A Special Situation Set Up By Bristol-Myers Squibb's Offer For Celgene

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About: Bristol-Myers Squibb Company (BMY), CELG
by: Richard Berger
Summary

Bristol-Myers Squibb tendered an offer for Celgene Corporation.

The markets currently are pricing a large discount for the uncertainty of shareholder approval into the deal value.

This uncertainty discount provides a special situation for investors to realize yield rates >28% on net cash invested.

I have structured the investment such that it can avoid exposure to the shareholder and regulatory risks by closing prior to the shareholder votes of 4/12/19.

Nature delivers some spectacular special situations from time to time. These provide experiences rarely encountered. We are enriched by finding them. Special situation investing is a class of opportunities that arises from a departure of the normal course of business and trading. Mergers, acquisitions, activist investors, turnarounds, and some financing launches are examples of a departure from the natural day-to-day world. These present us with targeted ways to profit from their development and presence over a limited time.

The Situation

On January 3, 2019, Bristol-Myers Squibb (NYSE:BMY) tendered a bid for Celgene Corporation (NASDAQ:CELG). The offer boils down to each Celgene share receiving $50.00 in cash, one share of BMY ($50.05 at close 2/7/19), and a contingent value right ("CVR") worth $9 cash if specified Celgene matters in its pipeline are met. This values the deal for a total buyout offer of $100.05 to $109.05 per share for CELG holders.

The Deal Highlights

The merger will position BMY as the top oncology player, a top five immunology company, and the top cardiovascular player in biotech. The combined company will have a pipeline which includes six near product launches pending over the next 24 months. Together, these represent more than $15 billion in potential revenue per company estimates.

Bristol also expects to achieve $2.5 billion in synergies via combining the sales, general, and administrative costs, the R&D, and the manufacturing functions of the two companies. BMY, pro forma, projects 2020 results boosting EPS 40% due to this accretive growth from the pipeline products and operational synergy savings.

The offer is attractive to CELG at over 50% premium to market and removing the FDA approval risk for the three products in Celgene's pipeline. The $9 CVG is based on the FDA approval of these three products, including ozanimod (by December 31, 2020), liso-cel (JCAR017) (by December 31, 2020) and bb2121 (by March 31, 2021). The CVG will list and trade as a separate unit. The discount from its full value can be expected to peg the trading value for the CVG initially at $3 to $4.50, perhaps with full value only realized if all three meet the FDA approval milestones laid out.

Market Reaction To The Offer

Upon the merger news release, Bristol's shares fell from $52.43 to close at $45.12. Subsequently, the shares have rebounded, now trading in at $49.97 in a consolidation pattern. Celgene's shares immediately gaped up to close the day at $80.43. In the subsequent days, they have quickly settled into trading within a very narrow sideways channel currently having closed February 7, 2019, at $87.47. This deep (greater than 13%) discount to the offer price represents the market uncertainty over the completion of the deal. It is an unusually large arbitrage spread.

The Arbitrage Risk

Risk exists only if the deal is not ultimately approved. Even if rejected, the risk then becomes a question of the value of CELG's shares sans the offer. Therefore, let's look at relevant factors.

The large arbitrage gap between the Bristol offer price (~$100.05) and the current CELG price ($87.91) is $12.14. Celgene's shares closed at $66.64 on the eve before Bristol's public offer. Thus, that figure marks the maximum downside pain of a failed deal. However, there are reasons to believe a higher valuation and trading figure for Celgene's shares sans a Bristol deal.

CELG shares had reached the bottom of a swoon that began in early October and bottomed 12/24/18. Since last Christmas, shares were in a rebound, advancing strongly four out of the five days leading up to the Bristol offer. Celgene shares have been trading in strong correlation to the overall sector, as represented by SPDR Biotech ETF (NYSEARCA:XBI). Both began the strong post 12/24/18 rebound. Based on that index rebound, CELG is expected to be trading at the $75.00 level.

The market pause in the narrow range of $87.00-88.00 at the early stage of the Bristol offer has selected a level matching the lower limit of the long-term consolidation range for Celgene seen from July through early October 2018. This suggests that traders view a likely trading target for the shares in the event of a failure to complete the merger to be in that $86 to $93 range of the 2018 consolidation channel.

Regulatory approval is thought to be simple, and very little risk is assigned to the deal on that basis. There is, however, some risk that Bristol's shareholders may resist approving the offer due to the high premium (>50%) it provided CELG's shares. Activist shareholder Starboard has taken a BMY stake and is expected to object to the merger. BMY's shareholder approval is still very likely simply because this is a good deal for them, as documented by the synergy cost savings and new drug revenues from exiting Celgene lines and those in late-stage FDA review currently.

On the other side of the coin, some Celgene holders may object to the price even at the strong premium to the January 2nd trading. A look back to October 2017 saw shares trading at their high of $147.17. The deep slide since that time is due to a combination of factors, including the disappointing test results of some Celgene pipeline drugs and the expected decline in sales of the company's three top revenue-producing drugs beginning in 2022. While these forecasts have not changed, several other drugs continue to make progress through the FDA approval pipeline. This couples with the perfect storm of how low shares traded at on 12/24/18, as CELG prices, already deeply suppressed, were further dragged down by industry macro trends (as discussed and shown above).

The structure of the deal as a combined cash and stock offering rewards Celgene holders with substantial cash now, a CVG offering the promise of an additional $9 to come, and shares of BMY to continue to benefit from future results. This structure easily trumps the look back to prior Celgene share price highs not seen since 2017. Therefore, CELG's approval is seen as very likely.

A look at the fair value appraisal for CELG based on well-correlated traditional financial value metric ratios is also useful in assessing the risks at the current price levels in the event of a merger failure. All three of the charted valuations conform well to the historical CELG market price (light blue). Note also that since 2014, these valuations have never given appraisals above the actual market price, until the disconnect which resulted in the Celgene price collapse in late 2017.

With three very well (and conservative) priced correlation metrics all clustering at values well above current market, a CELG fair value of $150.00 is indicated as a conservative appraisal at this time.

In summary, little risk exists for regulatory or shareholder rejection at this time. In the event of rejection, technical trading patterns and valuation appraisals of Celgene suggest it should still trade at the $80 to $150.00 levels even without a deal from Bristol or anyone else. Any risk can be managed even further by limiting the time exposure of a trade position to short term, far less than expected for the final decisions on the merger approval/rejection. It is clear that the temporary limbo while the deal machinery grinds away leaves shares plateaued in a very narrow trading range around $86.00 to $88.00. The shareholders of both companies are scheduled to vote on the merger proposal on 4/12/19. Any trade with a planned exit before that date has minimal risk of being exposed to CELG's prices below $85.00, beneath the current limbo trading range.

On the Bristol side, shares, trading now at $50.22, remain depressed $2.21 for the level on the 1/2/19, the eve before the announcement. Since shares were in a strong rising trend before the deal, they can be expected to rise back at a minimum to the $52.53 level should the deal ultimately be rejected as activist Starboard wishes. An option structure to profit from this arbitrage gap also is present at this time.

Covered Option Opportunity

Given that Celgene shares are very likely to remain trapped in a narrow trading range above $85.00 until shareholders meet to vote on 4/12/19, consider writing (selling) the 32-day cash secured puts for 3/15/19 $85.00 @ $2.10 premium. This provides an absolute gain of 2.53% (a 28.89% annualized yield rate) on the $82.90 net covering cash. The more conservative lower strike price using the $80.00 @ $1.50 premium provides an absolute gain of 1.91% (21.8% annualized yield rate) on $78.50 net covering cash. The short duration exposure ending a month before the vote makes this a high-return, low-risk special opportunity.

Bristol's shares remain depressed below the $52.43 closing of 1/2/19, the eve before the offer announcement. Shares were rising prior to that and can be expected to rebound at least to that level should the deal end up rejected by shareholders. To play this opportunity, consider writing (selling) the 32-day cash secured puts for 3/15/19 $50.00 @ $2.03 premium. This is an absolute gain of 4.23% (48.27% annualized yield rate) on net covering cash for the 32-day contract length.

I am not a licensed securities dealer or advisor. The views here are solely my own and should not be considered or used for investment advice. As always, individuals should determine the suitability for their own situation and perform their own due diligence before making any investment

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.