Will Fresenius Now Also Abandon The NxStage Medical Deal?

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About: NxStage Medical, Inc. (NXTM)
by: Andri Capital
Summary

In light of the Akorn-Fresenius merger fallout, we take a look at the Fresenius-NXTM pending merger.

The market has been skeptical about the deal with NXTM's shares currently selling at 12% discount to deal price.

The primary risk to Fresenius merging with NXTM is regulatory one (relating to the Hart-Scott-Rodino Antitrust Improvements Act).

Currently, there is nothing suggesting that similar developments to the Akorn-Fresenius deal will happen with the Fresenius-NXTM merger.

Note on Fresenius Group Structure

Fresenius SE & Co. (OTCQX:FSNUY) ("Fresenius") is the parent holding company consisting of four segments, two of which are Fresenius Kabi and Fresenius Medical Care. Fresenius Kabi, a wholly-owned subsidiary of Fresenius SE & Co., offered (through its US-based segment) to acquire Akorn, whereas Fresenius Medical Care (NYSE:FMS), a publicly-traded company with Fresenius SE & Co. as the largest individual shareholder (31%), offered to acquire NxStage Medical.

fresenius group structure Therefore, the two merger deals ("Akorn-Fresenius" and "Fresenius-NXTM") involve two separate subsidiaries of Fresenius. Since Fresenius Medical Care is not 100% owned by Fresenius SE & Co. it can not be guaranteed that decision-making is identical between Fresenius Medical Care and Fresenius Kabi, and as such the two subsidiaries can strictly speaking not be viewed as the one and same company (Fresenius). However, there are still strong relations and potential power of influence of the parent (Fresenius SE & Co.) on Fresenius Medical Care, for example:

- Fresenius Medical Care CEO Rice Powell is Chairman of Management Board & CEO at Fresenius Medical Care Management AG and Member of Management Board at Fresenius SE & Co.

- Dr. Dieter Schenk is Vice Chairman of Supervisory Board at Fresenius Medical Care, Member of Board of Directors at Fresenius Management SE, Fresenius Medical Care Management AG, and Fresenius Medical Care

- Dr. Gerd Krick is Chairman of Supervisory Board at Fresenius Management SE, Chairman of Supervisory Board at Fresenius Medical Care, Chairman of Supervisory Board at Fresenius SE & Co. and Member of the Board of Directors at Fresenius Medical Care Management AG.

Readers should recognize that the two merger deals were made by two separate companies with (1) full influence (in the case of Fresenius Kabi's deal with Akorn), and (2) at least partial influence (in the case of Fresenius Medical Care's deal with NXTM), from the same parent (Fresenius SE & Co. or "Fresenius").

With that in mind, the information outlined above, and still recognizing the possible limitations of the deal comparison between the two subsidiaries, we for simplicity's sake refer to Fresenius Medical Care in relation to the NXTM deal as "Fresenius" in the discussion that follows.

Background - AKRX Deal

On April 22, 2018, Fresenius SE & Co. (OTCQX:FSNUY) abandoned its offer to acquire Akorn, Inc. (AKRX) after having agreed in 2017 to acquire the company for about $4.75 billion ($34/share). This came after Fresenius said in February that it could terminate the deal if its own independent probe found Akorn to have breached US Food and Drug Administration data integrity requirements related to product development. This investigation allegedly resulted in Fresenius finding "material breaches" of FDA data integrity requirements at Akorn, which Fresenius apparently deemed would have material adverse effect on Akorn's business and therefore giving basis to terminate the transaction, as to the following termination clause (source: AKRX merger filing, see also FDA's guidance on "data integrity"):

The merger agreement may be terminated at any time prior to the effective time of the merger in the following circumstances:

  • By Fresenius Kabi:
    • in the event of certain uncured breaches of the merger agreement by the Company [Akorn].

The market had become somewhat skeptical about the deal after Akorn's business deteriorated (with the company reporting an operating loss in Q4 2017). AKRX's shares generally sold at an approximate and relatively high 5% discount to the agreed deal price prior to February (when they started to fall in response to Fresenius' investigation).

As a result of Fresenius pulling out of the deal in April, Akorn accused it of having a "buyer's remorse" over the price, stating that the previously disclosed ongoing investigation, which was strictly not a condition to closing, had not found any facts that would result in a material adverse effect on Akorn's business. Akorn subsequently filed a complaint with the intent of requiring Fresenius to fulfill its obligations under the merger agreement.

For more details see our previous article "Reviewing The Akorn-Fresenius Merger Fallout".

Background - NXTM Deal

On October 27, 2017, shareholders of NxStage Medical, Inc. (NXTM) voted to approve a merger announced on August 7, 2017, with Fresenius Medical Care (FMS). "Upon completion of the merger, NxStage stockholders will be entitled to receive $30.00 in cash, without interest, for each share of NxStage's common stock that such stockholder owns. The merger, which is expected to be completed in 2018, remains subject to additional customary closing conditions, including regulatory review under the Hart-Scott-Rodino Antitrust Improvements Act in the U.S." (Source) The merger is still under regulatory review.

Ever since the deal was announced and following the vote, shares of NXTM have gradually decreased from near $30/share in August to a low of $23/share in February (currently the shares have rebounded and stand at roughly $26/share). The market has been skeptical about this deal for the longest time due to poor business performance of NXTM (greater operating loss in 2017, see e.g. article) and doubts about regulatory approval (see article).

Termination Clauses of the NXTM-Fresenius Merger

According to the NXTM merger filing, the merger agreement between Fresenius and NXTM may be terminated by either party or by Fresenius in the following ways (see the filing for details and ways in which NXTM may terminate it):

  • By mutual written consent of NxStage and Fresenius.
  • By either NxStage or Fresenius:

    - If any governmental entity has issued a final and non-appealable order, decree or ruling, or has taken any other action, having the effect of permanently restraining, enjoining or otherwise prohibiting the merger or making consummation of the merger illegal;

    - If the merger has not been consummated by August 7, 2018, which we refer to as the end date, which end date may be extended in certain circumstances by up to 180 days if necessary to obtain required antitrust approvals;

  • By Fresenius:

    - Upon a willful breach by NxStage of its no solicitation obligations; provided that Fresenius must exercise its termination right by the earlier of (x) the 20th business day following the triggering event and (y) the business day prior to the special meeting; or

    - If (i) NxStage commits a material breach of any of its covenants or (ii) there is an inaccuracy in NxStage's representations and warranties that would reasonably be expected to prevent or materially delay consummation of the merger or performance of NxStage's material obligations under the merger agreement, in each case which is not, or is not capable of being, cured within 30 calendar days following Fresenius's receipt of written notice of such breach or inaccuracy.

It is worth noting (in relation to potential concerns about NXTM financials) that under the section "NxStage Material Adverse Effect" in the filing the following is listed as an exception to what constitutes a material adverse effect:

any reduction in NxStage's revenue or the failure to meet any internal or published projections, estimates or expectations of revenue, earnings, or other financial performance results of operations, in and of itself (it being understood that the changes, developments, circumstances, conditions, state of facts, event or occurrence giving rise or contributing to such changes that are not otherwise excluded from the definition of material adverse effect may be taken into account);

Therefore, poor business performance (in terms of declining revenues) does not constitute a material adverse effect that might prevent NxStage to perform its merger agreement obligations. NXTM must still warrant "the conducting of business in the ordinary course consistent with past practice".

Outlook

Looking at the above clauses, it is unlikely that there will be a mutual written consent of both parties to terminate the deal (at least there is nothing that might indicate that today). This leaves regulatory disapproval and material breaches by NXTM as potential causes for termination.

Regulatory risk is certainly the main concern when considering if the merger will happen. Recently, there have been some concerns about antitrust issues, especially regarding AT&T (NYSE:T) and Time Warner (NYSE:TWX) (see article). Currently, the NXTM-Fresenius deal awaits antitrust regulatory approval in the US, which by itself leaves until August 7, 2018 (+ 180 days, if necessary) for the deal to go through.

In terms of potential material breaches or "inaccuracy in NxStage's representations and warranties that would reasonably be expected to prevent or materially delay consummation of the merger or performance of NxStage's material obligations under the merger agreement" there are currently no evident signs of those having or being suspected to have taken place. NXTM is conducting its business in consistency with the past, its indebtedness is unchanged and its filings are all seemingly in line with proper practices, to reference a few representations and warranties.

With the Akorn-Fresenius merger falling through and the seemingly conflicting views of both parties regarding the matter, the question arises - in case Fresenius actually had a "buyer's remorse" - whether similar development might happen with the NXTM deal.

It is true that NXTM has consistently reported operating losses - the loss for Q3 2017 was significantly greater than previous quarters; EBIT of -$8.3 million vs. approximately -$2 million in the previous three quarters. This was due to higher R&D and 10% increase in SG&A, which again was primarily due to merger-related general and administrative expenses, according to the company's annual report for 2017. As such, it could be strictly said that NXTM's financials are deteriorating, but the company is still conducting its business in consistency with the past and its revenues have been rising year by year. The business also performed better in Q4 '17 relative to Q3 '17 with revenues growing and R&D going back to similar levels as before Q3. Greater R&D expenses can also be viewed as efforts by the company to maintain its business in the ordinary state relative to the past (or "preserve substantially intact its and their present business organizations"). Hence, any currently visible business operational reasons do not give a reason for termination of the merger. Something significant and currently non-existent or unknown would need to happen for the "material breach" termination clause to come into effect.

Conclusion

Based on the above, it is clear that the primary risk facing the Fresenius-NXTM merger is regulatory risk. At the current moment, there is nothing to suggests anything specific in relation to potential material breaches, which would trigger similar developments to the ongoing Akorn-Fresenius situation. NXTM's business has not changed in a material way and no event has occurred after the merger agreement that might suggest otherwise. In fact, very little news has come out regarding NXTM since the merger was approved in October 2017.

Overall, the significant 12% discount between current market price (approx. $26/share) and the deal price ($30/share) should mostly be attributed to uncertainties regarding regulatory approval in the US. Following Fresenius' pullout from the Akorn merger, there is nothing that currently indicates the same will happen to the pending Fresenius-NXTM deal.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.