Valuing Celgene's Contingent Value Rights

Summary

• The Bristol-Myers deal with Celgene includes a $9 CVR component.
• Three drugs must get FDA approvals by deadlines for the CVR to pay out.
• We won't know if there is a payout until 2021, but a failure could come sooner.

Celgene (NASDAQ:CELG) has seen its stock price improve dramatically since it was announced it would be acquired by Bristol-Myers Squibb (BMY). The deal was approved by stockholders of both companies and looks likely to go through this year, unless there are regulatory objections. Currently, Celgene's stock price is near the cash value of the deal $50 per share, plus the price of one BMY share. But there is another potential asset in the deal: CVRs (contingent value rights). Right now these appear to be valued at zero. Here I will discuss why CVRs should carry a higher value when issued, and could be worth $9 each.

CVR terms

In the Celgene acquisition there is an unresolved mystery. The mystery is where will the CVRs (contingent value rights) be priced on issuance and how events will drive trade afterwards.

There is even ambiguity in the way CVRs were announced:

Each 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. [Bristol-Myers Squibb to Acquire Celgene, January 3, 2019]

The natural reading is that if any one of these three potential therapies fails to get FDA approval, the CVRs are worthless. But ozanimod has three indications in Phase 3 trials. Does it need to hit all three, or a particular one, or just any one of the three? I am assuming it needs only the most advanced approval, for multiple myeloma.

Ozanimod

Ozanimod is in Phase 3 trials for three indications: relapsed multiple sclerosis; ulcerative colitis; and Crohn's disease. It has a December 31, 2020, FDA approval deadline to make the CVR good.

The latest Ozanimod press release, Ozanimod Reduced Brain Volume Loss of May 7, 2019, adds to previous positive data. It notes that a New Drug Application was submitted to the FDA in this indication in March 2019. That gives plenty of time for the FDA to approve the drug before the end of 2020. The caveat is that sometimes the FDA rejects an NDA, asking for more information, and sometimes the data is deemed insufficient for approval. Details can be found in Celgene Submits Application to FDA for Ozanimod for the Treatment of Relapsing Forms of Multiple Sclerosis.

But the takeaway is that ozanimod is highly likely to get its approval by the deadline.

Liso-cel

Liso-cel, formerly JCAR017, is in a Phase 3 for r/r aggressive large B-cell lymphoma. Data released in June 2018 can be found in Celgene Announces Updated Safety and Efficacy Data from the TRANSCEND Trial of liso-cel (JCAR017) in Patients with Relapsed or Refractory B-cell non-Hodgkin Lymphoma at ASCO. 49% of patients remained in remission, and safety was good (for a CAR-T cancer therapy). The pivotal cohort was reported to be fully enrolled.

In the Celgene Q1 2019 results press release Liso-cel was on track to make its Biologics License Application to the FDA in the second half of 2019. If that happens and there are no FDA-related delays then there should be no problem getting an approval by the CVR deadline, the end of 2020.

bb2121

Licensed from bluebird bio (BLUE), bb2121 is In Phase 3 for r/r multiple myeloma. It is on a longer timeline than the other two therapies, with a deadline for FDA approval of March 31, 2021.

The latest update is Celgene Corporation and bluebird bio Announce Results from Ongoing Multicenter Phase 1 Study of bb2121 anti-BCMA CAR T Cell Therapy in Patients with Multiple Myeloma Published in New England Journal of Medicine, on May 1, 2019. The release says bb2121 could be approved by the second half of 2020. If so, that means there is about another quarter's time to get in by the CVR deadline, should there be a delay.

The follow up Phase 3 trial, KarMMa, is reported to now be fully enrolled. The data from the earlier trial is characterized as "compelling." So perhaps the main concern would not be timing so much as whether a larger trial continues to show strong efficacy and reasonable safety.

What are the chances the CVR is good?

While Celgene sounds confident, there are two risks to the CVR for each indication. One is failure to gain approval, given the safety and efficacy data package. The other is a delay, where the FDA asks for more data.

The main problem for those who are issued the CVRs is the all-or-nothing nature of the deal. If each indication were worth $3.00, then if each indication is assigned a 90% probability of success, the implied value is 0.90 x $9.00 or $8.10. Hypothetically, even with only a 50% likelihood of success for each drug, the CVR is would be worth $4.50, pending actual outcomes.

Instead all three indications must succeed, so the probability of success is found by multiplying each of the three probabilities, then multiplying that by $9.00.

Highly confident in each drug? Then use 90% three times. The bundle has a probability of 72.9%, so the fair price is $6.56.

As confidence declines, value declines quickly. At 80% for each of the three drugs, the bundle has a 51.2% probability of success, and the CVR is fairly priced at $4.61.

If the CVR seems priced unfairly low once it starts trading, an investor can wait for the outcomes. The first failure brings the value to $0.00, but the first success likely only increases the value marginally. At least you know if all three drugs are approved on time, you get the full $9.00.

What happens during the trading period?

I don't want to try to predict either investor psychology on this or the trading strategies or algorithms that will affect the market. Keep in mind we are dealing with biology for trial outcomes, a complicated science that makes standard coin-tossing statistics less of a predictor than textbooks imply. Then we are dealing with humans for approval timelines. A government shutdown, for instance, might spoil the whole game.

I would start with the $6.56 number because I like the trial results to date and think the timelines are adequate. If the CVRs trade at about that level or higher before the first result comes in, I would be inclined to sell mine. But I would not be surprised if they start selling for $1.00 or less, as the risks are difficult to assess. At the low end of the range I would hold my CVRs and take my chances.

I welcome investor feedback on strategies for dealing with this out of the ordinary situation.

Also note that cash paid out by Bristol would detract from the value of that company. So if you assume you will get the $9 bonus for the Celgene shares, you should assume your Bristol shares, if you keep them, will be worth less. Or in the glass-half-full view, not getting the $9 bonus will make your Bristol shares worth more.

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.