Seeking Alpha
Long/short equity, special situations, value
Profile| Send Message|
( followers)

Shareholders of Cubist Pharmaceuticals (CBST) are reacting positively to the announcement of two large acquisitions made by the firm on Monday after the close.

Shares set fresh all time highs after the antibiotics company announced the acquisition of Trius Therapeutics and Optimer Pharmaceuticals which means a big push for the company's product pipeline in the coming years.

While current earnings are depressed following the modest dilution of the deals and increased research and development spending, the long-term prospects have only become better.

Deal With Trius Therapeutics

Cubist announced that it has entered into a definitive agreement to acquire shares of Trius Therapeutics (TSRX) for $13.50 per share, valuing the company at $707 million on a fully diluted basis.

Shareholders in Trius will also receive a contingent value right, which is entitled to $2.00 in cash if certain commercial milestones are achieved, bringing the total transaction value to $818 million. To be eligible for $1.00 in additional payments, sales in the US, Canada and Europe have to exceed $125 million by 2016. Another $1.00 in payments are made on a pro-rata basis for sales between $125 million and $135 million.

Trius has a late-stage antibiotic candidate named tedizolid phosphate (TR-701) and several pre-clinical antibiotic programs. Tedizolid is an orally administrated oxaolidinone in development for treatment of Gram-positive infections, including methicillin-resistant Staphylococcus aureurs, also known as MRSA.

A new Drug Application will be filed with the Food and Drug Administration in the second half of 2013, while a Marketing Authorization Application will be filed with the European Medicines Agency in the first half of 2014.

For the year of 2012, Trius generated revenues of $27.2 million on which it reported a net loss of $53.9 million. The company operates with a net cash position of $83.6 million.

The deal has already been approved by the board of directors of both companies and is expected to close later this year following regulatory approval and normal closing conditions.

The Deal With Optimer Pharmaceuticals

At the same time, Cubist announced that it reached another agreement to acquire Optimer Pharmaceuticals (NASDAQ:OPTR). Cubist will pay $10.75 per share in cash, for a deal value of $535 million on a fully diluted basis.

Shareholders of Optimer will also receive a contingent value right, which is publicly traded and could result in a net cash payment of $5.00 per share, if sales milestones for DIFICID®(fidaxomicin) are achieved.

Shareholders stand to receive $3.00 per right if net sales in the US and Canada for the two-and-a-half year period up to December 2015 exceed $250 million, which will increase pro-rata towards $5.00 per share in case cumulative sales reach $300 million or more. Including these contingent payments, the total deal value could climb up to $801 million.

Optimer has received approval from the Food and Drug Administration back in May of 2011 for its antibacterial drug, which treats Clostridium difficile-associated diarrhea (CDAD) in adults 18 years of age or older. The market for CDAD is large, with up to 700,000 cases in the US per annum. The occurrences of CDAD has roughly four-folded over the past fifteen years or so.

Both companies already have a two-year agreement in which Cubist promotes DIFICID to hospital and healthcare institutions. The agreement is now extended for another year.

Optimer Pharmaceuticals generated annual revenues of $101.5 million for 2012 on which the company reported a net loss of $37.0 million. The company operates with a net cash position of $93.3 million.

The deal has been approved by the board of both companies and is expected to be accretive in the first quarter after closing. The deal is furthermore subject to regulatory approval and normal closing conditions.

Valuation

Cubist ended its second quarter with $1.00 billion in cash and $408 million in total debt, for a solid net cash position. As such, Cubist has plenty of liquidity to finance both deals.

For the first six months of 2013, Cubist generated revenues of $488.7 million, up 10.5% on the year before. Net income fell by more than 70% toward $21.3 million as research and development efforts almost doubled. At this pace, annual revenues could come in around $1 billion, while earnings could come in around $50 million.

Factoring in gains of 10% in Cubist's shares following the announcement, the market values the firm at $4.1 billion. This values the operating assets of the firm at $3.5 billion, or roughly 3.5 times annual revenues and 70 times annual earnings.

Some Historical Perspective

Shareholders in Cubist had a great run over the past decade. Shares rose from merely $10 in 2004 to fresh all-time highs of $65 following the announcement of these deals.

Between 2009 and 2012, Cubist has increased its annual revenues by a cumulative two-thirds towards $926 million. Net income roughly doubled to $155 million last year, but is pressured on increased R&D spending as major candidates are in the later stages of the pipeline.

Investment Thesis

First of all, I would like to applaud management for the way in which the deals have been structured. Cubist will pay a combined $1.27 billion for the firms upfront and pay up to $350 million in contingent value rights, which shares the risks between current shareholders and Cubist. Factoring the combined net cash position of roughly $175 million, Cubist effectively pays $1.1 billion upfront.

The two deals are significant as the total upfront cash payment alone represents some 30% of Cubist's own market capitalization. While Optimer will contribute directly with meaningful revenues, Trius won't do so yet. Sill the deals will provide a massive boost to Cubist's total pipeline which now contains many end-stage product candidates.

The deals furthermore reinforce Cubist's market position in the antibiotics area, an area traditionally shunned by major pharma companies. Combined, the deals are expected to be accretive to earnings in two years.

For now, investors understand and they have confidence in management given the strong long-term track record. Actually investors applaud management for making these deals, although they will be dilutive to short-term earnings. Short term earnings took a beat already after the company's R&D spending is ballooning on the back of late-stage development products. Still Cubist remains profitable and has plenty of liquidity.

The current valuation of over $4 billion for the firm's equity seems more than justified as the company has already proven to be capable of earning $150 million per annum, like it did last year. This valuation at 27 times last year's earnings could be extremely appealing once multiple products start to come online in the coming years. This knife should cut on both sides, boosting revenues while cutting research and development expenses, resulting in strong profit growth.

Disclosure: I 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.

Source: Cubist Pharmaceuticals: 2 Promising Deals To Bolster Future Pipeline