Biotech Megadeal: Is The Stock A ‘Buy’?
It’s one of the few holdings in my Daily Paycheck portfolio that has lost ground in 2019… But there’s a good reason.
On January 3, Bristol Myers Squibb (NYSE: BMY) unveiled plans to buy Celgene (Nasdaq: CELG) in a blockbuster $74 billion transaction.
Acquirers typically fall when these mega-deals are announced, while shares of the target bolt higher. True to form, BMY slid 14% on the news, while CELG jumped 25%.
Despite the drop, my subscribers and I are still in the black on this one. But is this a good deal? And is BMY worth owning today?
First, let’s get some of the specifics out of the way. Bristol Myers is offering one share of BMY and $50 cash for each share of CELG. There is also the possibility of additional cash remuneration for Celgene investors later down the line (known as a contingent value right, or CVR) if three drugs in the firm’s pipeline eventually gain regulatory approval.
Based on BMY’s share price at the time of the announcement, the bid (excluding CVRs) works out to a little more than $102 per share. That’s a healthy premium of 53% above where CELG closed the day before the announcement.
As you might expect, just about every financial media outlet from Barron’s to the Wall Street Journal has weighed in on this transaction. I’ve read at least a dozen different pro and con takes.
What Bears Are Saying
The arguments against the purchase boil down to this. First, Celgene is overly reliant on a single product, Revlimid, which is used to treat myeloma (a type of blood cancer). This single drug accounts for roughly two-thirds of the firm’s revenues and is facing not only legal challenges but also looming patent expirations. Celgene had a promising treatment for Crohn’s disease, but it got shot down in the latter stages of clinical trials in 2017.
#-ad_banner-#The greater concern is that this deal will pile a ton of debt onto Bristol Myers’ clean balance sheet. The company currently has $1.1 billion in net cash on the books and boasts an A+ credit rating from Standard & Poor’s. But it will be borrowing more than $33 billion to close the deal and will assume another $20 billion owed by Celgene, pushing total company debt north of $50 billion.
There was an immediate reaction in the firm’s credit default swaps. These instruments (used to insure a company’s debt against nonpayment) spiked 66% almost overnight to the highest levels since 2010. That reflects some concern that Bristol Myers may be biting off more than it can chew.
These are the real reasons BMY stock slumped on the news (not the traditional complaint that it overpaid). There was also some letdown from investors hoping that Bristol Myers would itself be bought out by a larger rival like Pfizer (NYSE: PFE), a less likely scenario after the Celgene purchase.
These arguments aren’t to be taken lightly. However, there are more positives to this deal than negatives.
What Bulls Are Saying
While rising debt is certainly a concern, it’s nothing Bristol Myers can’t handle. After the transaction settles, total borrowings would only equal about 3.5 times annual EBITDA. That’s quite manageable.
And the proceeds will be put to good use.
Management expects the deal to be immediately accretive to the bottom line, boosting earnings per share by 40% in the first year. In time, the merger could also yield $2.5 billion in annual cost savings synergies by eliminating overlap.
The combined company will have a strong portfolio with nine billion-dollar drugs on the market — not to mention one of the industry’s most promising development pipelines. Bristol Myers and Celgene have complementary platforms with numerous candidates in the key areas of oncology, immunology and cardiovascular disease.
At least six of those are in the latter stages (Phase III) of clinical trials and are expected to launch soon, potentially adding $15 million in incremental yearly revenues. Management is forecasting $45 billion in cumulative free cash flows within the first 36 months after the deal closes, paving the way for continued dividend hikes.
As it stands, the backlash from this big purchase has lifted the yield to 3.3%.
Action to Take
While there is some debate regarding the benefits of this acquisition, most agree that the price was right. The premium sounds generous, but that’s only because CELG had been cut in half from its former peak above $120. Bristol Myers pounced at an opportunistic time, picking up Celgene for less than 10 times forward earnings — a sharp discount in the biotech world.
The legal challenges facing Revlimid won’t be resolved for at least the next couple of years, and generic competition won’t be a real threat until 2022 at the earliest. Meahwhile, this merger will create a biopharma powerhouse in cancer research with a more diverse revenue stream, a stronger pipeline, and deeper cash flows that should allow for both increased dividends and deleveraging.
BMY may have a hangover for a while, but is more valuable after this deal than before. That’s why I upgraded the stock to a “Buy” and told my Daily Paycheck readers that we’d be adding more shares.
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