Bristol-Myers Squibb Co’s (BMY) plans to acquire Celgene Corporation (CELG) is game-changing. The total deal is worth around $74 billion and will be the biggest deal in the sector since Roche acquired Genetech back in 2009. BMY plans to pay US$ 50 cash plus one share of BMY for every share of CELG, for a combined US$ 102.43 per share. As surprising as the announcement was, the deal looks like it could be net positive for BMY.
Plus, there is also a contingent value right on the table. Existing CELG shareholders will receive US$ 9.00 per share from BMY if the Food and Drug Administration (FDA) approves three of CELG’s pipeline drugs. Overall, the deal should prove fairly lucrative to CELG shareholders, as evidenced by the price moving close to the combined deal price.
The case for BMY is not as clear cut. The market reacted negatively to the news, but the situation is not as straightforward as the price action suggests. It is CELG’s product pipeline, which potentially makes this a good deal for BMY. The products are strategically aligned with BMY’s therapeutic focus and offer much-needed diversification to the product line. It is for this reason that, assuming the deal goes to completion, BMY stock is worth a look at current prices.
A Bitter Pill to Swallow?
Shares of BMY fell 10-15% on the day of the announcement, having closed on the 2nd January 2019 at US$ 52.43 and US$ 45.12 on the 3rd of January. In contrast, the share price of CELG increased, taking the spread to a three month high, by around a 30% margin.
Figure 1. 3-Month history of the share price of BMY and CELG, and the spread
While CELG shareholders view the acquisition as exceedingly good news, the shareholders of BMY view it in a less favorable light. Some of the blame for the sharp decline following the announcement is that the market no longer sees BMY as a target for acquisition itself; some BMY investors have abandoned the idea that they may receive a nice premium on their shares in a takeover and sold their shares.
Also, BMY would be inheriting the issue that CELG currently faces in a critical product, Revlimid, facing generic competition potentially as early as 2021. Revlimid and Pomalyst — two CELG products — offer close to US$ 12.6 billion in current sales for BMY, and generic competition on one of those lines would be unwelcome. Bear in mind, however, that BMY management believes Revlimid revenue for the next three years alone is key to paying for the deal.
The deal will be costly and paying for it will increase the ratio of net debt to earnings before interest, taxes, depreciation, and amortization to around six times. This ratio is expected to fall to about three times after a full year of operations as a combined company, and further if the company chooses to pay down some of the debt. Here is where there is some concern over the earlier than expected Revlimid competition, as sales and profit from this product will hamper the deleveraging that investors will need to see to support the post-merger share price.
The timing of the deal has been explained by BMY management as being due to the upcoming number of short-term launches in CELG’s portfolio, and the strong corporate performance for 2018. Both companies are active in oncology, immunology, and inflammatory conditions treatment, and BMY separately has a cardiovascular presence.
The combined company would have a leading presence in therapies for solid tumors (from BMY) and hematology (from CELG), and according to the management of BMY would be the number 1 oncology franchise. The combined company would expect to launch six new drugs by 2021. It is, according to BMY, the combined portfolio, fuller pipeline, and synergies (worth around US$ 2.5 billion) that make this deal a good one, and not just the extra revenue gained on Revlimid.
(Source: Bristol-Meyers Slides)
Also, there are expectations for the combined company to generate more than US$ 45 billion in free cash flow over the first three years, and BMY management has indicated that they are committed to maintaining the current dividend policy and maintaining the strong investment grade credit rating. The last point supports the company seeking to pay down the debt taken on to pay for the acquisition vigourously.
Key risks to the deal
The deal would need to be approved by shareholders of both companies first and foremost. Initial reaction from BMY shareholders was negative, but it is not uncommon for sell-offs in the acquiring companies stock to occur in deals of this magnitude. CELG stock traded above US$ 100.00 for much of 2017 and 2018, which raises the question of whether they will view the deal price as a fair one. But the past is the past, and comparing the deal price to more recent price history indicates that they will ultimately consider the price reasonable. However, the large spread between the share prices confirms that there is some concern that the deal will close; this is expected in the 3rd quarter of 2019.
Then there are some patent-related events expected over 2019 – 2022, which could be positive or negative for the combined company. Competition for Revlimid is expected in March 2022. There are, however, a number of intellectual property right fillings under review by the Patent Trial and Appeal Board (PTAB), and initial trial decisions expected in late 2019 or early 2020 concerning generic challengers, with final decisions not expected before 2021/2022. If the results go against the company, meaning competition is earlier or fuller than expected, then some impact to the share price is expected.
The consensus view seems to be that assuming the deal completes, the combined company, with realized synergies, and performance in line with what was expected for the separate companies, has significant upside potential.
We agree with this view.
In particular, we like the added diversification and the promise of consolidating the#1 oncology franchise by combining Bristol-Myers, a leader in solid tumors, and Celgene, a leader in blood tumors. We think the products are well-aligned and the pipeline will be strong for years to come.
Though we are quite skeptical of management’s ability to hit lofty post-deal guidance (e.g., non-GAAP EPS accretion of >40% in the first full year), we think current BMY valuations provide sufficient margin of safety anyway. Overall, we like the deal and think BMY is worth a look at current levels.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.