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Executive Summary

Lilly's price for Hybritech of approximately six times estimated 1985 sales and well over 100 times estimated net earnings may set a high benchmark price for future acquisitions of established biotechnology firms. Under a definitive merger agreement announced Sept. 18, Lilly is paying approximately $280 mil. in cash and warrants in what amounts to the first acquisition of an established biotech firm. Combined with a contingent payment that is part of the agreement, the two firms said in a joint Sept. 18 press release that the "transaction is expected to have a total value in excess of $300 mil." Hybritech sales for 1985 are on the way to topping $50 mil. while net income should surpass $2 mil. based on first half sales of $26.3 mil. and net earnings of $1.2 mil. (including a $500,000 tax loss carry-forward). In addition to giving Lilly a biotech entry into the diagnostic market, Hybritech's therapeutic monoclonal antibody research program dovetails with Lilly's research efforts directed at developing tumor specific cancer chemotherapy with the use of monoclonal antibodies. Top execs from both firms highlighted the synergies between Lilly and Hybritech's R&D program in the area of tumor specific antibodies to treat cancer. Lilly Chairman Richard Wood declared that the acquisition of Hybritech will "enhance ]Lilly's[ existing research efforts in the emerging technology of monoclonal antibodies for the therapeutic treatment of certain types of cancers." In comments on the merger, Hybritech Chairman Howard Greene also underscored the advantages to the biotech firm of Lilly's fermentation know-how, derived from the company's work in antibiotics and the scale-up of its recombinant human insulin product, Humulin. "Lilly, like Hybritech, has an extensive monoclonal antibody research program and a wealth of experience in fermentation technology, which is required for the commercial production of monoclonal antibodies," Greene noted. Since its founding in 1977, Hybritech has been successful in moving monoclonal antibody products to market rapidly. The firm was the first to get a monoclonal diagnostic through FDA in 1981. Hybritech now has 17 Tandem in vitro diagnostics on the market; five in vivo cancer imaging agents; two imaging devices; and a selection of monoclonal antibodies for use in research labs. Hybritech product sales during the first six months of this year were annualizing at $30 mil. Hybritech's first therapeutic R&D program to reach the clinical stage is its radio-labeled polyclonal antibody study at Johns Hopkins for treatment of hepatoma. In the biotech firm's six month report to shareholders, Hybritech reported that as of mid-year 1985 six patients had been injected "using conventional antibodies labeled with a radioactive isotope of yttrium." In addition, Hybritech also said in its 1984 annual report, that a monoclonal radiopharmaceutical product linked with yttrium "should soon be cleared for clinical trials in melanoma patients." Further back in the pipeline, Hybritech is also working on linking standard cancer chemotherapeutic agents, such as methotrexate and Adriamycin, to monoclonal antibodies with the goal of increasing the possible dosage of the drug while minimizing side effects. Hybritech is taking this approach a step further by exploring the possibility of linking biological toxins, such as ricin toxin, to monoclonals to limit non-tumor tissue damage, the company said in its 1984 annual report. The lead product of Lilly's monoclonal antibody R&D program is KS/14, which represents a cancer chemotherapeutic agent linked to a tumor-specific monoclonal antibody. Lilly says it hopes to have the agent in clinicals "in early 1986." Indicative of Lilly's interest in the monoclonal antibody area prior to the purchase agreement with Hybritech were two agreements with monoclonal research firms announced late in 1984. In late October, Bio-Response announced it had signed an agreement with Lilly to help the pharmaceutical firm with the production of monoclonal antibodies over a two-year period. In December, Lilly announced that it had placed orders with Damon Biotech for production of initial quantities of several different monoclonal antibodies. At that time, Lilly reported that it was "evaluating monoclonal antibodies as potential delivery systems for anti-cancer drugs and as direct therapeutic agents." Lilly said that neither agreement would be affected by its agreement to acquire Hybritech. In buying Hybritech, Lilly is apparently relaxing its traditionally strict requirements for potential acquisition candidates. Historically, the pharmaceutical firm has been known to require that a purchase not dilute earnings; Hybritech realized its first profitable year in 1984. One reason Lilly may be taking a more flexible approach to the acquisition is that, for a firmly established biotech company, Hybritech is still relatively unencumbered. The company has entered into only two limited research and development partnership arrangements. In 1984, Hybritech formed Hybritech Clinical Partners, for the development of products for the diagnosis and treatment of certain cancers. The contract will generate $63 mil. through 1989. Hybritech has an exclusive option to buy any resulting technology, the report notes. In 1982, the company entered Hybrigenetics Cancer Research, a limited partnership for the development of monoclonal antibodies to target cancers. That contract has provided revenues of $6.5 mil. and is due to run out this year. The purchase agreement calls for Lilly to pay Hybritech shareholders approximately $26 per share, consisting of $22 in cash or convertible notes, and warrants, valued at $4, to purchase Lilly common stock. Additionally, Hybritech shareholders will receive "one contingent payment unit per share under which they may receive additional cash payments of up to $22 per share, depending upon Hybritech's operating results through 1995," the companies said. "While there can be no assurance, Hybritech believes that the contingent payment unit may have an initial trading value of approximately $3 per Hybritech share." Lilly noted: "Both the warrants and the contingent payment units are intended to be tradeable instruments." Lilly's offer represents a modest premium over Hybritech's closing stock price of 25 on Tuesday, Sept. 17 -- - the day before the merger announcement. Including the contingent payment, Lilly and Hybritech are valuing the offer at $29 per share. After a quick view of the offer, the "Street" is placing $27-28 per share value on the transaction. The stock closed the week ended Sept. 20 at 27-1/2. Hybritech management is expected to stay on after the transaction goes through, Lilly said. The business will be included in Lilly's pharmaceutical division, reporting to group president Eugene Step. The deal is subject to approval by Hybritech shareholders. Owners of about 30% of Hybritech shares outstanding have granted Lilly options to buy their shares, Lilly said.

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