No sooner than the GlaxoSmithKline (GSK) $2.6 billion offer was announced, Human Genome Sciences (HGSI) made its intentions known that it thought that it was drastically undervalued and rebuked the offer. Instead of carefully weighing the long-term ramifications of it, HGSI hired Goldman Sachs and Credit Suisse to help explore strategic alternatives and promulgate that it was looking for an alternate suitor.
GSK attempted to initiate a well-choreographed Kabuki dance, an art form that would confer some majesty and respectability to the overture to HGSI. The response by HGSI was not a reciprocal Kabuki-style movement toward GSK, but rather a highly dramatized and out-of-step behavior that in no way was in the same character and class as its suitor's dance step. In my estimation, the response by HGSI was strategically ill-advised. I believe this from the standpoint that HGSI has no viable alternative partners and it will immeasurably tarnish the relationship that these two companies have moving forward. This is a classic lose-lose outcome for HGSI. The facts are that GSK started this dance back in the early 1990s and had appreciated, long before it was recognized by its peer group, that HGSI had the intellectual capital to generate some mid- and late-stage contenders relative to its pipeline development. HGSI is a robust incubator of ideas and molecules. As opposed to acquiring them, GSK prudently formed a series of alliances, and agreements, along with their milestone payments and royalties that have served to actually transform the viability, and growth trajectory, of HGSI.
GSK purposefully chose this route to not disrupt the entrepreneurial spirit of HGSI. This is especially critical when a company is in the inception and creative phases of its growth cycle and is spared the constraints imposed by judgment, which thwarts and can annihilate ideas from truly gaining altitude. The chances of discovering and engineering molecules that have a therapeutic effect and are able to successfully meander through the rigors of clinical trials and get approval by the FDA are extremely slight, and even remote. The average cost to bring a drug to market is calculated by the Healthcare Economist at $802 million from Phase I clinical trials to approval.
GSK, as a pharma partner, created incremental bridges with HGSI. Each bridge allowed GSK to get a better vantage point as to the promise of the HGSI discoveries. Each novel pharmaceutical compound discovered, and advanced, was a new act for the Kabuki play (they usually have five acts) that both parties carefully practiced and embedded into their cultural DNA. So instead of stringing these together as a complete Kabuki play, HGSI decided to come to the Kabuki stage without its makeup, and sense of rhythm, and just stand motionless in the corner of the stage with its back turned to its stage partner, GSK.
So let's take a look beyond the fancy kimonos.
Source: Yahoo Finance.
HGSI emphatically stated that the GSK $2.6 billion offer did not reflect the true value of the company. But, history is elusive and does not guarantee future performance -- that is, relative to HGSI's stock price. The reality of the situation is that HGSI experienced unprecedented growth compared to GSK over a period of two years (see graph above, comparing growth of GSK and HGSI over five years). It was a result of the investment community knowing that GSK's interest, and appetite, to form some bonds with this small biopharma company had some intrinsic value.
There is no doubt that HGSI has a unique capacity to tinker with molecules and discover entities that are unique and that address bona fide medical (and unmet) needs. But that is still a far cry from the commercialization of these entities and widespread acceptance by both the healthcare providers, payers and patients alike. And that has been the rub.
HGSI has been seduced by its own greatness in one area and has made the careless mistake of thinking that this confers success to all areas of its existence. Unfortunately, this has tainted its perception of itself and reality. HGSI chooses to live in the days gone by (at least in terms of its perception of its own stock value). But what has remarkably changed is the execution. I don't know what goes on behind closed doors, nor do I know what the details of the marketing of Benlysta (the novel new monoclonal antibody that is used for the treatment of Lupus, a potentially fatal autoimmune disease). But what I can intuit is that the co-ownership of this product has probably caused innumerable problems with respect to the execution of Benlysta's launch and its early adoption by physician thought leaders. I suspect that the circumstance that GSK finds itself in is no different from the new young parents who stubbornly make the same mistakes that have been made over the eons in caring for their newborns. The wisdom of the grandparents (in this case, GSK) is ignored and never used, or leveraged, as a basis to grow from.
The recent and steady decline of HGSI value coincides with the poor traction, market penetration and poor ramp up of adoption of Benlysta. Adoption by Rheumatologists for any novel product is abysmally slow. HGSI asserted that this unique Lupus drug would have a multibillion-dollar label by the end of 2015. As of last quarter, it delivered $31.2 million (net). But I suspect that the GSK grandparents have had their proverbial hands tied relative to the marketing of Benlysta. It potentially can take the form of ineffective contracting, failure to get the right J codes at launch, failure to obtain payer reimbursement, payer pricing pressures, regulatory resistance, failure to recognize failure, and so on. If I know anything about GSK, it is exquisite in its execution and marketing processes. It took this expertise to make Zantac, Zofran, Imitrex, Valtrex, Paxil and Advair staples in the physician armamentarium against the diseases for which each of these pharmaceuticals were intended.
So here we are back at the Kabuki theater, locked in the present. GSK is left on the stage magnificently dancing and singing by itself as HGSI remains, steadfastly, motionless. It stands in the corner occasionally, letting the audience know that it wants to entertain other suitors. None will appear because they all know the intimacies that have developed between both of the companies and, more so, the entanglements that all the agreements that join these two companies would impose. What HGSI has totally ignored is the impact to its valuation if GSK just decided to walk away from the venture. Some project that the share price would rapidly decline to the $8-$9 range. What HGSI has not done is to heed the principles of negotiations as developed, and formalized, in the book "Getting To Yes" by Fisher and Ury:
In negotiations, your odds of a successful negotiated agreement are only as good as your BATNA (Best Alternative to A Negotiated Agreement).
An example that demonstrates this axiom is seeing how asking for a raise from your boss is strengthened if you already have another job waiting in the wings. My BATNA radar doesn't detect one for HGSI. GSK is also aware of this. GSK controls 50% or more of most of HGSI's assets. So the characterization of being hostile (with all its dramatic manifestations), in my humble estimation, is nothing of the kind. GSK is taking the only course that it has left to exact a fair, rapid and seamless acquisition of HGSI -- to tender an offer directly to the shareholders. Why is this important to GSK? GSK understands that if Benlysta can be solely marketed under the machinery of GSK marketing and its business acumen, it will allow Benlysta to properly receive the medical recognition and acceptance it deserves. True, it is difficult to overcome a poor first impression, but if GSK has proven anything, it is that it can positively alter the life cycle of a product when it is fully supported by its marketing and sales assets.
A relatively recent example is what GSK did with Arixtra (fondaparinux), which was originally sold to GSK by Sanofi (SNY) after SNY had limited success with it. GSK had the titanic task of competing with the SNY anticoagulant, Lovenox, which had a stranglehold on this market by virtue of the breadth of its clinical indications and contracting strategy. In spite of the poor initial response to Arixtra when in the hands of SNY, GSK managed to create growth with this product. But the real prizes in the HGSI pipeline may very well be darapladib for chronic coronary heart disease and albiglutide in patients with type 2 diabetes mellitus. And the operational cost synergies from the acquisition have been calculated at $200 million if HGSI accepts GSK's tender offer.
So GSK and HGSI are at a critical juncture: Invoke costly litigation, create irreparable harm to the good relationships between these two companies, and undermine the synergies that have developed since 1993, or simply recognize that the offer is a fait accompli and posture the integrated GSK to effectively position the assets of the combined company as best of breed in their respective therapeutic areas. This would transform the incongruous, and disjointed, scene to that of the more dignified artistry of a well-choreographed and complete Kabuki play. I suspect that, at the end of the day, it will end as all Kabuki plays do in the fifth act (kyu) with a quick and satisfying conclusion.
For those waiting to see a counteroffer by GSK to reflect the recent historical highs that HGSI has experienced, I believe that day will never come. GSK appreciates the equity that its reputation lends to HGSI valuation. I suspect that GSK will reaffirm the value of its previous offer, but probably concede an offer that is a couple of dollars higher per share at $14 or $15 so that it appears, in the manner of a "getting to yes" transaction, a win-win.
I am currently long GSK and have no position in HGSI, nor do I intend to initiate a position in HGSI while it is on the threshold of acquisition by GSK. My only advice to the shareholders of HGSI is: Don't bite the hand that feeds you.
Disclaimer: The information in the aforementioned article is provided for informational purposes only. It represents the opinions of the author and is not a call for action relative to the buying or selling of stocks and other investment vehicles. It is highly recommended that you conduct your own research and reach your own conclusions before you make an investment in anything.