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

Summary

  • Merck is proposing to buy Idenix in order to boost its hepatitis C drug development.
  • The deal carries a huge premium, demonstrating Merck's commitment to hepatitis C.
  • Stakes are high, as potential benefits are huge.

Merck (NYSE:MRK) surprised the market on Monday by announcing the acquisition of Idenix Pharmaceuticals, which focuses on the discovery and development of drugs to cure hepatitis C.

Combined with its own offerings, Merck aims to gain a strong foothold in the large and very promising market for hepatitis C. Success in this multi-billion dollar market is required, with Merck's core operations no longer being able to support the entire valuation of the firm, as revenues and earnings are under pressure.

The Deal Highlights

Merck announced that it has entered into a definitive agreement to acquire Idenix (NASDAQ:IDIX) in a deal valuing the latter at $24.50 per share in cash. The $3.85 billion cash deal has been approved by the board of directors of both companies, and is expected to close in the third quarter of this year.

Merck is interested in the promising portfolio of hepatitis C candidates, based on the expertise in nuceloside/nucleotide chemistry and prodrug technologies.

Idenix's investigational hepatitis C candidates complements Merck's own therapies to develop a highly effective, once-daily, all-oral, ribavirin-free regimen with a treatment period as short as possible.

The Leading Candidates

Idenix has focused on the development of next-generation oral antiviral therapeutics to treat hepatitis C. The company has three candidates in the clinical development stage. These include nucleotide prodrugs IDX21437 and IDX21459, and an NS5A inhibitor.

Merck's own most advanced candidate for hepatitis C is a combination of MK-5172 and MK-8742. The combination of these drugs has received breakthrough status from the US Food and Drug Administration. The combination entered Phase III clinical trials in April of this year.

Merck's research chief, Roger Perlmutter says the company aims to combine Idenix's IDX21437 candidate with Merck's MK-5172 and MK-8742 into a triple therapy. Ideally, this should be able to cure patients with all genotypes or strains of hepatitis C in a period of 4 to 6 weeks. Merck's two own drugs cured 98% of the patients with the most common and hardest genotype 1 variant of hepatitis C.

Idenix has no marketed products at the moment, as it reported revenues of just $0.5 million over the past year, on which the company recorded a net loss of $122 million. The company has no debt outstanding, but holds $205 million in cash and equivalents at its latest quarterly filing.

Hepatitis C - A Hot Area For Pharmaceutical And Biotechnology

Merck is serious about the deal and the development of hepatitis C drugs, which can be seen by the deal premium alone. Before the company announced the deal, Idenix commenced a market valuation of just $1.14 billion, as Merck is paying a nearly 239% premium to acquire the company.

The market for hepatitis C is a hot area after Gilead Sciences (NASDAQ:GILD) saw its drug Sovaldi have a very impressive market debut over the past quarter. The $84,000-drug has seen a very strong debut, as it cures over 90% of patients in an 8-week treatment. The high cost has, however, already resulted in quite some backlash from both health insurers as well as politicians.

Just like Merck is aiming to do, Gilead "bought" its way into the market by acquiring Pharmasset in 2011 for $11 billion. The deal was huge at the time, with many questioning the steep 89% premium paid for a biotechnology company with no working products at that point in time.

Implications For Merck

Merck has a market valuation of roughly $170 billion, at $58 per share. Its shares initially dipped by a percent following the announcement of the deal, but quickly recovered to end the day with modest gains.

Financing of the deal should be easy for Merck, which holds $20.5 billion in cash and equivalents. Total debt of $28.1 billion results in a net debt position of $7.6 billion, which will increase towards $11.3 billion following the deal, as Idenix holds roughly $200 million in net cash. In this calculation is not included the proceeds from the sale of the consumer care business to German-based Bayer AG in a $14.2-billion deal.

Merck posted revenues of $44.0 billion over the past year, as its revenues have been declining for two straight years in a row now. Earnings fell to $4.4 billion, down from two years in a row in which the company posted earnings north of $6 billion. To justify the current valuation of $170 billion, earnings will have to rise significantly in the medium-to-long term future, as the company currently trades at nearly 40 times GAAP earnings.

Fortunately for investors, Merck pays a quarterly dividend of $0.44 per share, which provides them with a 3.0% dividend yield.

Implications For Investors

The stakes are huge in the market for hepatitis C drugs. Historically, this has been a very large market which has been very difficult for drug companies to serve by producing a reliable and safe drug.

The breakthrough of Sovaldi, which costs a shocking $84,000 and generated $2.3 billion in revenues in its first full quarter, has raised interest in the field. With Gilead on track to generate $10 billion or more in revenues from Sovaldi this year, the potential rewards for a successful introduction of a competing drug by Merck are huge.

Back in April, I last checked out the prospects for Merck. So far this year, shares have already risen 15% on the interest for the pharmaceutical and biopharmaceutical sector in particular. The Bayer deal and momentum related to anticipated drug launches, including its hepatitis C offerings, have been helpful as well.

That being said, the core business is reporting a decline in revenues and earnings, while the company will no longer see the contribution of the consumer care business. As such, a new blockbuster is required in the near-term future. Given the momentum witnessed already this year, investors have high hopes for the hepatitis C program, and the latest deal only underlines Merck's commitment to the program. Merck aims to deliver on its promises, and therefore, it is "happy" to pay a multi-billion premium for a drug candidate which can accelerate its ambitions in the multi-billion dollar opportunity which is still up for grabs.

I remain cautious, as there are still hurdles on the road and the company has much more to prove to justify the valuation or creating compelling appeal.

Source: Merck - Getting Serious About Hepatitis C After Acquiring Idenix