Thoughts On A Post-Merger Bristol-Myers Squibb: Scaling From Celgene To Buy BMS

April 1, 2019 3oliver

Very good news for the merger

Bristol-Myers Squibb, or “BMS” (BMY) has agreed to acquire Celgene (CELG). Each share of CELG will be paid with $50 cash, one share of BMS stock and a contingent value right, or CVR, with a $9 cash payment if three CELG drugs are approved timely.

My initial reaction in January was that CELG was attractive as an arbitrage play, and I scaled into a full position and then some with an average price around $88. As I studied the deal more, based on fuller disclosure of the thinking at BMY, I began liking it more. My position evolved to think that as the large cap stock market (SPY) began rallying but BMY began dropping again below $50, BMY began looking like a cheap value stock which offered several ways for the buyer of its shares to achieve alpha. Initially, one of the reasons to own BMY was that even though I did not think there would be limited takeover interest in it, and in any case I expected the deal would go through, owning BMY was a dividend-paying hedge against the deal failing and BMY suddenly being viewed as ‘in play.’

I’d like to summarize Friday’s sequence of events indicating the deal will pass. The first major news was summarized Friday by Seeking Alpha:

CELG is up 6% premarket on light volume in response to proxy advisor ISS supporting its announced merger with BMY (-1% premarket).
Shareholders at both companies will vote on the tie-up on April 12.

Insitutional Shareholder Service is quite influential. Their support was viewed by “Mr. Market” as critical to a smooth vote of BMY shareholders for the deal. In addition, as Business Insider reports, another influencer came out Friday for the deal (my emphasis):

Institutional Shareholder Services and Glass Lewis, two influential advisory-services companies, have recommended in favor of the deal, which has faced an unusual level of pushback from Bristol-Myers shareholders, including some of its largest stakeholders.

ISS called the deal’s rationale “sound” overall, while Glass Lewis described it as an “attractive” combination.

“Based on our research, review and analysis, we believe the proposed merger is strategically compelling and presents the opportunity for potentially significant returns to shareholders of the combined company, including existing Bristol-Myers holders,” Glass Lewis’ report said.

Finally, in response to this and the lack of other support against the deal, Starboard Value withdrew its proxy urging a “nay” vote.

I think that it’s a high-likelihood set of events for each company’s shareholders to approve the deal, and for regulators to approve it as well. But I’m not sure of the timing, and would model December rather than Q3 to be conservative.

With this context, I want to update and alter my thinking about CELG and make some early comments on a post-merger BMY.

CELG – fully valued

These are the stock prices at Friday’s close:

CELG: $94.34
BMY: $47.71.

Before adding in the CVR, the value of the deal is $97.71 at today’s prices. That is so close to $94.34 that I think it’s now an “arb” play unless the CVR is worth it. I don’t think it is; here are the terms, from the press release announcing the deal:

Each share also will receive one tradeable CVR, which will entitle its holder to receive a one-time potential payment of $9.00 in cash upon FDA approval of all three of ozanimod (by December 31, 2020), liso-cel (JCAR017) (by December 31, 2020) and bb2121 (by March 31, 2021), in each case for a specified indication.

So, let’s say that in December 2019 one has $97.71 worth of consideration for each CELG share. What’s the CVR worth? I would target a weighted average of one year for it to pay off if it does pay off; that it is worthless could be learned at any time, if one of the drugs is rejected by the FDA. I will thus value the CVR as a one-year coin flip worth $4.50 on average as of this December. This would be about a 5% additional return in about one year (maybe a little longer). This is below the required return most of us assume for a stock. So, unless one is especially bullish on BMY, I see CELG as fully valued – but then it would be OK to buy BMY anyway. Tax considerations may come into play here, so please take none of this as actual advice.

I am going to look next week at the call prices and open interest versus how CELG and BMY are trading before deciding on whether a call-selling strategy is interesting.

Now it’s time to look carefully at BMY in combination with CELG.

Enterprise value of a post-merger BMY

I am using 1.637 diluted BMY shares and the 715 MM shares CELG said in its Q4 press release would be its average diluted share count for 2019. I also assume that promptly after the closing, BMY will buy back 100 MM of its shares for $5 B (at $50/share) and do so from net cash reserves. This would give BMY a 2.262 B diluted share count post-merger. Multiplying by a proposed $50 share price and adding $60 B of net debt due to the merger would give a $172 B enterprise value. My estimate is for $45 B in 2020 revenues, based on the consensus of $19.3 B for CELG and $25.1 B for BMY; I round up because CELG generally beats consensus.

These numbers would give a prospective price:sales ratio of 3.8X for 2020 at the $50 price point for BMY.

The $60 B of net debt is estimated this way:

CELG has about $20 B of net debt as of now; assume no change
$36 B in cash to CELG shareholders
$4 B paid later to CELG shareholders for the CVR; note this is a weighted average, as the real number would either be zero or about $6.3 B.

Why I like BMY here

#1: Rapid debt paydown

The CELG assets are fantastic free cash flow generators. BMY generates good FCF, as well. But the two companies this year, taken as one, may spend a gigantic 30% of revenues on R&D. Cutting R&D spend is one way to pay down debt and invest in the many product launches anticipated through 2021. Also, some pipeline assets could be sold, not just dropped. Finally, regulators may not allow BMY to control both Otezla for psoriasis as well as BMY’s late-stage TYK2 inhibitor for the same disease. If forced to choose, BMY might opt to sell Otezla. I am modeling $8 B for this asset.

The valuation point of rapid debt paydown is as follows. Say that Revlimid sales peak at $14 B in 2022 and then drop to $2 B, then vanish to zero. If peak sales are $50 B in 2022, the company could still easily do $38 B or higher, and if net debt is lowered to $35-40 B by then with a stable share count, enterprise value would drop by the amount of net debt reduction.

Investors could then be looking at trough revenues, and then it is up to the imagination as to what P:S ratio would be accorded this company. It could easily be 5X or higher, giving a $200 B enterprise value and allowing for very nice price appreciation for BMY.

#2: Massive scale and focus

The post-merger BMY will be a global #1 in oncology and top-5 player in immuno-science. It also has Eliquis and research in CV and fibrotic diseases. However, BMY will be a very large niche player with all the advantages that provides. Strong management, and BMY’s independent board, in my positive view will indeed lead to synergies everywhere in the company, including:

basic science research
clinical-stage R&D
sales and marketing
general and administrative.

Also important is that the combined company will be so large that it may be approached to market or co-market oncology or immuno-science drugs simply due to its knowledge of the market and global reach. It will be like Pfizer (PFE) in this regard, which bodes well for its staying power during periods of slow new product development.

#3: Focus in hot areas of pharma/biotech

The advances in oncology and immuno-science have brought what were backwaters of the pharma industry 30 years ago to the fore. Being a leader in growing areas is a big advantage. The advantage involves both real growth prospects and the valuation that investors will give to the company. The vision that BMY management is painting for the post-merger BMY is sensible: tremendous near-term cash flow, numerous near-term product launches to replace Revlimid revenues when the time comes, and then the earlier-stage pipeline plus business development activities allow long term growth.

Many other points could be made on this topic, but your time is precious, so I’ll move to wrap up here.

Risks

If the merger unexpectedly is not approved by shareholders of both companies, or if regulators put unexpected hurdles in the way of the deal leading to its cancellation, I would expect CELG to trade down from here and BMY to trade up (all other things being held unchanged).

Post-merger, of course everyone is wondering when Revlimid will fall to generics. A growing drug doing perhaps $11 B in sales this year is so important that every additional month of sales matters. An early collapse in sales is one risk. Many others exist. Pipeline assets such as liso-cel have unpredictable launch costs and revenues, and of course until approved by the FDA and other regulatory agencies, they are purely cost centers, not profit drivers.

The risks are so numerous right now that I will simply suggest that any investor or potential investor in either CELG or BMY gain familiarity with them by reviewing either company’s disclosures.

Concluding points: BMY for the long run

When Bristol-Myers merged with Squibb in 1989, the deal had fewer synergies than the BMY-CELG deal offers. The stock was a star nonetheless, rising about 6X in the next 10 years (helped by the bull run in the sector). I like that precedent. This is a transformative deal. In more than half a century of looking at business developments – beginning with the conglomerate fad in the 1960s – I may never have seen a merger of equals that fits together as well as CELG and BMY do. So I agree with Glass Lewis, quoted above.

I also like the fact that a Big Pharma name with a board largely comprised of independent directors is the acquirer.

I trust that BMY’s CEO and head of R&D, both medical doctors, will make intelligent decisions on how to shape the combined company.

My current year-end 2020 price target on a post-merger BMY is $60. That implies about a 30% total return in the next 21 months, or mid-teens annual return. Given a secure dividend that BMY hopes to increase steadily through the merger and a current yield of 3.44%, buying the latest arbitrage-related drop in BMY makes sense to me. Conversely, I do not see much upside to CELG versus BMY here, and have mostly traded out of CELG around $94 to buy more BMY in the $48 range. A covered call-selling strategy on CELG may be worth considering.

Thanks for reading and sharing any thoughts on this evolving story you wish to contribute.

[Author’s note: Submitted Sunday morning.]

Disclosure: I am/we are long BMY,CELG. 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.

Additional disclosure: Not investment advice. I am not an investment adviser.