A Buyout-Driven Pair Trade: Buy Aurinia, Sell Merck (Or Seagen If You Must)


  • The most recent two hottest potatoes in the biotech arena are Aurinia Pharmaceuticals and Seagen.
  • While the latter is mostly/recently associated with an upcoming Merck buyout, the former has been associated with many big pharma names.
  • It's clear (to us) that AUPH should be on the long side, but you might find that choosing MRK for the short side is too much for your taste.
  • When you construct a pair-trade, you mustn't treat each leg of the trade on a stand-alone basis; it's the combination that makes for the potential return and overall risk.
  • Looking for a portfolio of ideas like this one? Members of Macro Trading Factory get exclusive access to our model portfolio. Learn More »

Business people assembling jigzaw puzzle. Close up shot.

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Contrary to my alter-ego's Elon Musk-Driven Pair Trade, I promise you three things regarding my suggested pair trade:

  1. Shorter writing [but only slightly]
  2. Less controversial [but still controversial; as if one can expect anything else when Tesla (TSLA) and/or Twitter (TWTR) is/are involved...]
  3. It has nothing to do with Elon Musk [As long as he doesn't intend to come up with a buyout offer to any of the two biotech that are the focus of this piece]

Pairs trading is a non-directional, relative value investment strategy that seeks to identify 2 companies or funds with similar characteristics whose equity securities are currently trading at a price relationship that is out of their historical trading range. This investment strategy will entail buying the undervalued security while short-selling the overvalued security, all while maintaining market neutrality. It can also be referred to as market neutral or statistical arbitrage. - Source: Fidelity

Moreover, readers should keep in my mind the following important aspects:

  1. Non-Directional: A pair trade isn't about being against the company on the short side (of the trade) rather about being in favor of the stock on the long side relative to the stock on the short side.
  2. Relative Value: A pair trade isn't about choosing one stock that is expected to move up (long leg) and one stock that is expected to move down (short leg). It's great if this is the outcome, but the main purposes of a pair trade are hedge (lower risk trade) and edge (relative value).
  3. Similar Characteristics, e.g. same sector, same industry, similar yield, product/s, or customers.
  4. Out of Historical Trading Range. In most cases, this is quite obvious. However, when it comes to stocks that are subject to an immediate/near-term buyout - things are more complicated, surely not that simple.

Merck & Co

Let me start by saying loud and clear: Not only do we have nothing against Merck & Co (NYSE:MRK), but we actually like the company. After all, how can we dislike a company like Merck shortly after declaring that we're bullish on Healthcare & Biotech?

Nonetheless, there's a difference between a company's operations and the valuation of the exact same company. While the former can be great, the latter might be nowhere near as great.

Is there anything wrong with MRK's valuation right now? No, there isn't.

As a matter of fact, the stock just broke into a new all-time high, after a waiting period of 21.5-year!

Merck stock just broke into a new all-time high

Y-Charts, Author

Technically, this is a bullish pattern, however:

1) There's nothing particularly exciting about MRK's current valuation (TTM multiple of 16.5).

The stock been there, done that, and most of the past runs-up started from the stock trading with lower multiples.

MRK current valuation

Y-Charts, Author

2) The near-term future (12-24 months) doesn't tell the full story regarding Merck's mid-term future (3-7 years). Merck's Keytruda is one of the world's top selling drugs, with projected sales of ~$20B in 2022.

Top pharmaceutical drugs by projected 2022 global sales


Sometime after 2028, Keytruda will lose its patent exclusivity and Merck is already looking to fill what is expected to be an over $30B/year loss to its top line.

When the time of the patent expiration comes, Keytruda sales are projected to account for more than half of Merck total sales. Therefore, this is a real threat for Merck; a threat that must be addressed way before 2028.

Proportion of Keytruda out of Merck total sales will only grow as the company lurches towards patent expiration

SVB Leerink

This is the main reason behind the recent chatter regarding Merck potentially making a move to buy Seagen (NASDAQ:SGEN), a promising biotech that is:

  • boasting marketed drugs
  • having an impressive pipeline
  • operating without a CEO (over the last couple of months)

SGEN is a perfect fit for MRK (as well as a few others), and so it's anything but a surprise that many believe a Seagen takeover (by Merck) is inevitable.

Nonetheless, in this article, we're not going to analyze the potential and/or merits of such a deal. Instead, we're only going to focus on the (likely) possibility that Merck is about to push forward with an acquisition.

As we all know, following most buyouts, the stock price of the acquiring entity tends to move down (especially if there's dilution) and the stock price of the acquired entity tends to move up (due to the premium that is almost always being paid).

If so, it would only be natural for MRK to move down and for SGEN to move up, if and when a buyout is announced.

Thing is, there's more to it than just this.

The Seagen Factor

Remember the "Out of Historical Trading Range" that we've mentioned above? Well, if you look at the MRK/SGEN ratio, you can clearly see that it's trading out of the historical trading range.

Based on this ratio, SGEN is too expensive relative to MRK.

Based on MRK/SGEN ratio, SGEN is too expensive relative to MRK.

Y-Charts, Author

Does it mean that buying SGEN isn't a worthwhile move for MRK? No, it doesn't, but it does suggest that such a deal would be an expensive one.

Merck has a market-cap of ~$234B.

Merck market cap


Seagen has a market-cap of ~$33B.

Seagen market cap


Even if MRK makes a move, we don't know whether the deal would be cash only, stock only, or a combination of both.

That's key to understand what would be the impact on MRK, because not only the exact valuation is important (SGEN is expected to be taken out for at least $200/share, or about $38.5B), but also the mean of payment.

Since MRK is trading at an all-time high, it would be tempting (for the company) to pay in the form of its stock, however that would be a fairly significant dilution (even if the value of SGEN for MRK justifies this).

No matter what, SGEN is going to be a big deal for anyone buying it, and it's likely that the market is going to "punish" the acquiring company, for the inherited risk that comes with paying ~$40B (no matter how good/promising is the purchased item), regardless of the exact mean of payment.

Side note: Without a deal, SGEN is likely poised to decline from here.

Without a deal, SGEN is likely poised to decline from here.

Y-Charts, Author

Why do we touch upon all of this? Because if you ask yourself why do we use MRK, and/or why don't we use SGEN, on the short leg of the pair trade, there are a few answers:

  1. If a deal doesn't happen, we believe that MRK's upside is limited.
  2. If a deal happens, we believe that MRK is poised to lose steam.
  3. If a deal doesn't happen, we believe that SGEN's downside is limited because if it won't be MRK now - it would be someone else (or MRK...) later on.
  4. If a deal happens, we believe that SGEN is likely to soar. We expect a deal (no matter who is the buyer) to be for at least $214.

If a deal happens, we believe that SGEN is likely to soar.

Y-Charts, Author, Wheel of Fortune

All in all, while MRK on the short side is little risk (that we're willing to take), SGEN on the short side is a big risk (that we don't want to take).

Aurinia Pharmaceuticals

Aurinia Pharmaceuticals (NASDAQ:AUPH) has been subject to buyout speculations for well over a year now.

It was as early as May 2021, when The Times mentioned AstraZeneca (AZN) or GSK (GSK) are "sniffing around" Aurinia. Later on, GSK itself denied the report.

In October 2021, it was Bloomberg reporting that Bristol Myers Squibb (BMY) might come up with an offer for AUPH, after losing to Merck (MRK) in the battle to acquire Acceleron Pharma.

In late October Cantor analyst Alethia Young said AUPH could be sold for $45-$53/share, with Amgen (AMGN), AbbVie (ABBV), Johnson & Johnson (JNJ) and Japanese Otsuka Pharmaceuticals (OTCPK:OTSKF) mentioned as potential bidders aside of BMY. Betaville added Roche (OTCQX:RHHBY) to the mix.

A month later, it was Novartis' (NVS) R&D day, where the company put the focus on smaller deals that refueled takeover speculation chatter.

In January 2022, a Stat News report added Biogen (BIIB) to the long list of interested parties, as part of the company's search for potential targets.

Over recent months, the non-stop stream of rumors has (somewhat) stopped, and AUPH's share price is reflecting this.

AUPH share price

Y-Charts, Author

However, just like a Phoenix arising from the ashes, the AUPH takeover chatter emerged (from the rumors) last Friday after Betaville issued an "uncooked" alert, once again pointing to Otsuka as a potential buyer.

As a result, the stock surged as much as 13% and expectations are for a fairly quick buyout.

Going back to trading "Out of Historical Trading Range", it's clear that based on the current MRK/AUPH ratio, AUPH is cheap relative to MRK.

[Perhaps MRK should be buying AUPH instead, or at least before SGEN?...]

Based on the current MRK/AUPH ratio, AUPH is cheap relative to MRK.

Y-Charts, Author

Unlike SGEN, let alone MRK, AUPH is a small fish, with a market-cap of only $1.6B. That makes a buyout an easy deal/pill to swallow for any large-cap, let alone mega-cap, pharma, even if a premium of 100%-150% is being applied.

[Note that Otsuka Pharmaceuticals, the most recent suspect to acquire AUPH, has a market-cap of $19.36B]

Aurnia Market Cap
Data by YCharts

As such, it's no wonder that most investors (including the ones that participated in our survey) are seeing a deal for AUPH coming before SGEN.

[We're not so sure about this, but again - that's a separate discussion which is less relevant for the immediate pair-trade idea we present in this article]

Valuations and Risks

Let's look at what Wall Street analysts are expecting from the relevant stocks:


  • Expected Upside (to average price target): More than double.
  • Max. Downside: None.
  • Max. Upside: +163%

Conclusion: Little downside risk; a significant upside (especially in a buyout)

Our take: We agree with Wall Street. AUPH buyout should be inside the 20-30 range, with a bias towards the upper half of the range.

AUPH: Expected Upside (to average price target)



  • Expected Upside (to average price target): None.
  • Max. Downside: -33%
  • Max. Upside: +16%

Conclusion: Even in a buyout, the upside potential isn't greater than the downside risk.

Our take: We disagree with Wall Street. As mentioned above, we believe that the stock is well-buoyed (limited downside risk), and we expect a 20%+ upside (at the very minimum) if a near-term deal is announced.

SGEN: Expected Upside (to average price target)



  • Expected Upside (to average price target): <5%.
  • Max. Downside: -18%
  • Max. Upside: +24%

Conclusion: Fairly valued, with a continued upward trajectory expected, but nothing out of the ordinary.

Our take: We agree with Wall Street, but if we look at the 12 months, both our downside and upside would be smaller than the extreme points Wall Street sees. +/-10%, 15% top, would be our expectation of the stock in an "extreme" scenario.

MRK: Expected Upside (to average price target)


Let's not also forget:

  • AUPH is trading 2/3 off its November 2021 high
  • SGEN is trading 15% of its October 2020 high
  • MRK is trading near its June 27, 2022 high

There's no guarantee that after losing a lot of ground, a stock price is poised to recover. Nothing is preventing a stock that has halved from halving again, and then again, if "needed"...

Still, when we talk about a small-cap biotech that is clearly drawing the interest of some big pharma guys, we can say that AUPH's current valuation is very low, without but surely with buyout chatter running in the air.

Aurnia vs Seagen vs Merck price
Data by YCharts


Going back to what we started with, when we look at AUPH-SGEN-MRK we can certainly construct a pair-trade that meets the basic requirements:

  • non-directional: we expect AUPH to perform better no matter what.
  • relative value: a buyout is a clear catalyst to create that.
  • similar characteristics: same sector/industry.
  • trading out of their historical trading range: we already ticked these boxes.

One (simple) way to look at it is to count on Wall Street and to expect AUPH to perform much better than either MRK or SGEN, without making too much of a story out of recent rumors regarding any of the trio.

Upside potential (vs current market price) of MRK, SGEN, and AUPH


A more comprehensive way is to analyze the situation based on the following table:

[Of course, our assumptions, projections, and expectations are built into this, and you may wish to use different figures, but the concept is the main thing to take out of this]

MRK, SGEN, AUPH acquisition projections


Note that since MRK is paying a dividend, the impact of the yield should also be taken under consideration. Nevertheless, since the yield is relatively small relative to the differences in the net impact - therefore, won't change the bottom line - we ignore it.

I assume that AUPH being the long leg of this pair-trade is something very few readers might have an issue with. Contrary to that, many readers are likely finding MRK being the short leg to be questionable.

The above table is the ultimate explanation why we prefer to short MRK, and not SGEN, against going long AUPH.

and just to be very clear about this: We don't suggest shorting MRK, and the only reason we would short MRK is if it's part of a pair-trade.

Theoretically, one may use SGEN instead of MRK, and (as per the above) we actually believe that this might work. Nonetheless, in such a case the expected return (out of the pair-trade) would be lower and the risk (of the pair-trade) would be higher, simply because SGEN is obviously a more risky investment than MRK - and that goes both ways.

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Looking to outperform the SPY on a risk-adjusted basis, in a relaxed manner

Welcome to my profile and thanks for stopping by!

First and foremost, let's clarify two important points that you might currently find confusing:

1. "Macro Trading Factory" ("MTF") by "The Macro Teller" ("TMT") is the second service we offer after the "Wheel of FORTUNE" ("WoF") by "The Fortune Teller" ("TFT").

2. TFT and TMT are the same person. It's due to SA policy that we need to open two profiles in order to run two services, but rest assured we don't suffer from schizophrenia (as of yet)...

TMT is an account that represents a business which is mostly focuses on portfolio- and asset- management. The business is run by two principals that (among the two of them) hold BAs in Accounting & Economics, and Computer Sciences, as well as MBAs. One of the two is also a licensed CPA (although many years have gone by since he was practicing), and has/had been a licensed investment adviser in various countries, including the US (Series 7 & 66).

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Currently, they run a business which is mainly focusing on active portfolio/fund/asset management as well as providing consulting/advisory services. The business, co-founded in 2011, is also occasionally getting involved in real estate and early-stage (start-up) investments.

The people who work in and for this business are an integral and essential part of the services that we offer on SA Marketplace platform: Wheel of Fortune, and Market Trading Factory. While TMT (or TFT for that matter) is the single "face" behind these services, it's important for readers/subscribers to know that what they get is not a "one-man-show" rather the end-result of an ongoing, relentless, team effort.

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The contributor RoseNose is both a contributing and promoting author for Macro Trading Factory. 

On a more personal note...

We're advising and consulting to private individuals, mostly (U)HNWI that we had been serving through many years of working within the private banking, wealth management and asset management arenas. This activity focuses on the long run and it's mostly based on a Buy & Hold strategy.

Risk management is part of our DNA and while we normally take LONG-naked positions, we play defense too, by occasionally hedging our positions, in order to protect the downside.

We cover all asset-classes by mostly focusing on cash cows and high dividend paying "machines" that may generate high (total) returns: Interest-sensitive, income-generating, instruments, e.g. Bonds, REITs, BDCs, Preferred Shares, MLPs, etc. combined with a variety of high-risk, growth and value stocks.

We believe in, and invest for, the long run but we're very minded of the short run too. While it's possible to make a massive-quick "kill", here and there, good things usually come in small packages (and over time); so do returns. Therefore, we (hope but) don't expect our investments to double in value over a short period of time. We do, however, aim at outperforming the S&P 500, on a risk adjusted basis, and to deliver positive returns on an absolute basis, i.e. regardless of markets' returns and directions.

Note: "Aim" doesn't equate guarantee!!! We can't, and never will, promise a positive return!!! Everything that we do is on a "best effort" basis, without any assurance that the actual results would meet our good intentions.

Timing is Everything! While investors can't time the market, we believe that this applies only to the long term. In the short-term (a couple of months) one can and should pick the right moment and the right entry point, based on his subjective-personal preferences, risk aversion and goals. Long-term, strategy/macro, investment decisions can't be timed while short-term, implementation/micro, investment decision, can!

When it comes to investments and trading we believe that the most important virtues are healthy common sense, general wisdom, sufficient research, vast experience, strive for excellence, ongoing willingness to learn, minimum ego, maximum patience, ability to withstand (enormous) pressure/s, strict discipline and a lot of luck!...


Disclosure: I/we have a beneficial long position in the shares of AUPH, SGEN either through stock ownership, options, or other derivatives. 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: TipRanks: BUY AUPH, SGEN

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