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Lion Shareholder Vote May Decide Fate of UK SRS Unit; Board Seeks Mgmt Buyout

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Lion Bioscience shareholders will vote this Thursday on whether to revise the company’s bylaws and potentially enable management to buy out its Cambridge, UK-based SRS bioinformatics business, currently known as Lion Bioscience Ltd.

In an invitation to its “extraordinary” shareholder’s meeting, scheduled to take place on March 24 in Heidelberg, Germany, Lion said: “In the opinion of [the] management board and supervisory board, Lion Bioscience Ltd. (UK) would have markedly better chances on the market as an independently operating company following the bundling of the operating activities in bioinformatics than it does in its present form as a business unit of Lion Bioscience AG.”

Lion’s board is proposing a new structure that would establish the Heidelberg-based parent firm, Lion Bioscience AG, as a “holding company” that would have only a “minority interest” in the bioinformatics business, which would remain in Cambridge. The holding company’s primary function would be to manage Lion’s remaining €25 million ($33.3 million) in cash holdings and to “invest in promising companies with excellent growth prospects as well as in intellectual property and industrial property rights, particularly in the area of the life sciences/IT sector.”

In the invitation to the shareholder meeting, filed with the US Securities and Exchange Commission Feb. 25, Lion’s board said it is “currently in negotiations with top management of the [Lion Bioscience Inc. (UK)] unit in order to evaluate the possibility of selling [it] to [Lion’s CEO] Thure Etzold and his management team in the form of a management buyout.”

However, Friedrich von Bohlen, chairman of the supervisory board, stressed that Lion’s options are still wide open, and that shareholders will not decide the specifics of the company’s future structure at this week’s meeting. Rather, he told BioInform, shareholders will vote on a set of bylaws designed to provide more flexibility for the company’s management, ideally enabling the board to separate Lion’s “operational” functions — namely, the SRS business — from the “strategic” functions envisioned for the holding company, which could operate along the lines of a “private equity business,” von Bohlen said.

If shareholders do pass the new bylaws, Lion’s board would then have the freedom to pursue a number of options, including — but not limited to — the management buyout of the SRS business.

Another option, von Bohlen said, would be “to continue with the bioinformatics business as it is right now, and have the right to do strategic investments in parallel.” However, he added, “that would lead to a mixed business model in the holding [company] — namely, running operations and running investments — which may have advantages and disadvantages.”

Another alternative that the company proposed in its SEC filing includes liquidating the operating business — an option that poses excessive financial risks related to “extensive” customer obligations and “high restructuring costs due to severance payments,” according to the board.

Lion’s board also considered selling the bioinformatics business, but said that this would be “very difficult” to do in its “current form.” The proposed solution of an independent entity, however, “would not preclude a later sale.”

Back to Basics

Assuming the shareholders approve the changes in the company bylaws, and Lion’s board moves ahead with its restructuring plan, Lion would essentially be returning to its roots as a privately held bioinformatics company with the SRS data-integration system as its primary product offering.

According to Lion’s board, operating the UK SRS business as an independent firm offers a number of advantages over the company’s current structure, including “a significantly improved cost basis given its much leaner and more efficient structure after being freed of all overhead costs and [stock] exchange listing costs.”

The numbers appear to back up this argument. According to a “hypothetical” balance sheet in Lion’s SEC filing, Lion Bioscience AG, the proposed holding company, would have had cash and cash equivalents of €28.8 million as of the end of 2004, while Lion Bioscience Ltd., the bioinformatics subsidiary, held €600,000 in cash. Lion Bioscience AG, however, racked up twice as much in general and administrative costs as the bioinformatics group did — spending €700,000 for the year as opposed to Lion Bioscience Ltd.’s €330,000 — while generating only €200,000 in revenues against the bioinformatics unit’s €4.1 million.

Selling costs of €3.2 million and other expenses, however, placed the bioinformatics subsidiary in the red for the year, although Lion said in the filing that “the expenses include structural costs that would no longer accrue under the new structure.”

According to the hypothetical balance sheet, the holding company would have had a positive operating cash flow for the year.

“The cost advantage is that you have everything in one place, it can be self-determined, and the management team around Thure [Etzold] — what we really think is the right management team — could really focus on that one business and not have to play a dual role,” von Bohlen said. “It’s a focus and cost theme.”

The board proposed in the SEC filing that Lion’s total staff — which numbered 128 employees as of Dec. 31, 2004 — be cut to around 60 by March 31. Around five people would be employed in the holding company, with the remainder in the operating bioinformatics unit. About 10 of those employees would be based in the US.

Lion originally announced plans to establish a top-down holding structure in November [BioInform 11-22-04], but the SEC filing reveals that the company has modified this original strategy in the ensuing months. In November, Lion said that it would retain its cheminformatics business in Cambridge, Mass., but the latest proposal from the company indicates that it does not intend to actively market the LeadNavigator cheminformatics product that it launched in August: “Lion Bioscience AG does not necessarily plan to transact business involving this product directly, but to possibly delegate this activity to suitable development, manufacturing, marketing, and distribution partners.”

Von Bohlen said that Lion will continue its cheminformatics collaboration with Bayer, and noted that the original plan to spin out the cheminformatics business as its own independent entity isn’t off the table. However, he said, “we’re focusing right now on what we’re best known for” — SRS — “and the product that has the highest visibility.”

In the event of a management buyout of the bioinformatics business, Lion Bioscience AG would retain the right to regain operations of Lion Bioscience Ltd. if it achieves profitability.

This scenario would shield the holding company from any risks — or further losses — associated with running the business, while still giving it the opportunity to benefit “if bioinformatics awakes and becomes a real business,” von Bohlen said.

Modest Proposals?

Lion’s fate hangs on whether shareholders opt to grant its board the “operating freedom” required to implement the proposed structure.

On Thursday, Lion shareholders will consider four resolutions outlining a number of changes to the company’s bylaws. According to von Bohlen, these include three key modifications: enabling the holding company to oversee the “strategic, direct investment or private equity business in addition to the operational business;” granting the company’s management the right to buy back company shares; and reducing the number of executive officers to a minimum of one, from its current minimum of two.

“Assuming we come to the buyout, and assuming the holding [company] remains, then we don’t need two officers, we only need one,” von Bohlen said.

Whether shareholders agree with the board’s recommendations remains to be seen, however. On March 9, Germany’s Association for the Protection of Shareholders (Schutzgemeinschaft der Kapitalanleger, or SdK) issued a counter-proposal in which it recommended voting against all four resolutions. Instead, the counter-proposal said, “SdK proposes that the company should be liquidated.”

In a harshly worded letter citing Lion’s “unprecedented” drop in share price since its IPO in 2000 and “astronomical” net loss of €237 million during that time, SdK noted that “The revelation, to be read in the invitation to the special shareholder meeting, that Lion ‘is obliged to increase sustained shareholder value’ comes, unfortunately, much too late for shareholders.”

SdK said it “believes it is time for management to admit not only that the business model has failed, but also to draw the only correct conclusion, that is to liquidate the company.” Further, the organization expressed no confidence in Lion’s ability to succeed in strategic investments, noting that it “cannot see how management with Dr. von Bohlen as chairman of the board can suddenly be successful in equity investments similar to a private equity fund. Our skepticism seems to be even more justified because equity investments [made by Lion] in prior years turned out to be failures.”

Klaus Schneider, chairman of SdK, told BioInform that he wasn’t sure how many Lion shareholders SdK represents, but he stressed that the group is urging all of the company’s shareholders to vote against the resolutions. “We don’t think that management is in a position to perform a turnaround of the position of the company, and we prefer a liquidation,” he said.

Thomas Höger, an analyst with Germany’s DZ Bank, agreed that the proposed structure is not likely to appeal to shareholders. “I do not see the immediate upside potential of this construct,” he said. However, he noted, the holding company structure is “a positive way to conserve the cash burn,” adding that “if the bioinformatics business is spun out and Lion AG has a call option [to step back into the business], they might in the long or medium term profit from an upturn in the bioinformatics business.”

In a response to the SdK counter-proposal, Lion management stated that it does not plan to change its resolutions for Thursday’s meeting, reiterating its position that “a re-direction is the best alternative for shareholders” and that liquidation is a prohibitively expensive option.

Von Bohlen, who is a major shareholder in the firm with a stake of around 10 percent, acknowledged that response to the proposals has been mixed so far.

“We have heard feedback from both sides,” he said. While admitting that predicting the outcome of Thursday’s meeting “is a bit like reading a crystal ball,” he was confident of the board’s ability to convince its shareholders.

“I think that it’s a good like lihood that these [proposals] will get approved,” he said, “but we will see.”

— BT, JK

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