Definition — what a CVR is
– A contingent value right (CVR) is a contractual claim given to shareholders of a company being acquired or restructured. It entitles holders to a future payment (in cash or stock) only if one or more specified events—called trigger events—happen within a defined time window. If the trigger conditions are not met by the deadline, the CVR normally expires with no value.
How CVRs are used in mergers and acquisitions
– Purpose: CVRs are a negotiation tool to close deals when buyer and seller disagree on the target’s future prospects. The buyer pays less up front and promises additional contingent payout if the target hits agreed milestones (for example regulatory approval, sales targets, or a stock-price threshold).
– Structure: The merger agreement spells out the trigger(s), the payout formula, the payout form (cash or acquirer shares), and the expiration date. CVRs can be issued to all existing target shareholders as part of the consideration for the deal.
Key features and jargon (short definitions)
– Trigger event: The specific outcome or milestone that must occur for the CVR to pay out (e.g., regulatory approval of a drug by a set date).
– Expiration date: The last date a trigger can occur; after this the CVR is void.
– Transferable (exchange-traded) CVR: A CVR that can be bought or sold on an exchange like a stock.
– Non-transferable CVR: A CVR that is granted only to the target’s shareholders at closing and cannot be sold separately.
– Unsecured obligation: A claim on the acquirer’s general credit; CVRs are typically unsecured, meaning they are not backed by specific assets.
Types of CVRs
– Exchange-traded CVRs: Listed on a market and transferable; any investor can buy/sell them before expiration. Listing requires extra regulatory steps and costs for the issuer.
– Non-transferable CVRs: Given only to shareholders at closing and usually cheaper for the issuer to implement; holders cannot trade them separately.
Risk profile and legal status
– CVRs are generally unsecured contractual obligations of the issuer. They behave more like options than bonds: payout is conditional and not guaranteed, and holders typically have no claim on collateral if the issuer defaults.
– Because the payout depends on future uncertain events, CVRs often have uncertain market value at issuance. Their risk includes the probability of the trigger happening, the issuer’s solvency, and sometimes tax/timing considerations.
When and why companies use CVRs
– Common when the target has a potentially valuable asset whose ultimate value depends on future events (e.g., drug approvals, commercialization milestones, or contingent liabilities).
– CVRs let acquirers limit upfront payment while giving target shareholders upside if favorable outcomes occur.
How a shareholder can profit (and what they must do)
– To receive a payout from a non-transferable CVR, you must be a qualifying shareholder at the time the CVR is issued and hold whatever claim the agreement specifies.
– If CVRs are exchange-traded, investors can buy them on the open market to speculate on the likelihood of triggers, much like buying an option.
Checklist: what to review before taking a position in a CVR
1. Read the merger agreement or CVR terms: identify trigger events, deadlines, and payout formula.
2. Determine transferability: can you trade the CVR?
3. Check payout form: cash, shares, or a formula that depends on a future share price?
4. Note the expiration date and any partial payment rules.
5. Assess issuer credit risk and
the availability of escrow or backstops, and whether the CVR payment is secured, subordinated, or dependent on the acquirer’s future cash flows. A CVR promised by a weak balance sheet has more counterparty (credit) risk than one backed by escrow or insurer.
6. Estimate trigger probability and timing: convert the trigger language into a probability and expected time to payout. For binary triggers (event happens or not), think in probabilities; for formulaic payouts (e.g., “$0.50 per share if product revenue > $200m”), build a revenue or price distribution and map outcomes to payoffs.
7. Discount rate and present value: choose an appropriate discount rate that reflects time value and credit risk. Use higher rates for higher issuer risk or longer expected wait times.
8. Check tax treatment and reporting: determine whether payments are treated as capital gains, ordinary income, or a reduction in purchase price for the acquired company. Consult official filings and tax guidance for the jurisdiction; CVR tax outcomes can materially affect net return.
9. Assess liquidity and trading costs: if the CVR is transferable and listed, check average daily volume, bid–ask spreads, and settlement mechanics. If it is non-transferable, you cannot exit in the secondary market and must hold until resolution (or rely on any special repurchase clause).
10. Review legal enforceability and remedies: look for dispute-resolution provisions, governing law, and whether the CVR holder has recourse in bankruptcy or in the event of a covenant breach. Evaluate precedents for enforcement in the appropriate courts.
11. Position sizing and stress tests: decide how much capital to allocate given the binary/contingent nature of payoff. Run scenario analyses (best case, base case, worst case) and a break-even probability for the market price you’d pay.
12. Ongoing monitoring plan: set alerts for milestone dates, regulatory filings (8-K, proxy statements), clinical trial updates (if biotech), sales reports (if revenue-based), and any news about the acquirer’s balance sheet or litigation.
Simple valuation checklist (formula and worked example)
– Basic expected present value (PV) formula for a one-time contingent cash payout:
PV = P(event) × Cash_payout / (1 + r)^t
where P(event) = probability trigger occurs, r = discount rate, t = time in years.
– Example (binary cash CVR): CVR promises $10 if a regulatory approval occurs within 2 years. You estimate a 40% chance and use a 6% annual discount rate.
PV = 0.40 × $10 / (1.06)^2 = $4 / 1.1236 ≈ $3.56.
– Sensitivity: if your probability rises to 60%, PV ≈ 0.60×10/1.1236 ≈ $5.34. If credit concerns push r to 12%, with P=40%, PV ≈ 4 / (1.12)^2 ≈ 3.19.
Worked example for a formulaic, equity-linked CVR
– Terms: CVR pays 0.05 shares of the acquirer’s
common stock if the target’s revenue in year two exceeds a set threshold. Valuing an equity-linked CVR requires a slightly different approach because the payout itself is equity rather than a fixed cash amount.
Valuation framework (equity-linked CVR)
– P(event): probability the trigger is satisfied by time t.
– k: number of shares (or fraction of a share) paid if trigger occurs.
– S0: current acquirer share price.
– E[S_t]: expected acquirer share price at payout time t (under the measure you choose).
– r: discount rate (or use risk-free rate under risk-neutral assumptions).
– q: continuous dividend yield (if the acquirer pays dividends).
General expression for present value (PV) of a one-time equity payout delivered at t:
PV = P(event) × k × E[S_t] / (1 + r)^t
Practical simplification under risk-neutral/no-dividend assumptions
Under standard risk-neutral pricing (no dividends, no arbitrage), the expected discounted stock price equals today’s price, so E[S_t]/(1 + r)^t = S0. That simplifies the CVR PV to:
PV ≈ P(event) × k × S0
This simplification assumes the event that triggers the CVR is independent of future acquirer stock returns, and that
the trigger event is independent of future acquirer stock returns.
If that independence fails, the simple PV ≈ P(event) × k × S0 understates or overstates value. More generally you should write the present value as the discounted expectation of the payout indicator times the acquirer share price at payout time t:
PV = (k / (1 + r)^t