The Story Behind Cellular Dynamics’ Sale to Fujifilm

Xconomy Wisconsin — 

Last week, Cellular Dynamics International CEO Bob Palay described the $307 million acquisition of his company by Fujifilm as a union of two businesses that “share a common strategic vision for achieving leadership in the field of regenerative medicine.”

In a March 30 press release announcing the deal, Palay predicted that combining their technologies—and tapping into the Tokyo-based conglomerate’s resources—“brings us ever closer to realizing the promise of discovering better, safer medicines and developing new cell therapies.”

All of that might prove true, but it doesn’t tell the full story of why Madison, WI-based Cellular Dynamics (NASDAQ: ICEL) decided to sell to Fujifilm, which is known for its camera film business but has been expanding into pharmaceuticals and other healthcare products.

Details of the deal-making process, disclosed in an SEC filing four days after the acquisition’s announcement, suggest this wasn’t necessarily a match made in heaven. Cellular Dynamics, also known as CDI, was partly motivated by financial obligations that pressured it to inject new capital into the business, and its leaders ultimately decided the acquisition was the best option on the table.

Palay declined to comment for this article because the transaction is subject to regulatory approvals and hasn’t closed.

CDI, founded in 2004 by University of Wisconsin-Madison professor and stem cell pioneer James Thomson, has built a steady business manufacturing living human cells in massive quantities. The technology is based on induced pluripotent stem cells: taking tissue from donors, CDI’s scientists coax the cells back to an embryonic-like state, then direct them to turn into desired cell types such as neurons and heart, liver, and retinal cells. The technology has applications in drug toxicity testing, cell banking, and the development of experimental cell-based therapies that could in theory heal or regrow body parts.

CDI netted $40.8 million in an initial public offering in July 2013. It generated $16.7 million in revenue last year, up nearly 42 percent from the previous year, but was still $30.6 million in the red.

By summer 2014, CDI was at a financial crossroads. It was facing a looming February 2015 deadline to begin repaying the principal on its credit facility—a $12 million loan taken out a month before the IPO, according to SEC filings. At the same time, it was spending significant amounts of cash on research and development and other expenses. Company leaders determined they would need to refinance the debt and/or raise new capital, according to last week’s SEC filing.

Over the next several months, CDI explored various options, ranging from selling more stock to the public, to new business partnerships, to an outright sale of the company. Besides Fujifilm, CDI execs talked with at least eight unnamed potential business partners during that time, the SEC filing says.

To buy some time, CDI tried to hold down its costs, in part by limiting new hires, the filing says. CDI employed 155 people at its facilities in Madison and Novato, CA, at the end of last year, up slightly from 128 at the end of 2013.

The company also tried to get an extension of the loan repayment period, but the agent administering the loan—major CDI shareholder Sixth Floor Investors, which is led by Daniel Pritzker—denied CDI’s request twice.

CDI officials tested the waters of a stock sale in mid-November meetings with investment banks and mid-February “road show” presentations to potential investors. But CDI didn’t pull the trigger on that option because the company’s stock was trading so low—ranging from $5.25 to $7.23 per share during those periods—that issuing more equity would significantly dilute the value of existing stockholders’ shares, the SEC filing says.

CDI and potential business partners held a series of discussions around limited collaborative agreements in some cases and full mergers in others. Fujifilm emerged as the lead candidate. Talks with other companies stalled or completely broke down for various reasons, including one potential partner being unwilling or unable to execute a partnership as quickly as CDI wanted, and another that made an acquisition offer that was lower than company shareholders would accept.

CDI officials first met with Fujifilm leaders in Japan last June. In an Oct. 21 meeting at Fujifilm’s headquarters, the corporation proposed buying a nearly 20 percent stake in CDI and the rights to distribute CDI products in Asia, and forming a joint manufacturing venture in Japan that would be 80 percent owned by Fujifilm. Fujifilm described the proposed deal as a first step toward a potential acquisition of CDI, the SEC filing says.

At a Nov. 12 meeting in Chicago, CDI made a counteroffer that would, among other things, reduce Fujifilm’s stake to 10 percent, limit its distribution rights to just Japan, and put CDI in charge of the Japanese joint venture. Fujifilm’s representatives said that deal wasn’t likely to fly with company management, and suggested the company might instead be interested in buying a 51 percent controlling stake in CDI.

Talks later shifted to Fujifilm acquiring all of CDI’s outstanding shares. During a Jan. 11 CDI board conference call, board members said Fujifilm’s offer to purchase the shares at a range of $13 to $14.50 per share was “unacceptably low,” and asked Palay about other prospective buyers. He reportedly named five possible suitors, “but indicated he did not believe any of these parties would be interested,” the SEC filing says.

Negotiations between CDI and Fujifilm heated up, and CDI decided not to pursue other bidders, in part because dealing with one suitor meant reaching an agreement more quickly, as well as avoiding additional sharing of intellectual property with outsiders and potential disruptions of existing partnerships. Plus, CDI leaders believed “other parties were unlikely to be interested in acquiring the company for the price”— $15.50 per share at the time—“and on the timeline being discussed with” Fujifilm, the filing says.

The two sides worked out the kinks from January through March, and ultimately both companies’ boards unanimously approved Fujifilm’s purchase of all CDI stock for $307 million in cash, or $16.50 per share. That’s more than double CDI’s closing stock price on March 27, the last trading day before the boards approved the deal.

At least one shareholder disagrees that Fujifilm’s offer was fair and attractive. Michael Kahl of Oregon, WI, filed a class-action lawsuit last week challenging the sale in part because he feels it unfairly benefits the company’s board members and fleeces outside investors like him.

If the sale goes through, it raises a number of interesting and important questions:

Will this deal help Fujifilm, which has been making a push into regenerative medicine through acquisitions and in-house research, become a big player in this emerging industry?

Will CDI and Fujifilm help fulfill the promise of regenerative medicine by delivering cell-based therapies to market, either on their own or in partnership with pharma companies?

Under different financial circumstances, would CDI have continued building the business solo? And all things being equal, would Fujifilm have been its first choice for a buyer?

Time will answer the first two questions. We can only guess at the latter two.