Celgene: Timing The Switch To Bristol-Myers

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

Bristol-Myers is expected to close on the Celgene merger around year-end.

The deal is about 50% cash and stock with an additional tradable CVR requiring investors to decide how to handle the cash and CVR portions.

The projected upside holding CELG shares is ~7.5%.

BMY shares trade at about 6.5x a post-merger EPS target of $7, but the stock likely struggles due to debt load.

As the Celgene (CELG) acquisition heads towards closure, investors need to position themselves for owning shares in the new Bristol-Myers Squibb (BMY). The cash and stock transaction positions the long-term value of the merger in owning BMY stock, requiring investors to have a plan for timing a move out of some more short-term gains in CELG.

Celgene logo

Image Source: Celgene website

Key Points

The deal has several key points. First, Celgene shareholders will get nearly 50% of the deal in cash. Second, Celgene shareholders get a tradable continent value right or CVR worth up to $9 based on the future approval of three drugs. Third, the deal provides substantial EPS upside for the new Bristol-Myers after the transaction closes due to the use of accretive debt and substantial synergies.

Bristol-Myers agreed to pay a listed transaction value of $102.43 per Celgene share and one CVR valued at up to $9. The total deal value was potentially $111.43, assuming the approval of three drugs for the CVR to pay.

The deal is broken out to 1.0 share of Bristol-Myers and $50.00 in cash for each Celgene share. At an updated Bristol-Myers price of $46.25, the current deal value on closing the merger is $96.25 plus the CVR.

Due to the decision for Celgene to divest Otezla to obtain FTC approval, the risk of the deal closing is minimal. The European Commission has already approved the merger. Therefore, the merger premium is a minimal $2.25 plus the CVR value with Celgene trading at $94.00. Assigning a $5 value to the CVR, Celgene has about 7.5% upside on a merger closing by year end.

The big question is where the CVR trades after the merger closes around the start of 2020. The continent right payoff requires the FDA approval of the following three drugs for specified indications under these timelines:

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

The valuing of this continent right is highly unknown due to the payout timeline and uncertainty of obtaining approval of all three drugs. Both ozanimod and lisco-cel have made positive steps towards FDA approval so the odds appear at least 50% at this point.

Bristol-Myers Weakness

Due to the merger premium, Bristol-Myers has far underperformed Celgene and the iShares Nasdaq Biotechnology (IBB) in the last year. The upside potential going forward is in Bristol-Myers after one claims the small Celgene upside and the CVR.

Chart Data by YCharts

Following a strong Q2, the company recently raised 2019 EPS guidance to between $4.10 and $4.20. Celgene had a similarly strong quarter raising guidance to $10.65 to $10.85.

The key here is that Bristol-Myers will see the full potential of higher earnings while Celgene is already mostly locked into gains. Ultimately though, Bristol-Myers has traded very weak due to shareholders not liking the debt of the merger. The new Bristol-Myers will have an estimated net debt balance of $42 billion.

For this reason, the merger is reminiscent of AT&T (T)/Time Warner and the recently closed IBM (IBM)/Red Hat. Both debt-fueled mergers traded around the lows (outside of the December crash) when the mergers were completed.

AT&T trades at about 9x EPS estimates while IBM now trades at about 10x updated free cash flow targets. Following this path, Bristol-Myers isn't likely to obtain a higher multiple until the deal closes, debt repayments start and the market becomes comfortable with the accretive EPS targets.

Chart Data by YCharts

Conservative $7 EPS Target

The key to the whole deal is that Bristol-Myers forecasts an EPS accretion of greater than 40% in first full year. The current $4.39 EPS target for 2020 quickly turns into $6.15.

The amount only includes a partial realization of the $2.5 billion in estimated merger synergies. Further, the company estimates $45 billion in free cash flow over the next three years that will help reduce interest costs by repaying a large chunk of $42 billion in net debt plus the potential $6.3 billion CVR liability.

The share count is a follows:

  • BMY = 1.63 billion
  • CELG = 735 million
  • $5B buyback = -100 million
  • Total = 2.27 billion

The synergies alone will potentially boost the EPS target to $7 while the debt reduction adds an additional sweetener to EPS targets in 2021 and beyond.

Takeaway

The key investor takeaway is for investors to own the new Bristol-Myers stock after the merger closes and on any weakness induced by the large debt total. The company is poised to generate $7+ annual EPS targets with a massive pipeline of 50 late-stage assets to help offset the LOE on Revlimid in a few years.

The conservative investment option is to immediately sell CELG and purchase BMY knowing the stock offers superb value. The more complicated path is to wait for the close and invest the $50 in cash into BMY and collect the CVR. The risk is that BMY runs into the merger close, but a few recent debt-fueled merger examples suggest the market won't rush into the stock.

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.

Additional disclosure: 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.