|Shares Out. (in M):||87||P/E||0||0|
|Market Cap (in $M):||4,400||P/FCF||0||0|
|Net Debt (in $M):||3,000||EBIT||0||0|
I don’t know about anyone else, but lately when I log into VIC and take the Bargain Meter poll, I’m forced to admit I’m not finding many value stocks out there right now. Given how challenging the current market environment is for me, I’ve been looking less at traditional bargain stocks and more at merger arbs.
I’ve found two merger situations that look compelling enough to share, and have included below a brief write-up for each one. ALR is a situation that that offers moderate upside, and ~20% downside in the worst case, and has an extremely high likelihood of success. INNL is a situation with somewhat less certainty, but offers the potential of a multi-bagger return if everything goes just right.
I’ve tried to keep each write-up succinct and focused to save everyone time, but I am more than happy to flesh out either thesis in the Q&A section. As always, thanks for reading.
Description: ALR has been involved in the most contentious merger in recent memory. Now that ALR has filed its 10-K, and ABT has agreed to amended merger terms, there is virtually no risk remaining. However, concerns over the past acrimony between the two companies means there is still a ~2% spread between where ALR trades today at $50/share and the cash buyout price of $51/share. I expect the deal to close by early August, so buying here creates a very high-probability 8% annualized return.
Why The Opportunity Exists: To call this merger contentious is an understatement. All the details are readily available in the public record, but I will note that the merger was first announced on 2/1/16 at $56/share, and since has included ALR financial restatements, a subsidiary having its Medicare and Medicaid billing privileges revoked, and a lawsuit from the acquirer ABT alleging the triggering of a Material Adverse Change clause. It’s no wonder that arbs are cautious after all this drama, but on 4/14/17 ABT and ALR dropped the merger terms to $51/share and on 6/5/17, ALR finally filed its 10-K, all but eliminating any possibility of the deal breaking.
Timeline: The recent filing of ALR’s 10-K is key to keeping the deal timeline intact. That timeline is now:
July 7th: ALR shareholder meeting to vote on the acquisition
July: regulatory approvals from the FTC, the Canadian Competition Bureau, and the South Korean antitrust authority.
Early August: merger to close (inferred).
September 30th: The official date by which regulatory approvals must be received, and the absolute latest date by which the merger should close.
Potential Downside: I feel strongly that at this point there is almost no chance of the deal breaking. However, should disaster strike, ALR’s share price would at worst likely return to ~$40/share. This is where the stock was trading when the deal was mired in legal limbo. Importantly, the Delaware Court of Chancery (where the lawsuit would continue on any deal break by ABT) has “never found a material adverse effect to have occurred in the context of a merger agreement.” https://www.themalawyer.com/material-adverse-effect-clauses/
Further support for ALR is offered by the stock’s reaction to a 4/5/17 court filing by ALR asking ABT to reveal documents on the due diligence process. That filing pushed ALR’s stock up 12% on the day on the expectation that the documents would conclusively show that ABT understood what it was buying and that no MAC existed. It is telling that less than two weeks later, ABT agreed to the terms of the revised deal.
In short, buying ALR at ~$50 offers a near-certainty of an 8% annualized return, while any downside risk is remote and manageable.
Description: INNL is being acquired by Gurnet Point for $1.75/share cash, and up to an additional $4.90/share in contingent value rights (CVR). The first CVR payment of $0.70/share appears to be readily achievable, and makes buying INNL at ~$2.20 a good trade. If any of the other CVRs pay out, this will be a real home run.
INNL was seeking FDA approval of a bupivacaine collagen-matrix that could be implant after surgery for pain relief. This is a relatively untapped market that could greatly cut down on opioid use. However, on 12/16, the FDA replied with a Compete Response Letter (CRL) denying INNL approval, saying that their matrix was a drug/device combination, not just a drug, and therefore additional data would be required.
After meeting with the FDA, INNL determined that all issues could be addressed with a few short-term studies and that a resubmission was possible by YE17. Unfortunately, their financial resources were so minimal ($14.9mn cash and $27mn in debt at YE16) that clearing even this minor hurdle was beyond them.
At this point, Gurnet Point L.P saw opportunity and negotiated the take-over. Gurnet Point is affiliated with Waypoint Capital, the family fund of Ernesto Bertarelli, and is run by Christopher Viehbacher. Bertarelli was the CEO of Serono, a biotech firm sold to Merck for $13.3bn, and Viehbacher is the former CEO of Sanofi and chairman of Genzyme. Clearly, both men have a strong track record of value creation in the biotech space, and their interest goes a long way towards validating INNL’s certainly that they can successfully respond to the FDA’s CRL.
Why The Opportunity Exists: If the FDA CRL is so manageable, and extremely sophisticated biotech investors like Bertarelli and Viehbacher are willing to pay up to $6.65/share for INNL, why is it trading at ~$2.20 today? There are multiple factors contributing to this valuation discrepancy. Currently, INNL is an illiquid microcap, making it impossible for a large fund to acquire a position. Even for smaller funds, the idea of holding a non-tradable CVR possibly into 2020 is unattractive. This creates all kinds of mark to market issues, and it’s obviously much less appealing to enter a trade when there’s a decent chance you may have moved onto another firm before it pays out. Real-world issues like this definitely cause funds to steer clear of trades that look great on paper.
June 28th: INNL shareholder meeting to approve the acquisition.
First CVR Payment Event: Gurnet Bidco will pay $0.70 in cash per CVR if on or before December 31, 2018, XARACOLL is approved by the FDA with a label covering indications for the treatment of postsurgical pain immediately following open abdominal Hernia repair.
Second CVR Payment Event: Gurnet Bidco will pay an additional $1.33 in cash per CVR if, on or before December 31, 2018, XARACOLL is approved by the FDA with a label covering indications for the treatment of postsurgical pain immediately following Soft Tissue repair (and not limited to hernia repair).
Third CVR Payment Event: If the milestone is met, Gurnet Bidco will either pay: $1.00 in cash per CVR if, on or before December 31, 2019, XARACOLL is approved by the FDA with a label covering indications for the treatment of postsurgical pain immediately following Hard Tissue repair; or, if not
$0.60 in cash per CVR if, after December 31, 2019 but on or before June 30, 2020, XARACOLL is approved by the FDA with a label covering indications for the treatment of postsurgical pain immediately following Hard Tissue repair.
Fourth CVR Payment Event: If the milestone is met, Gurnet Bidco will either pay: $1.87 in cash per CVR if global net sales of XARACOLL exceed $60 million in any four consecutive Calendar Quarters ending on or prior to December 31, 2019; or, if not, $1.00 in cash per CVR if global net sales of XARACOLL exceed $60 million in any four consecutive Calendar Quarters ending on or prior to March 31, 2020.
Potential Downside: The risk of the acquisition falling apart is essentially nil, and so the only real downside scenario to consider is the unlikely possibility of INNL failing to address the FDA’s CRL. In this case, downside would be to the $1.75 acquisition price.
In summary, buying INNL today gives a very strong probability of a ~55% return by YE18 (initial outlay ~$2.20/share until deal close, committed capital $0.45, with the first CVR paying $0.70) , with a possibility of much more upside should Bertarelli and Viehbacher be able to use their biotech expertise to maneuver the bupivacaine collagen-matrix into additional indications or sales.
Entire thesis above is catalyst driven
|Entry||06/12/2017 04:48 PM|
Thanks for the interesting idea. What probabilities would you assign to the various milestones - do you think it's pretty likely they get the first payment?
|Entry||06/13/2017 12:54 PM|
Thanks for the question. Short answer: I will be very surprised if the first milestone doesn't pay out, and am much less certain on any of the subsequent CVRs.
A few more thoughts: Here's a link to a 2013 synopsis of a study that found that of 146 NDA and BLA submissions that received a CRL, 55% went on to later gain approval: http://www.raps.org/focus-online/news/news-article-view/article/2761/
I think the odds of INNL gaining approval in 2018 are closer to 90% than 55%. First, management really seemed blindsided by the FDA decision that Xaracoll is a drug/device combination. The FDA focus on that specific nuance indicates that, unlike many other CRLs, there's no problem with the submitted data. INNL is simply being asked to generate some additional details, rather than being forced to explain away or redo a flawed study. This new hurdle seems pretty easy to clear, given that INNL management expects to generate the additional data and have it ready for submission by YE17 (from their 3/29/17 PR).
But let's not put too much trust in the INNL management. This is where the very strong biotech background of Gurnet Point gives me added conviction. They clearly seem to agree that the CRL isn't a major setback, considering that they are buying INNL at a 120% premium to where INNL was trading before the deal leaked, and given that they will be footing the bill for the $100mn INNL will require to fund operations through 2019 (from the 4/4/17 PR). To the best of my knowledge, Gurnet Point has ~$2bn AUM, so I'm not trying to argue that it's a huge position for them. Still, this is a situation where highly experienced people are committing a lot of money. All of this gives me conviction that the odds of a 2018 approval to trigger the first CVR are much higher than the 55% for any random CRL.
Moving onto the other possible milestones, my conviction drops quite a bit, but here are my thoughts (much of this comes from discussion with a general practitioner doctor friend):
2nd CVR: $1.33 if Xaracoll is approved by YE18 with a label covering all Soft Tissue repair, not just hernia: This seems very unlikely. The two PIII studies both were for hernia repair, and it takes a big leap of faith to assume the FDA would be so generous with a label in unstudied indications. There just doesn't appear to be enough time for INNL to submit Xaracoll by YE17, get approval, run an additional study, and get FDA approval for an expanded label all in 2018.
3rd CVR: $1.00 if Xaracoll is approved by YE19 with a label for Hard Tissue repair, or $0.60 if approval comes by June 2020: This seems possible, but as above, would likely require an additional study. Although the addressable market is large enough to justify such a study, it's hard to know if Gurnet Point would want to spend the money.
4th CVR: $1.87 if global sales exceed $60mn in any four consecutive Qs prior to YE19, or $1.00 if sales exceed $60mn in any four consecutive Qs prior to YE20. This one is the most compelling of the CVRs after the first one. The current standard of care for pain management after hernia repair involves opioid use in nearly 90% of patients, and obviously doctors are actively looking for alternatives. This CVR seems do-able, and is one that Gurnet Point is clearly highly motivated to hit as well. Even getting this one payout would make the trade very successful.
Thanks for reading, and feel free to keep the questions and comments coming.
|Subject||Re: Re: INNL|
|Entry||06/14/2017 09:10 AM|
Thanks - very helpful!