Monday, April 29, 2013

A Closer Look as Quintiles Makes Final Preparations to Go Public

A Closer Look as Quintiles Makes Final Preparations to Go Public

Within the next two weeks Quintiles should be a public company again. I’ve already written about this company a couple of times.  In my first installment (“Quintiles Files to Go Public:  The Details Matter” [February 20, 2013]), we learned about the many relationships between the company’s founder, Dr. Dennis Gillings, and Quintiles by examining the first iteration of the prospectus.  A few more details were added in a subsequent draft of the prospectus (“Quintiles Update:  Company Will Pay a $25 Million Termination Fee” [April 3, 2012]).  Now the company has filled in a few more tidbits in the latest draft as it drums up interest among stock investors for this offering.
Addressing the Consequences (1996)
Before we delve into the details, I want to make it clear that I don’t think anything I’ve written will matter much to money managers considering a position in the company.  A significant number of the new owners are going to be traders and speculators.  Some investors (they aren’t really investors at all) will own the stock for mere hours as they bet on the strength of Quintiles’ stock on the first day of trading.   Others will be betting on next quarter’s earnings or the size of the next big contract.  Most new investors won’t care about the minutiae unless something goes wrong.  If Quintiles were to fail to deliver the requisite profits and resulting stock appreciation, then the traders and speculators might go back and peruse the details and call their lawyers. Perhaps there are few long-term investors for whom the particulars matter.

In this installment of the prospectus, we learn that the existing investors are selling $225 million worth of stock (or $338 million if the IPO goes well and the underwriters exercise the option to purchase more shares).[1]  This means that existing owners will have pretty much recovered their investment in Quintiles.  Anything they receive from subsequent sales of the stock will largely be profit.   In addition to his share of the $25 million termination fee on the management contract, Dr. Gillings will be selling $54 million in stock.

By the way, Quintiles isn’t going to be getting much money from the IPO.  For one brief moment, the company will receive $490 million in proceeds.  However, $375 million will immediately be used to repay a $300 million loan made in February 2012, a $50 million piece of another loan, and $25 million for the aforementioned termination fee.  

Meanwhile in 2012, the company paid out dividends of $567.9 million to the existing investors after borrowing $481 million.  Apparently, the board of directors pitied the management team because they held stock options, which were not entitled to the dividends. They were paid a special bonus of $11.7 million in lieu of the dividend payouts. 
In summary, almost all the proceeds of this IPO are either directly or indirectly going to Dr. Gillings and the private equity investors. Moreover, a handful of investment banks are earning chunky fees on the short-term loan issued in 2012 ($6 million) and the IPO (an estimated $50 million in discounts and commissions, plus $6.4 million in legal and accounting fees).

Before adding some details on Dr. Gillings financial arrangements with the company, the revised prospectus reminds us that his employment contract was negotiated at “arms length” with the private equity sponsors.  I’m not sure the private equity investors truly represent the interests of the new investors.  As a result, the employment contract may be in the best interest of Bain, TPG and, 3i, but not the public investors. 

We’re also told that the cash bonuses, stock options and $6-$8 million in potential severance payments are seen as necessary in retaining Dr. Gilling’s services.  I would have thought that Dr. Gilling’s 26 million-share position, worth just under $1 billion, would be plenty of incentive for him to continue to serve the company.  It’s hard to understand why he needs to be treated as a highly compensated executive and a major owner.

There are two more items to mention, although they pale in comparison to the figures I’ve been bandying about.  First, Dr. Gillings will be taking a $200,000 pay cut down to $800,000 in base compensation.  You might recall from my previous post, that he’s no longer CEO.  His cash bonus will be limited to 100% of the base.

Second, Dr. Gillings will be receiving another $1.5 million in exchange for agreeing not to seek more than $2.5 million in reimbursement for the business use of his jet.  In other words, if he flies more than 185 hours for business purposes, he’ll absorb the additional expense.  I haven’t seen this type of arrangement before.  The prospectus seeks to assure us that the $1.5 million isn’t coming from proceeds from the IPO.  What difference does that make?  Whether Dr. Gillings gets paid from existing cash or IPO proceeds, it’s money going out the door for a strange reason.

There’s no question, Quintiles is a powerhouse in biopharmaceutical development services and commercial outsourcing services.  It may turn out to be a good investment for its new shareholders.  However, it is carrying a lot of excess baggage that appears to serve the interests of the founder, his family and the private equity sponsors.

[1] I’m using a $38 per share price, which is the estimated midrange for the offering.

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