Bristol-Myers: Analysis On Celgene Deal

Bristol-Myers Squibb (BMY) started the year by announcing a mega deal as it is looking to combine its operations with that of Celgene (CELG) in a near $90-billion deal. The deal is not liked given the premium and incurred leverage, as the timing of Bristol-Myers looks pretty decent which combined with the negative reaction in the stock makes that I have initiated a position in the mid-$40s.

Deal Terms

Before looking into the strategic rationale behind the deal, let’s first check out the deal terms. Bristol-Myers has agreed to buy Celgene in a deal which adds up to $74 billion in actual dollar terms, or $90 billion (if net debt is included) as that number even excludes the value of the contingent payments included in the deal.

Investors in Celgene stand to receive $50 per share in cash and a share of Bristol-Meyer’s stock. That is not all, investors furthermore receive a contingency value right which receives a payment based on future regulatory milestones with a maximum value of $9 per CVR.

Based on the $52.43 share price for the unaffected stock of Bristol-Myers, the deal comes in at $102.43 for Celgene stock (excluding the CVR) as investors in Celgene combined will hold 31% of the shares of the combination.

The Reasons For The Deal

Like most large-scale M&A, the reasons behind dealmaking are similar, that of strategic and financial rationale. Let’s start with the former. The strategic rationale is that of complementary portfolios which become larger and more balanced, with strength in oncology, immunology & inflammation as well as cardiovascular. Celgene will furthermore add significantly to the pipeline as shared expertise, and infrastructure should allow for both revenue and cost synergies.

These cost synergies, should not underestimated, are expected to run at $2.5 billion a year by 2022, as Bristol-Myers has an unleveraged balance sheet as well ahead of the deal. Roughly half of the synergies are seen in SG&A expenses, complemented by R&D and manufacturing efficiencies. Interesting enough, Bristol-Myers still expects to execute a $5-billion accelerated share repurchase program ahead of the deal closure.

The Calculations

In the deal presentation, Bristol-Myers came up with some quick back-of-the-envelope calculations about the state of the balance sheet. Current combined cash balances come in at $10 billion, as $32 billion in new debt will be assumed on top of $20 billion existing debt of Celgene. That would suggest a $42-billion net debt component as well as a $38-billion equity issuance.

Let’s check these calculations real quickly. Bristol-Myers ended Q3 with $8.8 billion in cash, equivalents and marketable securities while operating with $7.3 billion in debt and another $1.0 billion in pension liabilities. The company had 1.64 billion shares outstanding. This valued the company at $85 billion at $52 per share in terms of both the equity and operating asset valuation as net debt (including pensions) was pretty flat. That is equivalent to roughly 4 times sales seen around $22 billion, and at just around 13-14 times anticipated adjusted earnings, with EBIT seen around $8 billion this year.

For Celgene this is the math: the 718 million shares outstanding represent an equity valuation of $74 billion at $102 and change. Including $4.4 billion in cash and $20.2 billion in debt, it is valued at around $90 billion (actually slightly more than BMY ahead of the deal) while product sales are seen at just $15.2 billion, for a roughly 6 times sales multiple. Nonetheless, Celgene reports higher margins with adjusted earnings seen as high at $8.80 per share, or $6.3 billion on the bottom line. After adding back interest of $700 million a year and a 17% tax rate, I see adjusted EBIT around a similar +$8 billion number, which makes that multiples on that front are more in line with BMY.

Adding this together, I peg pro-forma sales at roughly $37 billion and EBIT at little over $16 billion. We know that the share count of BMY will rise from 1.64 billion to 2.36 billion shares (excluding the impact of the accelerated $5 billion buyback program). We furthermore know that a flattish net cash position of BMY and $16 billion net debt load of Celgene still has to account for a $50 per share cash component – on 718 million shares that work down to $36 billion, for a pro-forma net debt load of $52 billion. That is quite a bit with adjusted EBIT running at $16 billion, which already has added back all the amortisation charges in the “adjustment” part, with pure-play depreciation charges typically being quite limited for these businesses. Assuming that leverage ratios come in around 3 times, and working with a 5% cost of debt, I peg pro-forma interest expenses at $2.6 billion.

That makes that $16 billion in EBIT will fall to $13.4 billion ahead of taxes, or to $11.4 billion after incorporating a 15% tax rate. With 2.36 billion shares, earnings could jump to $4.80 per share, up a full dollar from current earnings in the case of BMY. Accretion is driven by usage of debt, a low multiple for Celgene and the fact that we are looking at adjusted earnings, with adjustments for both firms being quite aggressive. Note that in the case of Celgene, this kindly excludes stock-based compensation to a rate of close to $1.2 billion a year!

Market Takes It As A Negative

The market does not like the deal very much. Shares of Celgene essentially rose from $66 to an implied offer price of $102, indicating a $26 billion premium, or even $33 billion premium if the maximum CVR is included. Shares of BMY are down 15% or $8 per share. Including the to-be-issued shares, that works down to $19 billion in value going up in smoke. That suggests total accretion of just $7-14 billion despite the rationale behind the deal, including that of $2.5 billion in cost synergies. Note that if achieved, after taking into account 20% taxes and valuing at a 10 times multiple, these synergies alone should be worth $20 billion!

The reason for the lack of enthusiasm is easily understood and that is that mega-deals in the pharma space have typically not worked out great as they have created conglomerates without too much focus, too much operational distraction and becoming too large to manage, on top of a difficult and expensive and long integration process.

On the other hand, strategic and financial benefits are probably realistic to some extent as one has to congratulate BMY on the timing of this deal, as it is most certainly not chasing a hot and very expensive target.

Nonetheless, the combination is getting a lot more diverse and trades at very reasonable multiples, although some focus on deleveraging is probably needed given the net debt load, planned buybacks and all the “restructuring” and “one-time” costs which will be taken in the quarters to come.

Given the reduced expectations, I am getting quite appealed to Bristol-Myers as the cheap multiples, realisation of synergies and gradual deleveraging really put the company on a >$4 per share and probably $5 earnings per share road map in the years to come, which combined with the diversification and firepower should provide sufficient appeal to buy this decent long-term performer at an appealing price.

Disclosure: I am/we are long BMY. 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.

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