Exercise B3-1: Equity Carve Outs

Exercise B3-1: Equity Carve Outs

Read the July 24, 2018 Wall Street Journal article titled, “Eli Lilly to Offer Minority Stake in Animal-Health Business,” included on the next page. In addition, download Eli Lilly’s excerpted December 31, 2018 financial statements from the Session B03 Pre-Class Readings in Canvas. The Wall Street Journal article will give you a better idea of the “why” behind the transaction and Eli Lilly’s financial statements will provide you with a glimpse of “what” they actually did.

Required:

1. As described in the Wall Street Journal article and represented in the Eli Lilly financial statement excerpts, Elanco sold 19.8% of its equity to non-Eli Lilly investors via an Initial Public Offering.  Using your by-now well-developed abstract-concept representation skills, diagram the ownership structure of the Eli Lilly and Elanco before the IPO, the flow of cash and shares in the transaction and the affiliate structure of the companies after the transaction (i.e., draw some pictures).

2. What is Elanco getting in this deal?  What is Elanco giving up in this deal?  What is Lilly getting or giving up in this deal?

3. (Ignore the cash payment from Elanco to Lilly.) What entry was made by Elanco to record the stock offering?

4. (Ignore the cash payment from Elanco to Lilly.)  Did Lilly make an entry on its books to record the stock offering by Elanco?  If so, what was the entry?

5. How is Elanco reported in Lilly’s December 31, 2018 financial statement?

Eli Lilly to Offer Minority Stake in Animal-Health Business

By Peter Loftus and Allison Prang

Eli Lilly & Co. is taking public a minority ownership stake in its Elanco animal-drug business, a prelude to shedding the unit and focusing more on its medicines for humans, the company said Tuesday.

The Indianapolis pharmaceutical company announced in October that it was reviewing options for its animal-health business, including spinning it off. Potential buyers expressed interest in acquiring the business, but Lilly decided an initial public offering was a more tax-efficient approach, Chief Financial Officer Josh Smiley said in an interview.

With an IPO, Lilly also seeks to capitalize on investors’ increased appetite for animal-health companies. “I think investors are looking for more animal-health companies,” Mr. Smiley said. “They appreciate the underlying growth.”

Lilly rival Pfizer Inc. made a similar move in 2013, raising $2.2 billion in an IPO of a minority stake of its Zoetis animal-drug business, and then spinning out the remaining stake to Pfizer shareholders. Such a move is an option for Lilly, which said it eventually plans to shed its remaining stake but didn’t specify the form that would take.

Zoetis, the largest animal-health company, now has a market capitalization of about $40 billion, its shares carrying a price-to-earnings ratio more than double Pfizer’s and trading near all-time highs.

Elanco sells drugs and vaccines for pets and livestock. Last year, it recorded sales of about $3.1 billion, or 13% of total Lilly revenue. JPMorgan analysts previously estimated the business could have fetched $14 billion to $16 billion in a sale.

Mr. Smiley said the animal-health market is expected to grow about 5% annually for the foreseeable future. It faces less pricing pressure and generic competition than the human pharmaceutical business, and has shorter product-development cycles.

Chief Executive David Ricks has said that Eli Lilly used to depend on the business more in the past for revenue, but that its human-drug business is in a better place after several key products lost patent protection. On Tuesday, Mr. Ricks said the move would allow the company to focus more on its human pharmaceutical business.

Eli Lilly said the ownership stake that it will be taking public will be under 20%.

The company said it expects to file the registration statement for the initial public offering with the Securities and Exchange Commission “in the coming weeks” and that it anticipates the process will be done in the latter half of this year. Eli Lilly said it hasn’t decided on the IPO’s pricing or how many shares will be offered.

In Eli Lilly’s second quarter, the results of which it released Tuesday, the animal-health division brought in $792.1 million in revenue, up 0.9% from the comparable quarter a year ago.

Total revenue at the company increased by 9.1% to $6.36 billion, boosted by higher sales of its insulin Humalog and its diabetes treatments, Trulicity and Basaglar.

Lilly reported a second-quarter loss of $259.9 million, or 25 cents a share, compared with a year-earlier profit of $1 billion, or 95 cents a share. Excluding costs related to a pair of acquisitions, the company reported earnings of $1.50 a share, above the average analyst estimate of $1.30 on Thomson Reuters .

Shares of Eli Lilly, up 6.9% year to date, rose 2.9% to $91.49 early Tuesday afternoon.