Could This Buyout Go Down As One of the Worst Deals Ever?

You certainly don't have to look far these days to see that merger and acquisition activity is picking up across a number of sectors.

Investors and Wall Street analysts love to see M&A activity because it signals two things. First, it points to companies' willingness to take on risk by paying a premium (in most instances) to acquire a rival or expand into a complementary business. Secondly, and perhaps most importantly, it demonstrates improved corporate visibility and the expectation of long-term growth. In other words, when investors see M&A activity they get excited, and rightly so.

However, history has shown us that not every M&A deal goes according to plan. The merger of AOL with Time Warner is perhaps one of the biggest tech wrecks of all time, while Bank of America's $2.5 billion purchase of Countrywide Financial during the financial meltdown wound up costing it $40 billion in settlement costs. Although I believe the magnitude of failure from these deals may be tough to match, I would also opine that the deal announced earlier this week between Merck (MRK -0.05%) and Idenix Pharmaceuticals (NASDAQ: IDIX) has the potential to rank highly among the worst deals ever.

Source: EMD Group.

Does this deal make sense?
Under the terms of the buyout Merck agreed to pay $3.85 billion, or $24.50 per share in cash, to acquire all outstanding shares of Idenix. Assuming everything stays on track the deal would close in the third quarter, and it'll represent a 239% premium to last Friday's closing price.

The move was made by Merck to get its hands on Idenix's lead drug samatasvir, an NS5A inhibitor, as well as its two additional clinical-stage nucleotide prodrugs, IDX21437 and IDX21459. Merck's press release notes that Idenix's pipeline will help complement its own developing hepatitis C pipeline, and should help broaden its chances of getting a hepatitis C therapy to pharmacy shelves.

On one hand I have to admit there are scenarios where this deal makes sense. Idenix's proprietary technology could be one way for Merck to cash in on its purchase. Idenix is already squaring off toe-to-toe with Gilead Sciences (GILD 0.12%) over Sovaldi claiming that Gilead is infringing on one of its key patents. If Idenix were to win it could be set up with a hefty upfront payment or perhaps even a steady royalty payment.

In addition, the ability to possibly combine samatasvir or Idenix's nucleotide prodrugs with either of its own investigational oral hepatitis C compounds, MK-5172 and MK-8472, could give Merck even more opportunities to develop a blockbuster. Merck is looking for ways to avoid the patent cliff, and testing as many hepatitis C combination therapies as possible could prove to be a smart move.

Source: EMD Group.

Among the worst biotech deals ever
But, in my opinion this has all the makings of being a complete dud for Merck.

Putting aside the potential royalty or upfront revenue from Gilead Sciences, let's look at what Merck is actually purchasing: namely two midstage therapies in samatasvir and IDX21437, and a single phase 1 investigational drug in IDX21459, as well as a number of preclinical nucleotide inhibitors currently being studied.

These generally early stage compounds would already be considered a serious stretch to be purchased for $3.85 billion, but if you take a closer look at the pipeline history behind Idenix the premium Merck paid seems even pricier.

As a refresher, since 2010 Idenix has had four of clinical compounds placed on hold by the Food and Drug Administration (five if you count IDX184 which was actually placed on hold twice!). Subsequent to those holds Idenix wound up discontinuing IDX320, IDX184, and IDX19368, all of which were once considered to be an instrumental component to Idenix's long-term success. At the moment it still has IDX20963 on FDA hold with the regulatory agency requesting additional preclinical safety data from Idenix. With Idenix failing to get any of its pipeline therapies beyond a phase 2 study what exactly is Merck hoping to accomplish with a nearly $3.9 billion purchase?

Worse yet, it's as if Merck's completely ignored the fact that Gilead Sciences and possibly AbbVie (ABBV 0.98%) haven't completely beaten it to pharmacy shelves by years!

Gilead's Sovaldi has drastically improved patient quality of care for genotype 2 & 3 patients who no longer need to take interferon (which is known to cause flu-like symptoms in patients), and the potential approval of Sovaldi in combination with ledipasvir has the potential to expand that to genotype 1 patients as well. Not to mention that Gilead's multiple studies with Sovaldi have consistently produced sustained virologic response (SVR) rates (i.e., undetectable levels of disease) in 90% or more of patients.

By a similar token AbbVie has filed new drug application paperwork for its direct-acting antiviral combo which could mean an approval before 2014 is over. It, too, can be given to genotype 1 patients without the need for interferon and also produced SVR's consistently at 90% or above in clinical trials.

Source: Cameron Neylon, Flickr.

What this means for Merck and Idenix is that unless samatasvir or some combination of samatasvir and one of Merck's compounds can consistently produce mid-90% SVR's there's probably little chance of it unseating Sovaldi or AbbVie's DAA.

We also have to consider what sort of chance Merck and Idenix have at penetrating the HCV marketplace with the assumption that samatasvir probably has little chance of making it to pharmacy shelves, even under the most ideal study conditions and results, prior to 2017. By then Gilead and AbbVie will have established themselves, potentially leaving but scraps of market share left over for the latecomers.

Finally, investors should keep in mind the precedent set by Bristol-Myers Squibb (BMY -0.30%) when it purchased Inhibitex for $2.5 billion in 2012 only to have the company's lead drug (which eventually was known as BMS-986094) scrapped in midstage studies due to safety concerns. The end result was Bristol taking a $1.8 billion writedown tied to its Inhibitex purchase all because it desperately wanted to be a part of the HCV race.

Only time will tell
Could a similar fate await Merck? It's possible. If Idenix is successful in its case against Gilead it could net Merck a moderate revenue stream, though probably not enough to recoup its $3.85 billion investment. The real wildcard is whether or not Idenix can overcome its numerous safety obstacles and get a drug past phase 2 trials. Based on four years of history I'm not certain that's possible. Although time will truly tell the tale, based on the information we have right now as investors I'm calling the potential for this deal to be a dud much higher than 50-50.