Failed But Not Forgotten: The Sequenom Tax

Despite failing in its hostile bid to acquire EXACT Sciences, the proposed Sequenom takeover yielded a tax strategy that would have shielded shareh...
Robert WillensFebruary 19, 2009

Bob Willens 2

Early last month, Sequenom Inc., a maker of genetic analysis products, attempted a hostile takeover of EXACT Sciences Corp., a genomics company working on cancer cures. By January 28, Sequenom withdrew its bid after EXACT Sciences entered into an intellectual property deal with Genzyme Corp., something Sequenom previously said would cause it to abandon the deal.

Although both companies say a merger is no longer an option, the tax implications of the proposed deal were interesting and worth noting, as other companies may find Sequenom’s two-step tax play useful. Here’s how Sequenom would have set up the deal had the business issues been resolved.

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Sequenom proposed to acquire all of EXACT Science’s stock through a two-step process embodying both a tender offer and a “back-end” merger. For the merger to proceed, at least 75 percent of EXACT Sciences’s shares had to be obtained in the tender offer phase of the transaction.

To make sure that happened, a newly-created subsidiary of Sequenom, ESC Acquisition Subsidiary (ESC), would offer to exchange each of the shares of EXACT Sciences for $1.50 in Sequenom common stock pursuant to the “exchange ratio.”

The exchange ratio is a fraction equal to the quotient of $1.50 divided by “the Sequenom stock price give certain thresholds. That is, if Sequenom stock price was more than $28.06, the exchange ratio would have been fixed at 0.0535 of a share of Sequennom common stock. If the stock price was less than $20.74, the exchange ratio would be 0.0723 of a share of Sequenom common stock.

In addition, the tender offer would have been followed by a merger of ESC and EXACT Sciences, in which the remaining shares of EXACT Sciences would have been converted into the same number of Sequenom shares that stockholders whom participated in the tender offer received.

By the time all the dust settled, EXACT Sciences would have emerged as a wholly-owned subsidiary of Sequenom, and the former EXACT Sciences shareholders would have owned about three percent of Sequenom’s outstanding stock.

Integrated Transaction

The tender offer documents noted that for federal income tax purposes, the exchange offer and the proposed merger, taken together, were intended to qualify as a reorganization. Accordingly, the exchanging shareholders would not recognize gain or loss on the swap of their EXACT Sciences stock for Sequenom stock. Further, the documents said that a holder of EXACT Sciences stock who receives shares of Sequenom stock would have to recognize a taxable gain or loss if the exchange offer was completed, but (1) the proposed merger did not occur; or (2) the proposed merger did occur but was not “integrated” with the exchange offer – as could be the case if the proposed merger was delayed substantially beyond the completion of the exchange offer.

Clearly, if the exchange offer was completed, but the merger was not, the EXACT Sciences shareholders who surrender their EXACT Sciences stock for Sequenom shares would have been taxed on the exchange. Indeed, in this case, the exchange would not have qualified for tax-free treatment as a reorganization.

The only variety of reorganization available in this instance would have been the so-called “B” reorganization, but the requirements would not have been met. To qualify for B reorganization status, the acquiring corporation must (after acquiring stock of the target corporation in exchange solely for shares of its voting stock) be “in control” of the target corporation. Here, the control requirement would not be satisfied because control is defined as ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote – and at least 80 percent of the total number of shares of each class, if any, of the non-voting stock (see Section 368(c) of the tax code).

So if the exchange offer was consummated between shareholders of the two companies, but the merger was not, it is clear that immediately after the exchange offer occurred, Sequenom would not have been in control of EXACT Sciences.

If however, the exchange offer and the merger are each consummated, there seems to be little doubt – regardless of the length of time that elapses between the two steps – that the steps would be integrated. In that case, the integration constitutes a reorganization. As a result, an EXACT Sciences shareholder would recognize neither gain nor loss on the exchange of EXACT Sciences stock for Sequenom stock.

The IRS Ruled

Integration of the steps is supported by several Internal Revenue Service pronouncements and one in particular addresses a transaction virtually identical to the one that Sequenom attempted to complete. That transaction is described in a 2001 Revenue Ruling (Rev. Rul. 2001-26, 2001-1 C.B. 1297.)

In the ruling, Pi Corporation and Tau Corporation are each widely-held and publicly-traded. Pi seeks to acquire all of the stock of Tau. The acquisition will be completed by means of a tender offer for at least 51 percent of the Tau stock, to be acquired solely in exchange for Pi voting stock. The exchange is followed by a merger of Sigma Co. – a Pi subsidiary – with Tau.

As part of the deal, Pi acquires 51 percent of Tau’s stock in the tender offer phase of the transaction. Immediately thereafter, Pi forms Sigma and the subsidiary merges with Tau. In the merger, each of the shareholders of Tau (other than Pi), holding the remainder of the Tau stock, exchanges the stock for consideration consisting of two-thirds Pi voting stock and one-third cash.

When all is said and done, Sigma has become a direct, wholly-owned, subsidiary of Pi and the former Tau shareholders have exchanged their Tau stock for a combination of Pi voting stock and cash.

The ruling observes that under the tax code – specifically Section 368(a)(2)(E) – a transaction otherwise qualifying under Section 368(a)(1)(A) will not be disqualified as a reorganization by reason that stock of a corporation in control of the merged corporation is used to compensate the shareholders of the acquired corporation.

But that is only the case if in the transaction former shareholders of the surviving corporation exchange an amount of stock in the surviving corporation – that constitutes control of that company – for voting stock of the controlling corporation. The ruling concludes that, “under general principles of tax law, including the step-transaction doctrine, the tender offer and subsequent merger (even if it occurred, we can surmise, a “considerable” period of time following the completion of the tender offer) are treated as an integrated acquisition by [Pi] of all of the [Tau] stock.” 

The principles of a 40-year-old court case, King Enterprises v. United States, 418 F.2d 511 (Ct. Cl. 1969), support the conclusion. That is, because the tender offer is integrated with the merger, the tender offer is treated “as part of the merger.” Consequently, the IRS revenue ruling deduces that the integrated steps must be evaluated together to determine whether the requirements, most notably the “control for voting stock requirement” of Section 368(a)(2)(E), are satisfied. They were.

Consider that, “in the transaction” (the tender offer and the merger) the shareholders of Tau exchanged an amount of Tau stock constituting in excess of 80 percent of the voting stock of Tau for Pi voting stock. Therefore, the control for voting stock requirement is satisfied and “the transaction” qualifies as a reorganization.

We have little doubt that if the tender offer and merger that Sequenom had planned were each consummated, the two steps would have been integrated, even if such steps were not taken in close time proximity. The result would have been a transaction, comprised of the tender offer and the merger, that constituted a reorganization within the meaning of the tax code (Section 368(a)(2)(E).) Accordingly, no shareholder of EXACT Sciences, whether her stock is exchanged in the tender offer or merger phase of the transaction, would have had to recognize gain or loss on the exchange. (See Sec. 354(a)(1).)

Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for