On Nov. 20, Bristol-Myers Squibb (BMY 1.15%) announced the completion of its $74 billion acquisition of Celgene (CELG +0.00%). Bristol-Myers' strategy centers on merging an innovative, agile biotechnology company with the reach and resources of a major pharmaceutical company. Without question, Celgene brings an exciting pipeline, however, it also brings a large drug, Revlimid, that is set to lose its patent protection and face generic competition in the not-so-distant future.
Bristol-Myers paid an attractive price for Celgene
In the two years prior to Bristol-Myers' acquisition of Celgene, Celgene's stock price declined from $119 per share to $67 per share -- a decline of more than 40%. Perhaps even more remarkable is that Celgene traded for just 6.7x forward 12-month earnings, at that point. Thus, Bristol-Myers essentially paid zero premium to acquire Celgene based on its early 2017 valuation.
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Celgene shareholders received $50 in cash, plus one share of Bristol-Myers, and one contingent value right (CVR) share for each share of Celgene. The total purchase price including the assumption of debt and the Federal Trade Commission's required divestiture of Otezla is around $85 billion, depending on taxes owed on the Otezla divestiture. Otezla, which generates over a billion dollars in sales, primarily from psoriasis and psoriatic arthritis indications, was sold to Amgen (AMGN +0.04%) for $13.4 billion in cash, pre-tax.
The CVR share is an all-or-nothing payment based on U.S. Food and Drug Administration approval of three Celgene pipeline drugs by predetermined dates. If successful, CVR holders will receive $9 per share in cash, which will account for another $6.5 billion payment from Bristol-Myers. If unsuccessful, the CVR holders will receive nothing.
The Revlimid patent cliff
Revlimid generated $10 billion in sales in 2018, and has generated $8 billion in sales year-to-date in 2019. Revlimid is a hematology (blood cancer) drug, approved for multiple indications. While Bristol-Myers has had a large presence in oncology for at least the last 25 years, Celgene represents its first true foray into hematology. Revlimid is Celgene's key product. It accounted for approximately 63% of Celgene's 2018 sales, and a similar amount of Celgene's 2019 sales year-to-date. On a combined basis with Bristol-Myers, adjusting for the Otezla sale, Revlimid accounted for about 27% of the new Bristol-Myers year-to-date 2019 sales.
Revlimid is surrounded by a portfolio of patents, however, Celgene has been settling with U.S. generic manufacturers allowing them limited-volume generic launches beginning in 2022, followed by full generic launches on Jan. 31, 2026. This should give plenty of time for Bristol-Myers' new pipeline to achieve critical mass.
What does Celgene bring besides the Revlimid patent cliff?
For starters, Bristol-Myers expects $2.5 billion in synergies within three years post-closing, which seems realistic enough at 13% of the combined operating expense base. But more important is the late-stage pipeline Celgene brings to Bristol-Myers. With Celgene, Bristol-Myers now has nine compounds in phase 3. Six compounds have potential approvals within the next two years (although one was recently approved), and five of these are Celgene's. Combined, Bristol-Myers believes these six products could produce $15 billion of revenue. Keep in mind that new revenue would be off a starting base of approximately $40 billion in sales for the combined trailing 12-months of Bristol-Myers and Celgene excluding Otezla. So clearly this near-term pipeline could have a meaningful impact. Further, there are another 50 compounds in phase 1 or phase 2 development, plus over 20 new indications for Bristol-Myers' Opdivo and Yervoy oncology compounds. So Bristol-Myers has a very full pipeline.
In addition, free cash flow generation should approach $45 billion over the first three years allowing for rapid deleveraging and restoration of the balance sheet by 2023. This will allow for ample financial flexibility should it be needed through the patent cliff. Bristol-Myers also launched a $7 billion ASR (accelerated share repurchase), to be completed by the end of the second quarter of 2020, buying back close to 5% of the outstanding stock. Further, a recent 10% dividend hike further displays management's conviction.
Bristol-Myers has a patent cliff, but its long-term prospects are robust
For years, Bristol-Myers has pursued a "string of pearls" strategy. Effectively making small add-on acquisitions to bolster its internal pipeline, and this will continue. But Celgene, even with Revlimid, simply became too compelling of an asset to pass up. The market discounted Celgene beyond anything rational, giving virtually zero value to its pipeline. Bristol-Myers saw the opportunity and acted. It has referred to the Celgene pipeline as "a bundled string of pearls."
At less than 10x forward earnings with a yield close to 3%, Bristol-Myers is attractively valued. While the stock has climbed 25% this year, it was down 28% last year, meaning the stock has barely moved over the past two years. With the Celgene acquisition officially closed, the newly combined Bristol-Myers appears well-positioned for growth for years to come. Applying a more reasonable 12x forward earnings implies upside into the high $70s. Coupled with the dividend, investors could yield returns approaching 25%. Investors should take advantage and buy shares now.
