Bristol-Myers/Celgene: Win-Win Merger

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About: Celgene Corporation (CELG), Includes: BMY, IBB
by: Stone Fox Capital
Summary

Bristol-Myers agreed to pay a 54% premium to acquire Celgene.

Celgene shareholders get an immediate price boost plus the long-term potential to participate in cheap BMY stock.

The deal provides a 40% EPS boost for Bristol-Myers and cost synergies of $2.5 billion.

Free cash flows should allow for the elimination of debt by peak Revlimid sales in 2022.

The conservative EPS target is $7 by 2020.

Rarely are mega mergers so appealing as the Bristol-Myers Squibb (BMY) bid to buy Celgene (CELG). The latter biopharma had been beaten to such a pulp that the deal provides an immediate upside for suffering shareholders and the potential to participate in substantial earnings upside for the combined entity. The merger appears a win-win for both sides.

Celgene logo Image Source: Bristol-Myers/Celgene merger presentation

Merger Details

On January 3, Bristol-Myers announced the intent to pay $74 billion to purchase Celgene. The deal values Celgene at $102.43 a share plus a potential $9 CVR (contingent value right).

As detailed below, Celgene shareholders will get $50 in cash and one share of Bristol-Myers plus the CVR. The deal is expected to close by Q3.

Source: Bristol-Myers/Celgene merger presentation

An important aspect of the deal coming together is how beaten down these stocks have been over the last few years. Even with the iShares Biotech ETF (IBB) down about 6% in the period, both Bristol-Myers and Celgene have far underperformed with losses of nearly 30% in both cases. Noteworthy is that Celgene far underperformed prior to the merger announcement.

Chart BMY data by YCharts

The above chart explains the impetus of the deal when Celgene was only trading at about 6x '19 EPS estimates of $10.39. The risk of Revlimid coming off patent is further diluted due to the Bristol-Myers drugs and pipeline added to what Celgene already has in place.

Expansive Pipeline

The drug pipeline of the new entity is so deep and broad that an individual investor can't possibly analyze the portfolio. As the biopharma mentions, the company has 10 assets in Phase III trials with an additional 50 assets in Phase I/II studies.

Source: Bristol-Myers/Celgene merger presentation

This merger actually doesn't resolve some of the problems with Celgene where the feared sales declines of Revlimid by 2023 or so were seen as a known risk while a strong pipeline remained an unknown risk that drugs might fail to get approval.

Heck, the CVR is based on the principle that these drugs hold risks of failing to obtain FDA approval and BMY doesn't want to be caught paying a premium for drug failures. The company lists six drugs that have revenue potential in excess of $15 billion with no surprise that three of those include the drugs under the CVR:

  • ozanimod - December 31, 2020
  • liso-cel - December 31, 2020
  • bb2121 - March 31, 2021

Celgene had previously listed all three drugs as having $2+ billion in peak sales potential.

Source: Celgene Jefferies 2018 presentation

Upside Participation

Where the deal gets really interesting is the ability to participate on the upside of the combined entity. Bristol-Myers forecast an incredible 40% boost to EPS on the closing of the deal plus the additional benefits of $2.5 billion in cost synergies by 2022.

A good place to start reviewing the potential for the combined entity is this concept of an incredible 40% boost to Bristol-Myers' EPS numbers. Analysts now expect the biopharma to earn $4.30 per share in 2019 on a standalone basis.

Chart BMY EPS Estimates for Current Fiscal Year data by YCharts

An additional 40% upside amounts to a $6.00 EPS target. Considering the estimate is based on the first full year after closing the transaction in late 2019, one might want to use the $4.55 estimate for 2020. The company would hit $6.37 per share on that basis.

For this reason, BMY is rebounding 4% on Friday to return to $47. The stock only trades at about 7.4x these updated EPS estimates.

The press release appears a little vague on how the $2.5 billion in cost synergies play into this 40% EPS target considering some cost synergies occur immediately. Not to mention, a large amount is usually realized in the first year after merger close.

Bristol-Myers has 1.63 billion shares outstanding and Celgene has 735 million. Considering the one-for-one deal, the new entity will have 2.365 billion shares. One can quickly see how the cost synergies would boost EPS estimates.

The immediate $5 billion accelerated share repurchase plan would quickly reduce the share count by 100 million shares. The new entity would immediately see the share count reduced to 2.22 billion shares.

The $6.37 EPS target plus cost synergies plus debt reduction would place a 2020 EPS target towards $7.00.

Debt Issue?

Probably a bigger question considering the substantial drug pipeline reduces a lot of risk will be the debt load after closing the deal. Nearly 50% of the deal is in cash with the $50 payment per share to Celgene shareholders for $37 billion.

Per the merger presentation, the combined entity has about $10 billion in cash and Celgene has $20 billion in debt. The company is forecasting the issuance of $32 billion in new debt to finance the merger payment.

Source: Bristol-Myers/Celgene merger presentation

The numbers don't completely add up, but the company would have roughly $42 billion in net debt based on the above calculation plus the additional CVR liability of up to $6.3 billion. Of course, these obligations will only be paid, if Bristol-Myers gets the blockbuster drugs approved by early 2021.

The key here is that the new entity is projecting about $15 billion in annual free cash flow following the deal. The company forecasts net income jumping to the $15 billion range so the cash flows appear doable. In addition, the entities have about a year in cash flow generation before the deal even closes.

The market will focus on the debt issue, but the financials project this as a non-issue. The company will have the cash flows by 2022 to completely eliminate the debt position and repurchase the $5 billion worth of shares, if so desired.

Takeaway

The key investor takeaway is that the combination of Bristol-Myers provides a very compelling case. Celgene shareholders have already seen a $20 boost to their shares while Bristol-Myers shareholders that includes future Celgene shares have expectations for a significant EPS boost.

The very compelling part is that the new entity has the ability to eliminate debt by the time the Revlimid $10+ billion revenue stream peaks in 2022 with a pipeline of replacement drugs to cushion any financial blow. The end result is a stock trading below $50 that should have a sustainable earnings stream above $7 and substantial free cash flows.

Right now, the best play is probably to own Celgene with the intent to take the $50 cash payment and roll it into BMY stock when the merger closes.

Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock, you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

Disclosure: I am/we are long CELG. 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.