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Expert Financial Analysis and Reporting

Bristol-Myers-Squibb: Negative Market Reaction to Celgene Acquisition is a Buying Opportunity (BMY, Buy, $45.17)

Key Points

  • Investors have turned a thumbs down on the proposed acquisition of Celgene resulting in a 14% plunge in the stock price of BMY to $45. This is because Revlimid represents about 64% of CELG sales and by 2027 or so, generic competition will erode most of its sales.
  • The Revlimid concern was reflected in the CELG stock price as prior to this acquisition, the P/E ratio was 7 times the 2019 non-GAAP EPS guidance. (Investors focus on non-GAAP rather than GAAP EPS in valuing companies.)
  • If the Celgene acquisition goes through, my preliminary estimate is that the 2019 year end run rate for BMY EPS could be $5.80 on a non-GAAP basis. BMY is selling at about 8 times this EPS estimate with a 3.2% dividend yield. Clearly, BMY’s stock price now reflects the Revlimid concern.
  • The combined pipeline for the companies could (will in my opinion) make BMY the premier company in immunotherapy/ cell therapy as it combines the checkpoint inhibitor franchise with Celgene’s cell therapy franchise that is spearheaded by its CAR-T pipeline. In addition to cell therapy, CELG has other compelling immunotherapy products in development making for an exceptional pipeline.
  • BMY certainly understands the implications of the Revlimid patent expiration and did not blithely take on this albatross. Management made crystal clear in its conference call that it believes that cell therapy has the potential to be the next driving force in biopharma drug development and to become as important as monoclonal antibodies are today. Clearly, it believes this enormous potential justifies the Revlimid burden.
  • Aside from this paradigm changing, proposed acquisition of Celgene, investors are awaiting the results from BMY’s all-important 2,700 patient CHECKPOINT-227 trial that will define the role of Opdivo, Opdivo combined with Yervoy, and Opdivo combined with chemotherapy in first line non-small cell lung cancer. If results are positive, this could catapult BMY back into the lead in non-small cell lung cancer, a place that it lost to Merck in 2018. Results will be very important to the stock price. This trial is event driven so that the timing of results is difficult to predict but they could be reported in 1Q, 2019 or 2Q, 2019.
  • Like BMY, I believe that immunotherapy and cell therapy are the future for pharma drug development. With this acquisition, BMY could be the dominant player in this space for the next two decades and that this more than justifies the Revlimid risk.
  • In the near term, I think that BMY will guide to EPS growth of 10+% over the 2019 to 2022 period at the January 24 conference call reviewing 4Q, 2018. This is before we know the results from CM-227. Positive results in CM-227 would likely lead to guidance for higher rates of EPS growth.
  • And yet, BMY is selling at less than half the estimated 2019 P/E ratio of the S&P 500 and its current dividend yield is 3.2% versus 2.8% for the S&P 500. It should appeal to both growth and value investors.

Numbers Related to the Acquisition

Bristol-Myers Squibb stunned the investment community with its proposed acquisition of Celgene and the immediate reaction has been a sharp 14% decrease in the stock price of BMY to $45. Celgene shareholders will receive one share of BMY currently valued at $45 and $50 of cash for each share of CELG stock owned for a combined value of $95 per share. This represents a 42% premium over the closing price of $67 on January 2, 2019. Celgene’s latest EPS guidance for 2018 projected 2018 GAAP EPS of $5.25 to $5.75 and non-GAAP EPS of $8.75 to $8.80. Investors focus on non-GAAP EPS in valuing biopharma companies so using the mid-point for 2018 non-GAAP EPS of $8.77, BMY is paying about 11 times non-GAAP EPS.

Celgene was selling at 7 times EPS prior to the announcement of the acquisition and the stock price was 50% lower than its high reached two years ago. The low P/E and poor stock price performance reflect extreme concern about patent issues with Revlimid which currently accounts for about 64% of Celgene’s sales. Revlimid will face limited generic competition over the 2022 to 2025 period and full scale generic entries in January of 2026. Because it is a small molecule, I would expect sharp sales declines at that time and by2027-2028, Revlimid sales are likely to be de minimis. With this acquisition, BMY has assumed this investor risk.

Prior to consideration of the CELG acquisition, BMY issued guidance on January 3, 2019 that it expects 2019 GAAP EPS of $3.75 to $3.85 and non-GAAP of $4.10 to $4.20. Its previous guidance for 2018 was for GAAP EPS of $3.05 to $3.15 and non-GAAP of $3.80 to $3.90. Using the midpoints of the non-GAAP ranges of $3.85 in 2018 and $4.15 for 2019, this indicates an expected 8% increase in 2019 non-GAAP EPS (again this is before taking into account the CELG acquisition). I would note that BMY has a history of beating its EPS guidance. At the current price of $45 this represents a 2019 P/E ratio of 11 times EPS.

BMY has said that it will issue detailed EPS and sales guidance on its January 24, 2010 conference call. However, it has said that the Celgene acquisition will create 40% accretion to EPS in the first year of the merger. The merger is scheduled to close in 3Q, 2019 so this suggests that the run rate of non-GAAP EPS by year end 2019 for BMY-CELG combined could be on the order of $5.80. Assuming the merger closes in 3Q, 2019 only the 4Q, 2019 EPS will be included in 2019 BMY non-GAAP EPS so that reported 2019 EPS will be less than $5.80. Based on the $5.80 non-GAAP run rate estimate for year-end 2019, BMY is selling at a P/E ratio of 8 times. With a current dividend of $1.64, the current dividend yield is 3.2%.

BMY is projecting free cash flow of $45 billion over the next three years for the combined companies. The cash being paid out to Celgene shareholders in this deal is $36 billion. Hence, free cash flow should quickly retire and debt incurred in this deal. This further reduces the acquisition price to BMY shareholders.

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