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Summary

  • Merck has plenty of cash and cash equivalents on its balance sheet to continue making acquisitions.
  • Acquiring Mast Therapeutics would provide Merck with a competitor to Pfizer's sickle cell drug being developed and licensed through GlycoMimetics.
  • The net cash position of Mast Therapeutics and the billion-dollar U.S. market size of sickle cell drugs provides Merck with a favorable risk-reward scenario.

As we approach the midway point of 2014, merger and acquisition activity in the healthcare sector is heating up. With the big headliners like the attempted Pfizer takeover of AstraZeneca and the three-way deal between GlaxoSmithKline, Novartis and Eli Lilly, the sector is back in focus. Just a few months ago, many in the investment community were warning of a bear market in the biotechnology industry. Since then, the industry has steadily rebounded and is on pace to test its February highs.

Merck & Co. Inc. (NYSE:MRK) is another company that has conducted some recent M&A activity, with its proposed acquisition of Idenix Pharmaceuticals, Inc. for $3.85 billion. Merck is hoping this acquisition provides it with a serious hepatitis C contender to Gilead Sciences' blockbuster drug, Sovaldi. At the end of Q1 2014, Merck had approximately $15.8 billion in cash and cash equivalents on its balance sheet. After factoring in this acquisition, it will have about $12 billion in cash and cash equivalents. This leaves the company with ample cash to conduct additional M&A in order to diversify its drug portfolio. One drug that could be a strong addition to Merck's drug portfolio is MST-188.

MST-188 is in a Phase III clinical trial for treating sickle cell disease. The drug is being developed by Mast Therapeutics, Inc. (NYSEMKT:MSTX). Currently, there are no drugs on the market for the treatment of patients experiencing an ongoing vaso-occlusive crisis, or VOC. VOC is a painful and debilitating condition that occurs intermittently throughout the life of an individual with SCD. MST-188 is the most advanced drug for treating VOC, and has already undergone a partial Phase III clinical trial. The trial was conducted by SynthRx, Inc., and reported in Jama in 2001. SynthRx, which was acquired by Mast in 2011, ran out of funding and was unable to complete full enrollment. The results of the partial trial failed to show statistical significance by only five patients. However, statistical significance was shown in children aged 15 years or younger, and in patients who were receiving hydroxyurea. This trial only enrolled 255 patients, while Mast's Phase III trial plans to enroll 388 patients. Mast's trial is enrolling patients between the ages of 4 and 65. The company has sufficient funding to complete the trial, and has a high chance of showing statistical significance as a result. No safety issues were noted in the partial trial. More than $1 billion is spent annually in the U.S. in treating patients with SCD. MST-188 currently has orphan drug status for treating SCD and acute limb ischemia. If approved for treating SCD, Mast would have first-mover advantage for treating patients with an ongoing VOC, and could gain a significant amount of market share.

GlycoMimetics, Inc. (NASDAQ:GLYC) is also developing a drug for the treatment of VOC, and plans to initiate a Phase III clinical trial of rivipansel. In October 2011, GLYC and Pfizer entered into a collaboration and exclusive license agreement for the drug. The potential value of the agreement for GLYC is $340 million. GLYC's market capitalization at the time of writing this article is about $133 million, while Mast's is about $75 million. As of Q1 2014, Mast has $49.6 million in combined cash and cash equivalents and short-term investments. The company has only $9.6 million in liabilities, most of which relates to accounts payable. Based on a comparable company analysis with GLYC as the peer, the potential acquisition price of Mast could be around $1.16 per share, if Merck were to pay GLYC's current market capitalization. Factor in the net cash received from the transaction, and the acquisition would only cost Merck approximately $93 million, if Mast were to agree to the deal. This is less than 1 percent of Merck's estimated cash and cash equivalents, which is below de minimis. This purchase price would a big discount, based on the potential size of GLYC's licensing agreement with Pfizer. Mast's operating expenses for 2013 were about $22 million, and this also needs to be factored in to the risk profile of the acquisition. The estimated primary completion date for the MST-188's Phase III trial is December 2015. Although an acquisition or licensing agreement prior to the Phase III clinical readout is the riskiest and least likely scenario, waiting until after the trial results could lead to a higher price tag if the primary endpoint is met.

Merck's recent tender offer for Idenix shows that the company is willing to deploy a large amount of capital in order to gain a position in a market with an unmet need to drive future company growth. SCD is another market with an unmet need. On Merck's website, under areas of interest for licensing, late-stage opportunities that are Phase III-ready or later is listed as one of the areas of interest. The acquisition of Mast or licensing of MST-188 would be in line with Merck's growth strategy due to the above. In addition, Merck has the benefit of being able to analyze the partial Phase III trial data to assess safety and efficacy, which reduces its risk.

On June 19, 2014, Mast announced the appointment of Howard C. Dittrich, M.D., F.A.C.C., to its board of directors. From June 2003 to February 2012, Dr. Dittrich served as chief medical officer and senior vice president of Clinical and Regulatory Affairs at NovaCardia, Inc. In September 2007, NovaCardia was acquired by Merck for $350 million. Dr. Dittrich brings a wealth of experience to Mast's board for cardiac therapeutic research and drug development. Mast is also developing MST-188 for treatment of acute limb ischemia, and recently initiated a Phase II clinical study. Earlier in the year, the company obtained AIR-001 through the acquisition of Aires Pharmaceuticals, and intends on developing it for use in pulmonary arterial hypertension and pulmonary hypertension. Dr. Dittrich's experience is more geared towards the development of these drugs. While these drugs are also promising, MST-188 for use in SCD would be the best fit for Merck's drug portfolio. Dr Dittrich's appointment could facilitate any potential acquisition talks, assuming he still has a relationship with key opinion leaders within Merck.

On January 22, MSTX made a high of $1.10. Ever since then, the stock has been trending down. On June 20, the stock finally broke through its downtrend line. See the chart below, taken from freestockcharts.com. This means the new uptrend has begun. Some of the stock's key resistance levels are at $0.72, $.80, and $0.92. Above-average volume will be needed to take out these levels of resistance.

(click to enlarge)

The first half of 2014 has been very exciting for M&A activity in healthcare sector. Mast is at a pivotal stage in its history. Its drug portfolio is very promising, and could attract a larger pharma company as its MST-188 Phase III clinical trial in SCD approaches the midway point. Merck has plenty of cash on its balance sheet to continue acquiring smaller pharma companies, and MST-188 would be a great addition to its drug portfolio. The risk-reward profile of this potential acquisition is very favorable to Merck, due to the late-stage development of MST-188 in SCD, Mast's large net cash position, and the market size of SCD. With or without an acquisition or partnership, MSTX remains a speculative play, with the potential to provide patient investors with a multi-bagger gain. One notable institution that recently purchased 3 million shares of MSTX is Baker Bros. Advisors, LLC. This firm made a large bet on ACADIA Pharmaceuticals when its stock was trading around $2 per share. ACADIA made a high of $32 back in February 2014. Following the smart money tends to be the best strategy, and the smart money is now buying MSTX shares.

Microcap biotechnology investing is one of the riskiest forms of investing. Losses from investing in microcap biotechnology stocks can be substantially greater than in larger-sized stocks due to liquidity risk and other company-specific risks. Mast's cash burn rate is about $6.3 million per quarter. The company has sufficient cash to fund operations beyond 2014. However, the company has a sales agreement in place with Cowen and Company, Inc., and can sell stock whenever it chooses under an at-the-market offering. This poses a dilution risk to investors. Biotechnology stocks are known for extreme volatility. Daily percentage changes in excess of 50 percent in either direction are not uncommon for small stocks within the industry when material company news is announced. Extreme caution should be used when investing in microcap biotechnology stocks like MSTX.

Disclaimer: I am not an investment advisor and do not provide specific investment advice. This article is for informational purposes only and is not a buy or sell recommendation. I do not attest to the accuracy or completeness of the information in this article. Please consult your investment advisor before making an investment decision.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Source: Mast Therapeutics' MST-188 Would Fit Well In Merck's Drug Development Pipeline