With the exception of Apple's revenue face-plant, no story in the early going of January has gained more notoriety than Bristol-Myers Squibb's (NYSE:BMY) announcement that it was buying Celgene (NASDAQ:CELG) for approximately $74 billion.
Acquisitions in the drug-development space are relatively common -- but a deal on the scale of $74 billion isn't something Wall Street or investors see all that often. Assuming shareholders from both companies approve the deal and regulators don't stand in the way, it would create a cancer, immunology, and inflammation powerhouse with around a half dozen late-stage therapies with blockbuster potential readying for launch.
Breaking down Bristol-Myers' proposed acquisition of Celgene
Under the terms of the deal, Bristol-Myers Squibb will pay Celgene shareholders $50 in cash and one share of Bristol-Myers' common stock (valued at $52.43 on the day of the announcement), and Celgene shareholders would also receive a contingent value right (CVR) entitling them to $9 per share extra if three developing therapies are approved before specifically laid-out deadlines -- ozanimod and liso-cel both by Dec. 31, 2020, and bb2121 by March 31, 2021. Not including the CVR, the deal represented a 54% premium to Celgene's closing price on Jan. 2, 2019.
Some folks aren't thrilled with the deal, including my colleague Keith Speights, who, like me, is also a shareholder of Celgene. Keith argues that Celgene grossly undervalued itself with the $102.43 cash-and-stock deal and notes that Celgene repurchased a lot of its own stock at substantially higher levels prior to the Bristol-Myers acquisition announcement.
While I don't disagree with Keith's assessment, I do still believe there's plenty of reason for investors to consider buying Celgene right now, even after the deal with Bristol-Myers was announced. The way I see it, there's a potential win-win-win scenario on the horizon.
Win scenario No. 1: The buyout goes through
The most likely of all scenarios is that Bristol-Myers' and Celgene's shareholders vote in favor of the deal and regulators allow the merger to occur.
On the surface, there are a number of advantages to this combination. There's the expected $2.5 billion in peak annual cost synergies by 2022, as well as the noted half dozen new product launches expected within the next couple of years that could cover $15 billion in annual sales as an aggregate.
But it's the arbitrage opportunity that's particularly exciting here. As noted, Celgene shareholders would receive $50 in cash per share, as well as one share of Bristol-Myers' stock. Following the deal announcement, Bristol-Myers' share price dove on concerns of higher debt levels. As of Monday's close (Jan. 7), Bristol-Myers' share price stood at $48.41, down $4.02 since the deal announcement. However, with Celgene closing at $87.52 on Monday, this represents an arbitrage opportunity of 12.4%.
Mind you, this arbitrage opportunity doesn't factor in the CVR. Should Celgene's three lead pipeline products meet their regulatory deadlines, another $9 per share is headed their way. That's an arbitrage opportunity of up to 22.7%.
The wild card here is obviously Bristol-Myers Squibb's share price. Thankfully, growth from blockbuster blood thinner Eliquis and immunotherapy Opdivo, along with a forward price-to-earnings ratio of less than 12 (which is relatively cheap compared to the broader market), is unlikely to put too much downside pressure on Bristol-Myers' share price.
Win scenario No. 2: A bidding war commences
Although it's the unlikeliest scenario of all, it's possible that Bristol-Myers' bid for Celgene could be outdone by another pharmaceutical company looking to add abundant cash flow and near-term pipeline blockbusters. This would help appease those Celgene shareholders who believe the company sold itself too cheaply.
Admittedly, inclusive of debt, there aren't too many drug companies that would have the capacity to gobble up a company the size of Celgene...unless you're Pfizer (NYSE:PFE). Pfizer had more than $17 billion in cash on its balance sheet at the end of its most recent quarter, and it recently announced a joint venture to combine its slower-growing consumer health unit with GlaxoSmithKline's consumer health operations. That frees up Pfizer to focus almost exclusively on high-margin branded therapies.
With few exceptions, combining Pfizer and Celgene would make sense, especially given their focus on high-growth oncology indications. Although there would be some potential indication overlap in inflammation, the combination would easily be viewed more as a positive than as a negative in terms of portfolio expansion.
Even more so, it would line Pfizer's coffers in the years to come. With Pfizer having generated $17.9 billion in operating cash flow over the trailing 12-month period, Celgene may be able to add $8 billion to $9 billion in operating cash flow by 2021 in my estimate. This factors in organic growth opportunities for Revlimid and other cancer drugs, the expected launch of ozanimod for multiple sclerosis, and bb2121 and liso-cel, which are on track for well over $1 billion in peak annual sales if approved.
There's no guarantee that another suitor will emerge. But if one did, such as Pfizer, Celgene's shareholders would almost certainly see a higher offer, or at least a higher cash component.
Win scenario No. 3: The deal falls through and Celgene remains independent
The middle-ground scenario would entail the Bristol-Myers deal falling apart for some reason and Celgene remaining an independent public company. Although this could lead to a very short-term decline in the price of Celgene, it could work out very well for long-term investors.
Earlier this week, Celgene announced its 2019 guidance, and as is often the case with this company, it didn't disappoint. Total sales are expected to rise by 12% at the midpoint from 2018, with multiple myeloma giant Revlimid on pace for 11% sales growth to $10.8 billion. Every other blockbuster product, including Otezla, Pomalyst, and Abraxane, is also slated for double-digit-percentage growth from the previous year. As a result, and inclusive of those aforementioned share buybacks, adjusted earnings per share should increase by 22% at the midpoint to between $10.60 and $10.80. If the deal broke down here, Celgene would be valued at roughly eight times 2019's profit per share. That's incredibly inexpensive.
Investors have been worried about Celgene's reliance on Revlimid and the numerous challenges Revlimid's patents have faced. But Celgene has used the legal system and settlements to keep a flood of generics off pharmacy shelves. In fact, Revlimid's runway is pretty much clear until early 2026. By then, ozanimod, liso-cel, and bb2121 will have had plenty of runway of their own to get up to perhaps $8 billion to $10 billion in aggregate annual sales.
In other words, Celgene would be just fine on its own over the long run if this acquisition fell through.
This is a win-win-win situation for investors, which is what still makes Celgene an attractive stock.