Merrimack (NASDAQ:MACK) announced the sale of Onivyde and generic Doxil to Ipsen for $575 million in cash and up to $450 million in milestone payments. The market initially liked the deal and pushed Merrimack share price almost 50% higher, but the stock gave up its gains and is now actually below the price it was at before the transaction was announced. This article examines the terms of the deal and the reasons why the market did not like the transaction, the "new Merrimack" and provides my updated thesis.
Did Ipsen underpay for Onivyde?
Under the terms of the agreement, Merrimack gets $575 million in cash for Onivyde and generic Doxil, $33 million in milestones from Shire (NASDAQ:SHPG) (all due in 2017) and up to $450 million in milestone payments for Onivyde ($225 million for FDA approval in first-line treatment of pancreatic cancer, $150 for FDA approval in small cell lung cancer and $75 million for FDA approval in any third indication). This translates into around $4.70 per share for the approved indication (and this is assuming generic Doxil was free) and $3.46 per share for potential label expansion. The $4.70 per share is $2.30 below my conservative NPV for Onivyde (see previous article, subscription required), which means Ipsen either underpaid for the asset(s) or that the product's potential is lower than I, and most analysts, have assumed. I think the deal would have been fair if Merrimack kept the ex-U.S. royalty rights or if it received royalty rights for the U.S. market (or both).
So, why did Merrimack sell Onivyde for less than it is worth? The answer seems simple - a dire financial situation. The company started a major restructuring effort in October 2016 and gutted almost a quarter of its workforce, along with expectations for significantly lower expenses in the future. Merrimack probably determined that it will not be able to drive Onivyde sales high enough to cover operating expenses with the current structure, and the sale of Onivyde was the only realistic option. The timing of the sale has probably played a part too, since deal-making has almost vanished over the last few months due to the drug pricing/political uncertainties, which are still present. So, a 30% discount to the value I, and the majority of analysts (price targets ranged from $7 to $15), have assigned to Onivyde was probably the best the company could get now.
The "new Merrimack" and why the market doesn't like it
If the first reason for the market not being friendly to Merrimack after the sale of Onivyde is lower-than-expected price, the second reason is probably what's left of the company. Merrimack decided to keep developing the following assets: MM-121, MM-141, and MM-310. The first two candidates are in phase 2 trials, while MM-310 is a new candidate which should enter the clinic in Q1 2017.
The market probably doesn't like the "new Merrimack" because these are all early-stage assets (since phase 2 data are due in 1H 2018 at the earliest), while the second reason is the lack of catalysts over the next twelve months. The first meaningful clinical data release should occur in 1H 2018 (MM-141 phase 2 data in metastatic pancreatic cancer patients with high levels of free IGF1 in combination with nab-paclitaxel and gemcitabine in the front-line setting). All three candidates are targeting significant addressable markets, but I wouldn't put the probability of approval for any of these candidates above 15%. So, assuming each candidate has a 15% probability of approval and $500 million in peak sales potential (or $1.5 billion combined), the value of the pipeline is probably around $3 per share at this point (model available to Growth Stock Forum subscribers).
Use of cash and what's ahead
Once the deal closes, Merrimack's financials should look like this:
- Cash balance on a pro forma basis of around $630 million ($575 million from Ipsen, $33 million milestones from Shire and around $25 million cash on hand - this is my estimate for Q4, as the balance was around $48 million at the end of Q3).
- The company intends to use $195 million to extinguish the outstanding senior notes, while taxes and transaction expenses should be around $55 million.
- $125 million should be used to fund the pipeline, but this amount won't be burned right away, so I assume the cash is still on the balance sheet.
- Merrimack has additional debt of around $45 million.
- This leaves the company with around $380 million in cash ($335 million net cash).
- $200 million will be used for a special dividend of around $1.54 per share.
- Merrimack expects the $180 million that are left to last through 2H 2019.
So, the company has $335 million in net cash right now, or around $2.50 per share. And what are Onivyde milestones worth right now? The drug's success in three additional indications is highly uncertain, and I would put the combined probability of success in the 20-30% range. $450 million multiplied by 20-30% equates to $90-150 million, and if we take the mid-point ($125 million), we get roughly $1 per share.
If we add up the cash on hand (assuming the dividend is not paid out yet) of $2.50 per share, $1 per share for the milestone payments and $3 per share for the pipeline, we get $6.50 per share. And I may have been generous with the value of the pipeline. The combined value of cash on hand, Onivyde milestones and the pipeline is less than my NPV on the drug's approved indication ($7 at the low end of the range), so we can see why investor enthusiasm vanished soon after the deal was announced.
I believe Ipsen underpaid for Onivyde (and generic Doxil), and I don't particularly like the "new Merrimack." My investment thesis on Merrimack was based on Onivyde generating robust free cash flow and fully funding the pipeline which came as a relatively cheap call option, and the new thesis rests solely on the (unproven) pipeline. The major part of my biotech investment strategy rests on companies with approved products and valuable pipelines (preferably with at least one product in late-stage development), and Merrimack now doesn't have either. I am keeping my buy rating on Merrimack, but believe the stock is worth $6.50 per share at most at this point.
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Disclosure: I am/we are long MACK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article reflects the author's personal opinion and should not be regarded as a buy or sell recommendation or investment advice in any way.