The battle for control of Vectura Group Plc has put shareholders and the board in a bind, forced to decide if the highest bidder for the U.K. health care company is also the best owner.

It’s a dilemma thrown up by the nature of the two suitors. After private-equity firm Carlyle Group Inc. made the first foray, tobacco giant Philip Morris International Inc. jumped into the fray with a higher bid. A round of back-and-forth increases has given Philip Morris the upper hand on price, while Carlyle maintains that it’s a more suitable parent than a seller of cigarettes.

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As it’s a cash-only bid, Vectura investors could choose to simply take the Marlboro-maker’s money and move on. But the optics of putting asthma drugs and cigarettes under the same roof are testing investors’ commitment to the environmental, social and governance credentials that have become central policy pillars of financial markets. Some asset managers are outright barred from doing business with arms manufacturers or tobacco giants, regardless of the returns these so-called vice stocks may promise.

“The acquisition could create a positive feedback loop whereby the company would be firstly paid for selling tobacco products, and then secondly paid for treating patients with diseases they could have received from those same products,” said Pirc, the U.K. shareholder advisory group, which recommends investors reject the Philip Morris bid.

The showdown will come to a head this week when Philip Morris is set to decide on its next move. Carlyle has already said it won’t raise its bid again beyond the current 155 pence per share, or 958 million pounds ($1.3 billion). The competitor could boost its offer—already 10 pence higher than Carlyle’s—to a level that will make it hard for investors and the board to refuse.

Another increase would have the benefit of voiding commitments that Carlyle has secured from shareholders representing about 11{d847ba2f23daf15c773bda6cb71ac33aa9166b9578a171d654c6e3c528a0b6bc} of Vectura’s issued shares. But Carlyle has played up its credentials, saying its offer, while financially inferior, is in the best interests of “broader stakeholders,” including the scientists who work at the maker of asthma medicines.

Corporate Morality

The blowback against Philip Morris from the health-care community has been swift and harsh. The European Respiratory Society, whose constitution and bylaws reject any links—real or perceived—to smoking, has warned the deal is likely to be financially detrimental to Vectura, as health professionals will avoid prescribing drugs from any company that enriches the tobacco industry.

The society has urged U.K. regulators to intervene in the interest of protecting public health and confidence in essential medical supply chains. The U.S. COPD Foundation fighting the causes of lung disease has meanwhile said that a marriage of Vectura and Philip Morris “stretches the boundaries of corporate morality.”

Carlyle, Vectura and Philip Morris declined to comment for this story.

Michael R. Bloomberg, founder and majority owner of Bloomberg News parent Bloomberg LP, has been a longtime champion of tobacco control efforts.

The focus on ESG policies has grown in recent years, creating a new market force that has caught some companies off guard. Exxon Mobil Corp. was pushed to appoint activist board members focused on environmental issues after a hedge fund gained the support from giant investors like BlackRock Inc. Food-delivery company Deliveroo Plc tanked on its trading debut in London in March after some investors sat out the IPO, deterred by perceived poor ESG credentials and questionable labor policies that have prompted labor strife.

Board Choices

Vectura’s board faces the dilemma of looking out for the wellbeing of the company, while performing its fiduciary mandate by recommending the highest bid. Some investors argue that shunning Philip Morris denies the company—and really any industry trying to build a better future—the opportunity for change.

Few attempts at corporate realignment have been as audacious as a cigarette maker angling for an asthma company. Philip Morris says it’s all part of a transformation to embrace a smoke-free future. Aside from cigarette alternatives such as heated tobacco and vapes that are considered less destructive to health, that strategy involves an entire new business area that’s not linked to nicotine. Philip Morris aims to generate at least $1 billion in sales from non-nicotine products by 2025.

For now, the battle for Vectura has given Carlyle the moral upper hand, a somewhat unusual position for a titan of the private-equity industry often associated with short-term gains. To blunt that argument, Carlyle has said it plans to speed up Vectura’s expansion, under the expertise of managing director Simon Dingemans, who was previously finance director at GlaxoSmithKline Plc.

Financial Firepower

Investors that have exclusion policies on tobacco will have trouble bankrolling such transformations, whereas more “engagement-minded” shareholders who want businesses to evolve will find it interesting, said Daniel Klier, former global head of sustainable finance at HSBC Holdings Plc and now chief executive officer of ESG data company Arabesque S-Ray.

From oil companies buying into wind and solar, to car companies dropping the combustion engine, to fast-food chains selling salad—corporations around the world are trying to wean themselves off products seen as unhealthy for people and the planet.

“Is it good or bad that Shell and BP are investing heavily in renewables?” Klier said. “I would say it is probably a good thing as they have great financial firepower. There’s an element that ESG experts need to understand, too, that if you want good companies to prosper they need access to capital and networks.”

—With assistance from Suzi Ring, Naomi Kresge, Alastair Marsh and Lucca de Paoli.

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