Bristol Myers Squibb and AstraZeneca: A Big Break-Up in the Diabetes Space

Breaking up is supposed to be hard to do, but it happens often enough in the diabetes space. After a disappointing run with multiple drugs and rising FDA demands for new drugs, Bristol-Myers Squibb (NYSE: BMY  ) and AstraZeneca (NYSE: AZN  ) have reached an agreement to end their diabetes joint venture, with AstraZeneca buying out Bristol-Myers' stake. Although there are ways in which this deal can work out positively for AstraZeneca, competition from the likes of Novo Nordisk (NYSE: NVO  ) and Eli Lilly (NYSE: LLY  ) makes this a risky move for AstraZeneca and likely a savvy deal for Bristol-Myers.

The deal
Under the agreement, AstraZeneca will pay $2.7 billion upfront to Bristol-Myers for its half of the joint venture, plus another $225 million for a transfer of assets. Bristol-Myers will subsequently be entitled to as much as $1.4 billion in milestones ($600 million for FDA approval of Forxiga, $100 million for Forxiga approval in Japan, $100 million for a fixed-dose Forxiga/Onglyza combo outside the U.S., $600 million in sales-related milestones) and royalties on sales out through 2025. Depending on the assumptions you wish to make for those sales, the cumulative royalties could total between $3 billion and $6 billion.

Bringing all of the milestones forward, AstraZeneca is paying about 2.5 times trailing 12-month sales for Bristol-Myers' share of the joint venture. That's a discount to the industry-average multiple (as calculated by Reuters) of almost 4 times and a big discount to Novo Nordisk's multiple of 5.2 times, but closer to the likes of Lilly and Sanofi.

Why now?
This transaction has been foreshadowed for some time, particularly when Bristol-Myers announced the rising cost and FDA demands for diabetes trials had led it to decide to terminate further development of early stage diabetes drugs. Moreover, AstraZeneca has been very bold under the leadership of Pascal Soriot in acquiring businesses, products, and prospects to turn around a business battered by patent cliffs and clinical failures. This deal comes after the $225 million (upfront) acquisition of Amplimmune, the $560 million acquisition of Pearl Therapeutics, the $323 million acquisition of Omthera Pharmaceuticals, and the $1 billion-plus acquisition of Ardea in 2012.

In this deal, AstraZeneca is getting the approved drugs Onglyza (a DPP-4 inhibitor), Bydureon (a once-weekly GLP-1 analog), Symlin, and Forxiga (a SGLT2 inhibitor). I wish I could say this is a top-notch collection of assets, but I'm not confident that's the case. Onglyza has been losing steam to Lilly's Tradjenta and Bydureon has never really closed the gap with Novo Nordisk's Victoza, despite a more favorable dosing schedule (once a week instead of once a day).

In fact, Bydureon has disappointed to such an extent that AstraZeneca simultaneously announced a $1.7 billion writedown on the acquisition of Amylin with this acquisition agreement. While there may be more hope for Forxiga, head-to-head comparisons with other SGLT1/2 inhibitors don't favor this drug.

For AstraZeneca to earn a worthwhile double-digit return on this deal, it's going to have to show that unifying the assets under one roof adds value. I do believe that the joint venture format between AstraZeneca and Bristol-Myers led to some asynergies, so margins may improve under unified leadership.

AstraZeneca management also believes it can spur growth by leveraging its scale and expertise in emerging markets (where it gets more than 15% of its sales). That sounds nice, but I'd counter that Novo Nordisk has already made inroads into emerging markets, and Lilly is close behind. Simply put, I don't think AstraZeneca is going to make much hay by selling these drugs in markets where they haven't been aggressively marketed.

A win-win?
I think this is a definite win for Bristol-Myers. The company gets out from under a portfolio of disappointing not-first-in-class drugs and no longer has to contend with an FDA that is increasingly demanding with respect to diabetes drug trials. Moreover, with the royalties, Bristol-Myers is getting a large percentage of the benefits of this business with little risk -- and can use the cash to partner, license, and acquire other drugs in targeted areas like oncology.

Obviously, I'm skeptical on the gains to be had by AstraZeneca. I think Lilly's drugs are going to take away share from Onglyza and Bydureon, and I don't believe Novo Nordisk is going to lighten up either. New products like a dual-chamber Bydureon pen and a once-monthly formulation could offer some upside, but I fear that Novo Nordisk is liable to perpetually outmaneuver them in the GLP-1 space.

On a more positive note, even just low single-digit growth in this portfolio would generate a mid-single-digit return for AstraZeneca, and that's without including any real expense/margin benefits. That sort of return isn't good enough to justify the deal, but if that's the floor (and there's upside into the double-digits if sales exceed my expectations), it's worth doing the deal.

Kudos to AstraZeneca for making bold moves to fix the problems that ail its business, but this may have been a step too far, and I believe Bristol-Myers is the more likely the winner in this transaction.

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