If Achillion Was Going To Be Taken Out At A Big Premium, Baupost Would Probably Own It

Summary

Achillion shares have increased 165% since Merck's acquisition of Idenix was announced.

Investors seem to be expecting that there is the potential for Achillion to be taken out at a signficant premium to its current price.

However, Baupost, the shareholder who knew Idenix best, does not have a meaningful stake in Achillion suggesting that investors are misguided.

Sell-side brokers touting the stock have different incentives than investors and should not be relied upon.

Achillion (NASDAQ:ACHN) shares have rallied an astounding 165% ($450 million increase in market value) following the news that Idenix (NASDAQ:IDIX) would be acquired by Merck (NYSE:MRK) for nearly $4 billion (a 240% premium to its share price). Investors seem to expect that not only is a bid for Achillion likely, it is imminent. While it is commonplace for investors to speculatively bid up the price of 'peer' companies following the announced acquisition of a competitor, I believe investors are overlooking a critical piece of information. There is one investor which seemed to know Idenix better than most everybody else. That investor, Baupost (led by famed value investor Seth Klarman), owned a whopping 35% of Idenix. However, it is important to note that Baupost is not listed among major shareholders of Achillion (thus if it held/holds any shares, it is sub 5%). Thus, while it appears that Baupost was very confident that Idenix had a value significantly above the $5-7 it was trading in the months prior to Merck's acquisition, it doesn't appear that Baupost saw much value in Achillion - even at $2.50-3/share.

Why is Baupost's absence significant?

Baupost's absence is significant for two reasons. Firstly, in the process of buying shares in Idenix, Baupost most likely did a highly detailed study of not only Idenix but also looked at Idenix's industry and competitors. Given that Baupost took a 35% stake in Idenix, it clearly had a superior understanding of the company, its competitive positioning, and potential. In the process of researching the company, it's almost certain that Baupost encountered Achillion, but decided to pass (though I don't know why) even at a $2.50-3/share value. This makes me think that Achillion has significant disadvantages relative to Idenix and that Baupost passed for a reason. This is even more likely to be the case in a situation where Baupost took such a large stake in Idenix - Baupost manages ~$27 billion in assets and took a 35% stake (raised from 25% in 2011). This tells me that Baupost wanted to have very large exposure to the company (and companies like it) - as it is very rare to see a hedge fund take a stake greater than 10-15% in a company. Taking a 35% stake indicates that Baupost may have wanted to own even more of Idenix, but didn't breach 35% because of one or more of the following considerations: 1) internal guidelines capping ownership at 35% (2) Idenix management didn't want any shareholder larger than 35%. Assuming it wanted to own an even larger stake in Idenix, this increases the likelihood that Baupost took a reasonably close look at Achillion but passed.

The second reason Baupost's absence is notable is that the fund has proven to be not only one of the best investors, but one of the most successful biotech investors. Looking back over time, Baupost has successfully invested in a number of biotech takeouts, including Facet (acquired by Abbott Laboratories), Elan Corporation (acquired by Perrigo) and has profitably invested in Theravance.

What about all of the sell-side rating increases/sell price target increases?

As I've written time and time again, sell-side brokers are riddled with conflicts of interest, as they are typically wedded to investment banks. In the case of Achillion, I suspect bankers are seeking to position themselves favorably with management to benefit from a possible capital raise. As the shares have risen significantly, I expect that Achillion management may look to increase its cash balance by selling new shares - such a share sale could garner a nice fee for investment bankers touting Achillion shares. Recall that after Intercept Pharmaceuticals (NASDAQ:ICPT) announced positive news regarding OCA, the 'analyst' at Merrill Lynch put an $872/share price target (when the stock was selling at over $300). While the target looks ridiculous today (with shares at $280), it was effective in securing Merrill a place in Intercept's secondary share offering (likely earning Merrill a fee of $1 million+). My point is that if you are looking to Wall Street 'analysts' for guidance, you are likely to be misguided as their interests differ widely from those of an investor.

Disclosure: The author is short ACHN. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.