relationship-with-goldman/?mod=yahoo_hs