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Shareholders in Amgen (AMGN) were relieved after the company announced the acquisition of Onyx Pharmaceuticals. Executed at $125 per share, investors were relieved that the company did not pay even more for the company.

The deal adds nicely to Amgen's drug pipeline and future revenue prospects, thereby filling up gaps in Amgen's drug pipeline. After recent strong momentum I remain on the sidelines on the back of a fairly high valuation.

The Deal

Amgen finally announced that its board of directors unanimously approved the deal to acquire all outstanding shares of Onyx Pharmaceuticals (NASDAQ:ONXX) for $125 per share.

The total purchase price amounts to $10.4 billion, or $9.7 billion striping out the net cash position of the firm.

Onyx focuses on the development and commercialization of innovative therapies to improve the lives of cancer patients. Onyx's crucial medication Kyprolis has already been approved in the US.

The firm furthermore has three partner assets. This includes Nexavar and Stivargo, both tablets which are developed with Bayer Healthcare Pharmaceuticals. Onyx furthermore partnered with Pfizer (NYSE:PFE) for palbociclib.

Onyx holds the global rights to Kyprolis with exception of Japan. The orphan drug has exclusivity in the US until July of 2019 and Onyx holds patents extending till 2025.

Amgen will add significantly to its pipeline by adding Onyx's innovative oncology portfolio. Amgen intends to achieve synergies by leveraging the development programs and maximize the potential of Kyprolis across the world.

Onyx generated annual revenues of $362.2 million for the calendar year of 2012, on which the company reported a $187.8 million net loss. Amgen believes the deal will lead to accelerating revenue growth and be accretive to Amgen's adjusted net income for 2015.

Note that this is a slightly distorting picture. Revenues for the quarter ending in June more than doubled to $153 million, of which Kyprolis contributed $61 million in sales compared to no contribution last year. This resulted in net losses being cut in half to $53 million. Amgen expects to derive mostly revenue synergies from the deal, from marketing these products across the globe.

Amgen expects that the deal will be closed at the start of the fourth quarter. The deal is subject to normal closing conditions including regulatory approval. To close the deal Amgen will need 50% + 1 shares of Onyx, which is a rather low threshold.

Valuation

Amgen ended its second quarter with $22.02 billion in cash, equivalents and short term investments. The company operates with $23.92 billion in total debt, for a modest net debt position of $1.9 billion. Current cash balances and loans, which carry attractive rates of LIBOR + 104 basis points, are used to finance the deal.

Total revenues for the first six months of the year came in at $8.92 billion, up 4.6% on the year before. Net earnings rose by 9.9% to $2.69 billion. Full year revenues are seen just north of $18 billion, while Amgen expects to report annual earnings of around $5.5 billion.

Trading around $109 per share, the market values Amgen at around $82 billion. This values operating assets of the firm at 4.6 times annual revenues and 15 times annual earnings.

Amgen pays a quarterly dividend of $0.47 per share for an annual dividend yield of 1.7%.

Some Historical Perspective

Long-term investors in Amgen have had a great deal of pleasure from their investment in the company.

For most of the past decade shares have exchanged hands between $40 and $80 per share. Since the start of 2012, shares have risen some $70 to current levels around $110 per share.

An increased market interest in cancer treatment and recent merger and acquisition activity have bolstered prospects for Amgen and the wider industry.

Between the calendar year of 2009 and 2012, Amgen has increased its annual revenues by a cumulative 19% to $17.4 billion. While earnings fell by 6% to $4.35 billion, earnings per share actually increased as the company retired a quarter of is outstanding share base over the past four years.

Investment Thesis

Investors in Amgen initially reacted with great enthusiasm to the deal. Shares jumped almost 10% on Monday following the announcement of the deal to highs around $116 per share. Shares have fallen back a bit ever since, ending up at $109 per share on Tuesday.

Investors were relieved that Amgen ended up paying $125 per share in cash for Onyx, after making an initial offer of $120 for the company in July. Some investors and analysts feared that Amgen would be willing to pay anywhere between $120 and $160 for Onyx. For investors in Onyx, the deal offers a great exit opportunity as shares were trading in their mid-thirties at the start of 2012.

The deal is important for Amgen as the company suffers from a lack of growth in recent times. Therefore it identified the oncology space as a growth area, featuring the most important and highly priced medicines. While current Kyprolis sales totaled just $61 million over the past quarter, some analysts see the potential of $3-$5 billion in annual sales between the period 2020-2025. The drug is expected to be launched in Europe in the second half of 2014.

Kyprolis is used to tackle a common diagnosed blood cancer, multiple myeloma, which is diagnosed at over 20,000 Americans per annum according to the Leukemia and Lymphoma Society. The drug gives Amgen a key drug in the oncology market, but required a more than $10 billion deal, the largest deal after the $16.8 billion acquisition of Immunex back in 2001.

Overall the bet which Amgen makes seems reasonable. Onyx's activities could boost current revenues by some 20-25% if all goes to plan in a few year's time. Yet Amgen is willing to spend 12-13% of its market capitalization to acquire the firm. While the move is bold, it will certainly not bankrupt the company if the deal fails to bring the desired results. Key risks include the "peak" success of Kyprolis, European approval and the development of other drugs in the pipeline.

The deal adds nicely to the future pipeline and should result in meaningful and accretive earnings in 2015, if all goes to plan, allowing the company to fulfill its commitment to increase dividends over time. Note that the company warned that it would not "engage in any significant share repurchase activity in 2014 or 2015." Amgen has focused on the oncology area with 4 out of its 9 late-stage programs including oncological compounds

Despite the nice addition, I remain on the sidelines. The current valuation is high given the deteriorating pipeline position and "artificial' earnings per share growth on the back of recent sizable share repurchases. The strong momentum over the past year made shares a bit too expensive to my taste.

Source: Amgen: Deal With Onyx Pharmaceuticals A Calculated Bet To Restore Drug Pipeline