The April 12th vote for the $74 Billion Bristol-Myers Squibb (BMY) - Celgene (CELG) merger is fast approaching, and activist investors against the deal are calling shenanigans. Hedge Fund Starboard Value is leveling accusations of empty voting, which is when shares of a company are bought just to influence an upcoming vote. If it can be proven, it can file suit before the voting deadline. For the sake of Bristol-Myers shareholders, let’s hope that Starboard Value can prove its case and stop the vote.
Wellington Management has also voiced its displeasure for the deal. While it is common for some investors to be against this type of megamerger, this one is especially important because of the sheer size of the transaction, along with bringing up an overlooked issue with passive management. The tension around the deal has more to do with Celgene than with Bristol-Myers Squibb.
Celgene, for the past couple of years, has not lived up to past performance. The stock peaked in October 2017 at $146.08 which was its highest price point since July 2015. The drop in October of 2017 came from downgrades by Morgan Stanley (MS) based on concerns of a generic version of Revlimid hitting the market in 2020, along with challenges to their pipeline assets GED-0301 and ozanimod. This, along with other news, sparked a sell-off. While most companies went on a tear at the beginning of 2018, Celgene declined before ending the year at $64.
From a valuation perspective, the deal with Bristol-Myers assigns about a 25% premium to Celgene, which, at the end of 2018, had an Enterprise Value (EV) of $59.27 Billion. Before the market collapse in the 4th quarter of 2018, EV was around $79 Billion at the end of the third quarter. Prior to 2018, EV for the firm was above the offer amount, which is the reason why Bristol-Myers’ management believes this is a value play for them.
For the past two years, Celgene has had strong operating earnings as Earnings Before Interest and Taxes (EBIT) have increased from $2.79 per a share in 2015 to $9.25 per a share in 2018. Despite the strong operating earnings, its EV/EBIT multiple has dropped from a high of 44.24 in 2015 to 8.71 in 2018. The recent valuation multiples would be considered cheap when compared to other competitors such as Amgen (AMGN), Bristol-Myers itself, Eli Lilly (LLY), and Johnson & Johnson (JNJ).
Like other companies, Celgene has used the past couple of years to buy back and retire shares, hence boosting its EPS, artificially rather than organically. What is hidden from the public in the net number though is the abnormally low SG&A Expense growth rates in 2016 and 2017, which helped increase the operating earnings per share number. Also, what is not discussed is the amount of goodwill on Celgene’s balance sheet currently. Per the December 2018 10-K, the company has about 23% of its total assets in this line item.
This is a substantial risk for any acquirer of Celgene because this number could be potentially written down as was the case with Kraft Heinz (KHC) earlier this year. This is a risk that Bristol-Myers' stockholders would end up bearing if this acquisition goes through, which is why other investors have raised a red flag. Celgene's management team has been known to overpay for acquisitions in the past, and now, BMY would bear that risk/cost. If this is the case, then the premium for the deal would be close to $40 billion more if factoring in a full potential write-down of goodwill.
When it comes down to the voting structure, it will be close, but this is where passive investing creates an issue leading to adverse effects on the market. Firms like Vanguard, State Street, Northern Trust, BlackRock, and JPMorgan are all on both sides of the deal. Not only are they custodians, but they are also some of the largest passive index funds and shareholders in both companies. Passive funds have been known to vote with management, and in this case, it would be hard for them not to vote based on them benefiting from the allocation in Celgene. This has an adverse impact on Bristol-Myers' active holders because unless they vote, they will more than likely lose the proxy battle. According to the chart below constructed by Bram de Haas in his Seeking Alpha article on this acquisition, the vote could be very close, but a lot of active managers would need to come out against the deal. While one of the big indexers/custodians could sit out of the vote, I doubt they will because of their fiduciary duties.
There’s also a big problem with competition in the oncology space.
As can be seen from the chart above, this niche has fairly stiff competition with Roche (OTCQX:RHHBY), Novartis (NYSE:NVS), and Celgene being the only firms with over double-digit revenue in this group. These three comprise 57%, of the top ten revenue earners, with Roche making up the lion’s share at 30%. Out of the top 10 companies: Roche, Novartis, Celgene, and Bristol-Myers Squibb are the only ones with significant revenues coming from the oncology products. The issue that the Bristol-Myers/Celgene combination will create is that Bristol-Myers would have more revenue exposure to this segment, but the growth for these products has been eroding, and their total number of products would be seven, which is still less than Novartis (8) and significantly behind Roche (11).
Besides these three, the rest of the top 10 have had revenue growth in this sector, which is a significant threat for the merger going forward. The growth rates of Johnson & Johnson, Pfizer (PFE), Merck (MRK), AstraZeneca (AZN), and AbbVie (ABBV) resemble products in the beginning of their growth stages. While Johnson & Johnson has had some troubles with some of its other products, companies like Pfizer, Merck, and AbbVie have had good growth, with shareholders being rewarded along the way.
In closing, this deal should be overturned because the Bristol-Myers team is essentially providing a golden parachute for Celgene with no contingency plan being provided for investors. Celgene hasn't digested its past two acquisitions yet, which is another risk for Bristol-Myers shareholders. On the other side, based on the make-up of the institutional investors, this deal can meet the 50% threshold needed for approval, but the longer it drags on, the more that would play in favor for the investors against the deal. One thing is for certain and that is that BMY is a stock to stay away from until everything is done, and they have had a chance to take charges and write-downs on assets. A hold rating on this stock would be generous.
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.