Headlines in the biotechnology sector are frequently dominated by M&A news, and as of April 19, there is a new M&A headline to discuss and analyze. Human Genome Sciences (HGSI) has received and rejected a $13 per share offer from GlaxoSmithKline (GSK), its longtime partner of 20 years. However, of several recent biotech deals, this one stands out. Illumina (ILMN) simply rejected Roche's overtures and took many steps to defend itself against the Swiss company's hostile takeover. And Amylin (AMLN) has simply not said anything about Bristol-Myers' (BMY) bid (that should make for an interesting earnings conference call on April 26). Human Genome Sciences, however, announced that it had hired Goldman Sachs and Credit Suisse to conduct a review "strategic alternatives," and invited GlaxoSmithKline to negotiate further with the company, indicating that Human Genome Sciences is now effectively in play. The stock immediately soared right through the offer price, closing on Thursday, April 19 at $14.17, a gain of 97.63% as traders and investors anticipate that either a bidding war will emerge.
Just last week, we recommended that readers buy Human Genome Sciences, and based our thesis on the company's pipeline and the fact that the Street is too pessimistic on Benlysta's potential. And now, a week later, the company is in play. So how should investors proceed from here? We analyze the road ahead below.
Why Reject GlaxoSmithKline?
Takeover speculation involving Glaxo and Human Genome sciences has swirled for years, given the extremely close relationship the two companies have, and how deeply Human Genome Sciences' pipeline is intertwined with Glaxo. And yet, Glaxo waited years to make a bid, only to have Human Genome Sciences reject its offer. Why? The $13 per share offer represented an 81.31% premium. What company turns down that kind of offer? A company whose shareholder's are, for the most part, sitting on deep losses. A look at the company's chart over the past year shows just how deep the losses are.
(click to enlarge)Even when taking into account the post-offer surge, shares of Human Genome Sciences have lost almost half their value over the past year. And according to Bloomberg, which cites "people with knowledge of the matter," that is a key reason why Glaxo's offer was rejected. Bloomberg's sources say that of the Human Genome Science's top 25 shareholders, 22 have an average cost basis above $13, making a takeover difficult to accept. In our recommendation of Human Genome Sciences last week, we cited this factor as a key factor in why a takeover would be difficult to accomplish.
With the majority of Human Genome Sciences shareholders sitting on losses, it is expected that the company will attempt to extract at lease a few more dollars per share from Glaxo before agreeing to a sale. That is one reason why the shares are trading above the offer price. Another reason is that investors are expecting other suitors to emerge, now that Human Genome Sciences has effectively put itself up for sale.
To Bid or Not to Bid?
In our recommendation to buy Human Genome Sciences, we spoke of the difficulties the company may have in securing suitors other than Glaxo. The reason for this is the uniquely deep relationship the two companies have built over the past 20 years. Aside from Human Genome Sciences itself, no company knows more about it than Glaxo. The thinking amongst other pharmaceutical companies was that if Glaxo, with all its knowledge, did not see enough value in Human Genome Sciences to bid for the company, then why should they bid?
But now that Glaxo has officially made an offer, and Human Genome Sciences has put itself up for sale, expectations of a bidding war have soared. According to ISI Group, there are few legal complexities standing in the way of a rival suitor to emerge. None of the contracts outlining the deals between the 2 companies include change of control clauses. Human Genome Sciences has little in the way of takeover defenses, and a deal could be done at around $15-$20 per share. Several potential suitors are named, including Merck (MRK), Johnson & Johnson (JNJ), Abbot Labs (ABT), Bristol-Myers. In addition, Amgen (AMGN) has been mentioned as a suitor. Aside from Glaxo, Amgen has long been rumored to be the company most likely to bid for Human Genome Sciences. On the surface, it makes sense for an outside company to bid for Human Genome Sciences. After all, even at its current price, it still trades at just half of what it did last year, and its drugs have a great deal of potential. Benlysta, despite its slower than expected launch, is still projected to post sales of $2.15 billion by 2016, and the company's heart-disease treatment darapladib, if approved, could see annual sales of $10 billion.
We discount the likelihood of an outside bidder. Human Genome Sciences and Glaxo are intertwined at every level, including Benlysta and most of the Human Genome Sciences' pipeline. As a result, the 2 companies have a 50/50 split on Benlysta, darapladib, and albiglutide, a diabetes treatment. This structure will likely discourage outside bidders. No company bids for another to receive only 50% interest in its drugs. You bid to get complete control, which is why Glaxo will likely be the ultimate acquirer.
The Road Ahead
Despite Human Genome Science's rejection, most analysts believe that a deal between the company and Glaxo will be completed, albeit at a slightly higher share price. Cowen sees the deal being done at $15, and so does JMP. Baird sees the next offer coming in at $19. ISI casts a wider range, predicting a deal between $15 and $20 per share. And S&P upped its price target on Human Genome Sciences to $15, citing that as the most likely takeout price.
Ultimately, we think that after a bit of posturing from both sides, Glaxo will acquire the company for around $15. As Leerink Swan noted, that short of a sudden acceleration in Benlysta sales, Human Genome Sciences will "have to take what it can get without being too aggressive."
So what should investors do at this point in time? If you are not in Human Genome Sciences at this point, we see little reason to initiate a position here, short of merger arbitrage. As for existing stockholders, we see little reason to sell. Human Genome Sciences has put itself up for sale, and we think that now that GlaxoSmithKline has launched an offer, it will not walk away until a deal is reached. The company has made it clear that it wants to take full control of Benlysta and the other drugs it has co-developed with Human Genome Sciences, and we see nothing to indicate that GlaxoSmithKline will stop until it has taken over its longtime partner.
Additional disclosure: We are long shares of JNJ and MRK via the SPDR Dow Jones Industrial Average