A last minute merger arbitrage in Celgene

Today is the expected closing day of the merger between Celgene (NASDAQ:CELG) and Bristol-Myers Squibb (NYSE:BMY). All regulatory approvals have been received so there is basically nothing anymore that could derail this deal. Bristol-Myers is acquiring the company for one share of stock, a $50 cash payment and a CVR that will pay an additional $9 dollar if, and only if, three treatments that are in development receive FDA approval. With CELG trading at $107.80 at the moment of writing and BMY trading at $55.70 investors can buy the CVR for $2.10.

A hint that this might be on the cheap side can be found in this SEC filing made by Bristol-Myers in May earlier this year where the company puts an estimated fair value of $3.83 on the CVR. They don’t provide an break down how they arrived at this value, only this:

The preliminary estimate of the fair value of the CVRs was determined by applying a probability weighting to the potential $9.00 per share payment reflecting the probability of achieving all three necessary approvals. The probability-weighted value was then discounted to present value using a credit risk-adjusted discount rate.

Since that time all three treatments have progressed as planned, so presumably if they would redo this valuation today it would be higher. The three approvals that they need to get are:

  • Ozanimod (by December 31, 2020)
  • Liso-cel (JCAR017) (by December 31, 2020)
  • Ide-cel (bb2121) (by March 31, 2021)

These deadlines seem to be tight, and the combined probability of three events happening is obviously quite a bit lower than the probability of individual events, so there is reason not to be too enthusiastic about the CVR. But these treatments are all in a very developed stage of development, and the base rates of success of going from Phase III to approval or from NDA/BLA to approval are quite high. Celgene gave the following update with regards to above treatments when the company announced their results for the third quarter:

I’m not a medical expert, but given that base rates for success at this point are pretty high I think you could even make a case that the $3.83 valuation made by Bristol-Myers is somewhat conservative. These are all events that should be in the range of 75%-85% or something like that and taking very crudely 75%^3*$9 gives us a value of $3.80. This ignores that time value of money, but given that the deadlines are all relatively soon I think that doesn’t matter too much.

Because the deal will close very soon and I think that right now the CVR is probably attractively priced I bought a significant amount of CELG with a corresponding short position in BMY.

Disclosure

Author is long CELG, short BMY

14 thoughts on “A last minute merger arbitrage in Celgene

    1. Alpha Vulture Post author

      Ha, not as far as I know. But that description of what the view on the street is about the probabilities is certainly a suspicious match with what I wrote here…. πŸ™‚

      Reply
  1. David

    Timelines are pretty tight. According to your base rate of success documents, the average timeline for oncology approval is 1.1y. Because of this, it gets very attractive for Bristol-Myers to delay. They don’t need outlandish reasons to just delay a couple months and continue their business without a 6B+ payout.

    I think betting against incentives and human nature is quite risky.

    Reply
    1. Alpha Vulture Post author

      Yes, I agree that this is an unfortunate problem that exists in almost all CVRs and in this one there is even a bit more potential for gaming the outcome than normal because they only need one delay out of three. But I don’t think it’s all bad, I think it’s a pretty safe bet that the people involved in the day-to-day work of completing the trials, presenting their results and getting the approvals don’t care about this CVR payment. They want to do their job and get a treatment approved that can help people’s lives as soon as possible. Incentives inside BMY won’t be all aligned to save shareholders some money.

      Reply
      1. FromSinope

        “I think it’s a pretty safe bet that the people involved in the day-to-day work of completing the trials, presenting their results and getting the approvals don’t care about this CVR payment.”
        The CEO cares about $6 billion. That’s all you need to know. It might just be the case that another project becomes a higher priority just for a few weeks. Why not work on the other project that will also save people’s lives?
        I think you are being incredibly naive.

        Reply
        1. Alpha Vulture Post author

          Maybe I’m naive, but I think people are complicated and it’s not black and white. I’m sure the CEO doesn’t mind not paying $6 billion, but how much does he care? It’s not his own money that he is paying. Would he actively try to sabotage the progress of these projects? Many people have also a sense of trying to do what’s right, which I know, is a controversial opinion for a sceptical investor πŸ˜‰

          Reply
          1. pietje

            Agreed. Also, the CVR was negotiated and restructured by the CELG and the BMY boards together. CELG also has board representation in the new company. There will be lawsuits in case of delays because BMY promised a ‘diligent effort’ and has given timelines. Not to mention the fact that, shocker, some people involved might actually want to save lives and want to get approval

            There’s certainly a chance that things will be delayed. Maybe Alpha Vulture is being naive. But I think it’s even more naive to say: CEO, 6 billion, all you need to know, end of story.

  2. Bram de Haas

    I understand the concern about gaming the CVR payment. There is at least one case where we’ve seen that and that Alpha wrote up recently with the Sanofi GVCRZ (or something) CVR.

    Maybe I’m not weighing that probability highly enough.

    In addition to the points brought forward by Alpha above, I’ll add that gaming the CVRs would also mean missing targets while there is a critical activist scrutinizing the company and openly out for the CEO his head.

    This is a large organization and ninja sabotaging the

    CEO may be hesistant to mess with approval process and not feel like even running a slight chance of ruining this.

    If there are shenanigans it is bound to leak in a large organisation like this (especially as human lives could be impacted). This would result in severe reputational damage for the CEO as well as the company.

    Also a number of CELG CVR holders will be at the new BMY. Some will be within the units where the fate of this CVR is determined. Even CELG personnel that is cut will likely have good communication channels within the company (remind me not to actively trade this thing πŸ™‚ ).

    Large pharma has an incentive in protecting the CVR as an acquisition currency. This instrument may turn out to be an enormous blessing over the coming decades.

    If the CVR pays out this is a big win for CELG shareholders but it seems like a larger win for BMY shareholders. Winning party less likely to be malicious in circumstances of abundance.

    Of course, I may be guilty of some confirmation bias here. I really like the CVR.

    Reply
  3. Christian Olesen

    Good points for and against about potential gaming of the CVR. I’m not very familiar with this situation, so I don’t have an intelligent opinion in this case. One thing to consider is that an acquirer has no fiduciary duty to CVR holders, as far as I understand, so gaming at least seems like more of a possibility.

    Reply
    1. Bram de Haas

      There is usually a stipulation in the CVR agreement (ironically like in the Sanofi case) that the acquirer has to make a “genuine effort” (I don’t remember the exact legal wording). Maybe good faith effort.

      Reply
  4. Vincent

    Maybe I’m naive, but isn’t that for the foreseeable future, most people who doing the job to get those drugs approved will be formal Celgene employees that have some vested interests (celegene stock owner through ESPP, options, etc) to get CVR paid?

    Reply
    1. Alpha Vulture Post author

      That’s what I would assume. But of course, putting the wrong person in the “right” spot could probably accomplish a lot if you actively want to sabotage things.

      Reply

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