Buying Celgene

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About: Celgene Corporation (CELG), BMY
by: DoctoRx
Summary

Bristol-Myers Squibb has made a friendly offer to acquire Celgene.

Per share, Celgene shareholders will receive $50 in cash, 1 share of BMS stock, and 1 contingent value right worth either $9 or $0.

With Celgene at $87, I find the deal to have risks but also to have enough upside to like it and to have gone long the company.

I am not confident about the value to Bristol-Myers Squibb shareholders, however, and do not plan to initiate a position in the stock.

Introduction

Sorry to be a little behind the curve on the Bristol-Myers Squibb (BMY) deal to acquire Celgene (CELG), but I've been on the road and needed some time to research a few points before contributing some comments on this mega-deal.

In its presentation, BMY projects a Q3 close. I am going to be a bit more conservative and project that in essence, the company will get the deal done in Q4. There are some overlapping areas in myeloma and in the pipeline that some regulator may wish to study, and any delay from one venue delays the entire deal, but I expect the deal to close.

The deal terms for CELG shareholders include three types of payments for each share of CELG:

  • $50 in cash
  • 1 share of BMY
  • 1 tradeable contingent value right, or CVR

What is this worth? Depending on the value of BMY, and excluding the CVR, it's a $70 billion valuation. The CVR affects the prospective return for buyers of CELG, so let's begin with that.

Valuing the CVR

From the press release:

Each [CELG] share also will receive one tradeable CVR, which will entitle its holder to receive a one-time potential payment of $9.00 in cash upon FDA approval of all three of ozanimod (by December 31, 2020), liso-cel (JCAR017) (by December 31, 2020) and bb2121 (by March 31, 2021), in each case for a specified indication.

I assume that the ozanimod indication is for the delayed MS indication, and liso-cel (Juno CAR-T product) and bb2121 (bluebird bio (BLUE) myeloma CAR-T product) are clear. What are the odds of all three approvals coming timely? No one knows, and no one knows the timing of the last approval, either. An arbitrary 80% of approval within the above time limits for each drug implies a 0.83 = 0.51, or 51%, combined probability. Call that value $4.50. Then, one must discount for present value. We all use different discount rates, though, and the precise "maturity" of this CVR is also not known precisely. I'm comfortable thinking of it as a 2-year bond or note, and given prevailing rates, if it pays off, an 11% discount rate (about 5.5% per year) is OK with me.

This back-of-the-envelope analysis yields a $4 present value for the CVR.

Next, we need to assign a value to BMY.

Valuing BMY

BMY is going to issue stock and debt, and then plans to perform a $5 billion accelerated share repurchase after the deal closes. The company plans to continue paying a solid dividend and to maintain an investment-grade credit rating. The way it talks about free cash flow generation of the combined companies, my guess is that it plans to pay down a good deal of debt over the next several years.

BMY has been a fallen angel. This 1-month chart shows how the stock traded before the deal and after:

Chart BMY data by YCharts

The chart shows BMY reaching up to $52.50, down to $45 on announcement of the deal, and now trading at $47.72.

I would like to be conservative and take a 10% haircut off the current price in thinking about the deal. That gets me to $43.

There are some points on the company's valuation that I'll discuss later, as the ins and outs of takeover math get complicated if one thinks like Hamlet and tries to see all the possibilities.

Interim summary

The sum of the above values is: $43 + $4 = $47. Add $50 in cash to that and one gets $97. CELG closed Thursday at $86.95. Call it an 11% premium to the total value, but only a 7% premium if one excludes the CVR value. Yet, one gets back to the $97 range by using BMY's current trading value.

Overall, on the face of it, the deal appeared attractive enough to me to bring me back into CELG stock, which I had exited almost completely in the low $100s on its way down and completely in the $90-91 range also many moons ago.

There are risks and upsides here.

Risks to CELG shareholders

I can think of four risks, but this list may not be comprehensive:

1. Rejection of the deal

I doubt there is a material chance of CELG shareholders rejecting this offer, unless either BMY shares collapse or a better deal surfaces.

BMY shareholders may get cold feet. Yet, an old-line company as BMY is, it will certainly have run this by its core institutional investors. E-Trade data shows 72% of its investor base is institutional, and I expect that they will go strongly for this deal.

I give a 5-10% combined chance of deal rejection by either BMY or CELG shareholders.

2. BMY walks away from the deal

This is the worst-case scenario. CELG would end up with pocket change as a break-up fee, and I would expect the company's shares to drop precipitously.

3. The deal closes but BMY shares are in the $30s

If you ignore the CVR, which is a "maybe," then if BMY plunges to $35, the deal is only worth $85 - and even that would leave CELG shareholder with a BMY share that would be damaged goods (unless the whole market (SPY) suffers a wipeout).

4. Regulatory disapproval of the deal

I expect this acquisition to go through smoothly. I see nothing anti-competitive here. Perhaps a pipeline product that I'm not thinking of might be requested to be divested, or BMY may have to dispose of its interest in Empliciti (a myeloma drug it shares with AbbVie (ABBV)). But I do think that BMY is being optimistic in projecting a deal close by September.

I give points 2 and 3 a 5% combined chance of occurring - again, excepting the chance of a true market crash, in which case a deal is a good thing.

But there are offsetting upside possibilities

I see two reasons not to quail at the above risks.

1. BMY stock can rise as well as fall

The post-merger math on BMY is going to be confusing because of several factors. These factors include considering up-front integration costs and the overarching question of GAAP versus non-GAAP accounting that is so relevant to CELG. In addition, assuming that essentially this is a 2020 event in thinking of BMY's earnings, the many patent issues facing CELG will be that much closer to decisions which could be adverse.

In any case, the mythical Mr. Market may change his mind more than once about how good this deal is fundamentally for BMY's value. BMY may close the deal on a high note, and CELG shareholders may do surprising well as a result.

Getting back to the upside, if BMY merely gets back to $52.50, then the deal is worth $102.50 per CELG share, plus the CVR.

2. Another bidder for CELG may surface

CELG is not commenting on the extent to which it shopped itself, but even if it did and BMY moved quickly, I do not see this valuation as pre-emptive. I see CELG's products, pipeline and size meshing well with Johnson & Johnson (JNJ) and Pfizer (PFE). Acquiring CELG would, in a way, complete JNJ's emergence from health care conglomerate to, finally, heavily a pharma play (and then, perhaps, a 3-way split). Is it possible that these giants, and perhaps a small number of others, are moving rapidly toward a stronger bid? After all, the BMY-CELG deal is between companies of not dissimilar size, which forced BMY into the complexities of its offer. The giants could make cleaner and higher offers than BMY can, should they so desire.

Conclusions, and Comments on BMY

With Fed chairman Powell affirming on Thursday the Fed's commitment to shrinking its balance sheet, I reaffirm a risk-off posture. Within that posture, the risk-reward of CELG around $87 looks good to me. Even if the deal closes in 10 months rather than by September as BMY projects, it's easy to get to a 15% annualized return by buying CELG here - though I would be satisfied with a lesser return given I believe this deal will gain approval from all necessary shareholders and regulators, and that BMY's downside is limited under most scenarios for the SPY.

A word about BMY is in order. I went long the stock some time ago in the $55-56 range, but scaled out as it rose, given various competitive challenges. Even at today's much lower price, I am not confident that BMY represents a good risk-reward for new money thinking of entering here. CELG is a confusing asset, with Revlimid, Pomalyst/Imnovid and Abraxane having uncertain dates at which they will fall to generics (both the US and EU need to be considered for all drugs). Add all the pipeline uncertainties and the many collaborations that CELG has entered into with which BMY will need to become very familiar, and I would wait on BMY until real clarity is obtained. Assuming the acquisition does go through, that will not be for a long time, however. Thus, if I hold CELG through to deal close (if it does close), I am thinking of selling BMY shares soon thereafter.

I began traveling last week just as the deal was announced, and thus, I did not get into CELG at the $85 or sub-$85 price range. In any case, I'm satisfied enough with this deal to have gone long here. I hope I'm being conservative in expecting a $95 deal value in about 10 months, with reasonable risk-adjusted upside potential from there. A caution to any reader, especially one who is new to financial markets: this is not a sure thing. There is downside risk. The only advice I will give is to be careful. This deal was announced over a week ago, and many of the smartest people in the world have analyzed it every way they know how.

Good luck to all.

Disclosure: I am/we are long CELG, ABBV. 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: Not investment advice. I am not an investment adviser.