Expert Financial Analysis and Reporting

What is the CVR Worth?
I wanted to address some additional points in regard to the proposed acquisition of Trius (TSRX) by Cubist (CBST). In my earlier note of July 31, I had not yet analyzed the terms of the CVR which are that Trius shareholders will receive $1.00 for each share that they tender if tedizolid sales in the US, Europe and Canada reach $125 million in 2016 and $2.00 if they meet or exceed $135 million. In between the payment is pro rata for each $1 million of sales so that at $126 million we will get $1.10, at 127 million $1.20 and so on. The CVRs are non-tradable following the acquisition. This feature means that they will be subject to the capital gains rate rather than ordinary income if and when they are paid.

My projection for revenues with Trius marketing the product on its own had been that US sales would reach $137 million in 2016. Whatever Trius could have done on its own, there is no question that the already in place robust sales and marketing infrastructures of Cubist and also Optimer will bolster sales. And of course, the CVR is based on sales in the US, Canada as well as in Europe, where tedizolid will serve as the nucleus around which the Cubist European commercial organization will be built. It looks like there is a reasonable chance that the terms of the CVR can be achieved and that shareholders could receive $2.00 in 2017.

The stock closed at $14.10 yesterday which indicates that the CVR component of the deal is valued at about $0.60. There are risks that anyone investing on the expectation that the CVR will pay out $2.00 in 2016 must understand. The first is that the tedizolid NDA has not yet been approved. While the clinical data seems pristine, the FDA frequently issues Complete Response Letters due to chemistry, manufacturing and control. I think that Trius has minimized this risk through their work with their experienced Far Eastern partner Bayer, but the CMC risk is impossible to assess beforehand. In addition, there is always the investor concern that the FDA might be slow or fussy in the approval process and ask for more information because the agency is under-staffed . I think that the critical care nature of Trius mitigates the latter risk but doesn’t eliminate it. Also, the FDA has added staff to the anti-infectives area and is presumably eager to approve an important new antibiotic in the aftermath of the GAIN Act. Still, these issues have the potential to delay the approval and launch of tedizolid and make it difficult to reach the 2016 sales levels that trigger the CVR payment. Still another issue is that most new product launches seems to largely be disappointing due to difficulties in getting onto formularies and gaining reimbursement. Again, the critical care nature of tedizolid mitigates but does not eliminate that risk.

My best judgment is that the chances for Trius shareholders to realize $2.00 on the CVR in early 2017 are reasonably good.

Will There Be a Higher Bid?
The second issue that I would like to address is whether the deal is fair. Some investors have opined that the $13.50 offer and the potential $2.00 payment for the CVR are too low. Some bloggers have also suggested that a bidding war for Trius may take place. Based on investment banking sources, I understand that a number of big firms were interested in acquiring Trius and took a hard look over the past month. If so, it may be the case that Cubist was the most aggressive bidder. Certainly from a strategic standpoint, the Trius acquisition has more importance for Cubist than any other potential acquirer that I can think of.

The next question is whether the $13.50 offer is fair. This was based on the outside assessments of investment bankers and other consultants using a variety of methods such as discounted cash flow and comparison to peers. Based on these inputs, the board of Trius felt that this was a fair offer. Let me offer a few other data points. The offer of $13.50 was only a 15% premium to the closing price of $11.71 without consideration of the CVR. However, the stock has been trading up on takeover speculation and if we look at the premium over the 30 day moving average, it is 36% and for the 60 day moving average is 50%. Also bear in mind that however promising, Trius is still a pre-commercialization company. To my knowledge, the highest price paid for a pre-commercialization company was the $1.0 billion paid by Johnson & Johnson in May of 2009 to acquire Cougar Biotechnology. Cubist is paying $707 million for Trius and potentially $818 million if the CVR is paid out at the maximum $2.00 per Trius share. This represents the second highest acquisition price ever paid for a pre-commercialization company.

My best judgment is that there will not be a higher bid for Trius. If I am wrong on this and it is nothing but speculation on my part, I can’t see a bidding war or dramatically higher price being paid, just a slight bump. Nevertheless, I am hoping that I am wrong.

What I Am Doing with My Stock
I am holding my shares at the current price of $14.10 on the expectation that the CVR has a strong probability of being paid at $2.00 in 2017.