Alza and Bio-Electro Systems

ALZA and Bio-Electro Systems

1. ALZA, a pharmaceutical company that has led the industry for over a decade, has been largely successful due to their unique technical innovation. Rather than specializing in discovering new drugs and treatments for medical conditions, ALZA instead focuses their pharmaceutical talents on developing new methods to deliver drugs to patients. From skin patches to time released capsules, ALZA captures their market by providing their technologies to all major pharmaceutical companies, in return charging royalties that has led the company to realize immense consecutive profits. However, drug delivery technologies are constantly evolving, which has caused more effective and efficient methods to appear at a rapid rate. While ALZA is a leader in its industry, it needs to invest in advancing their own technologies if it wants to enjoy its current state of profitability, growth, and leadership. To implement this effort of advancing its drug delivery technologies, Martin Gerstel, CEO of ALZA, approved a 40 million dollar proposal to aid in developing its technologies. Yet, the solution wasn't nearly as simple as they had hoped, the company still needed to develop a method of organizing and paying for the 40 million dollar project. The company came up with three options:

a. Utilization of ALZA's own assets to finance the new venture

b. Partnership with a leading pharmaceutical company to establish a joint venture

c. Establishing a partly owned Research and Development organization funded by both ALZA and investors in equity

The first option is the most obvious method that has been utilized by many companies before ALZA, however it is not the most financially efficient method for ALZA to implement. By utilizing their own assets, their balance sheet will be severely impacted on the right side, which could cause a massive negative impact on the company's stock price. Many don't realize that a decrease in a company's equity price will ultimately increase their cost of capital which will in turn also increase their interest expense. This option will also not blow over well with ALZA's shareholders. By utilizing much of their own financial capital, ALZA would be bearing much more risk, thereby diminishing why the company is so attractive to equity holders in the first place. ALZA is regarded as having very low risk but also is associated with a high return. If anything threatens that state, shareholders will ultimately reject it.

To lessen these risks and impacts on their balance sheet, the company could partner with a major pharmaceutical company. While it will not impact its current earnings, it could prove to have negative impacts down the road, especially if the company's partner were to take ALZA's technologies and sublicense it to others; ultimately taking away potential profits in the future.

Thus, the third option seems the most financially feasible. While it still is a risky proposal, the risk associated with the funding and development of the new drug delivery technologies is completely independent of ALZA as a company. It also provides this opportunity of a potential high return to those investors seeks a high risk/return investment, rather than the current ALZA shareholders who are very content where they are currently at.

2. Being an investor in Bio- Electro systems you would realize the regular payoffs a stock until the stock reaches a value of 23 dollars a share, at which points you assume that ALZA will buy the stock back from you. At that point your return on the stock flatlines, for regardless of whether the stock drops to a value below 23 dollars, ALZA has already bought your shares from you and you are no longer accountable for those losses:

Terminal Payoff Diagram for Bio-Electro Systems' Shareholders

(Stock Ð'- Call with exercise price of 23 dollars)

Terminal Payoff

Bio-Electro Systems Stock