Description

The Celgene / Bristol Myers Squibb deal presents an interesting merger arbitrage opportunity. The deal was announced on 1/3/19 and if it goes through CELG shareholders will receive: 1) $50 in cash 2) 1 BMY share 3) 1 CVR related to Celgene's current drug pipeline. 

https://news.bms.com/press-release/corporatefinancial-news/bristol-myers-squibb-acquire-celgene-create-premier-innovative

In terms of the CVR, it could ultimately be worth $9, but could also be worth 0 given it is binary: in order for it to pay-out three drugs need to be approved by specific dates - most market participants think this is a combined 55-70% for each one ^ 3 which gets to a compound probabilty of ~20% so around $2-2.50 in expected value. There is some risk on some of the timelines as they are quite close to Celgene management targets so if they are delayed at all or need to be refiled and miss the deadline, the CVR is worthless (i.e., if even one drug misses the relevant date the CVR is a 0).

The deal has had a fairly wide spread for a deal of this nature given concerns someone would go activist on BMY to try to block the deal given BMY's stock dropped ~12% in response to the deal, and so this presented a big risk for the long CELG / short BMY trade. There were rumors for some time that Starboard had taken a position in BMY, but it was not clear they were necessarily against the CELG deal. There were several news articles and an interview with Jeff Smith and David Faber that hinted they might be against the deal.

https://www.youtube.com/watch?v=xHvmL8zNLec

https://www.wsj.com/articles/starboard-value-nominates-five-to-bristol-myers-board-11550683021

The WSJ article also noted that Dodge & Cox is potentially against the deal, though noted this does not necessarily mean they would vote against it.

Wednesday afternoon, Wellington which owns 8% of BMY came out against the deal, noting:

 "While Wellington agrees that Bristol-Myers should be active in business development that secures differentiated science and broadens the future revenue base, Wellington does not believe that the Celgene transaction is an attractive path towards accomplishing this goal. Wellington’s conclusion is based upon three tenets: 1) the transaction asks BMY shareholders to accept too much risk and the terms offer BMY shares to CELG shareholders at a price well below implied asset value; 2) execution success could be more difficult to achieve than depicted by Company management; and 3) alternative paths to create value for BMY shareholders could be more attractive."

There is some debate around how big Wellington's actual voting stake is given they noted in their 13D they have voting power over 28.2mm shares vs. their economic stake of 125.7mm shares (2% of shares out and 8% of shares out respectively). The shares that they economically own but do not control the voting for are related to Vanguard mutual funds that Wellington is the investment advisor for. No one knows for sure how these shares will be voted (i.e., if they will vote in-line with other Vanguard or shares, or if Wellington's input will be listened to and they will be voted in-line with Wellington's position).

On Thursday morning, Starboard came out with it's letter stating that they are against the deal, as they feel BMY management has not earned the right to do a bet the farm type deal and they think CELG's patent cliff risk and pipeline risk are not worth the investment. Additionally, they seem to want BMY to put itself up for sale.

https://www.sec.gov/Archives/edgar/data/14272/000092189519000610/ex1todfan14a06297263_022819.pdf

The letter is quite odd given it criticizes BMY management and says they have done a bad job, have positioned the company poorly, etc. and then goes on to say that someone might be interested in buying BMY. If BMY's current strategic positioning is so bad, it seems odd that someone else would be desparate to buy BMY - this would set-up much the same as the CELG deal for whatever company would theoretically try to buy BMY. Also, I think it is interesting to think about the strategy behind why BMY wanted to buy CELG in the first place - it seems likely management recognized its own strategic positioning was in a precarious position so they needed a big strategic deal to address this concern - i.e., in a way they need a deal like this because otherwise their own pipeline / patent cliff situation is quite bad.

The main argument in favor of the deal going through is that a large portion of the shareholder bases of the two company's overlap - ~>40-50% - which means that in theory most of those shareholders should be indifferent or even happy for the two companies to merge as there are a good deal of synergies - i.e., you already own both and want G&A / other costs to be lower in aggregate.

Based on current information, we know that Starboard has 4.4mm (0.3%) shares per their proxy Friday, Dodge & Cox has ~2.6%, Wellington has either 2% or 8% - so in a more conservative scenario that means there is ~11% of BMY shares against the deal if we assume Wellington can vote its entire stake and Dodge & Cox votes against the deal (both of which we don't know for sure). It seems hard for this contingent to be enough to block the deal given the large share overlap mentioned above, and there isn't really anyone with a large enough BMY position to move the needle. The vote will primarily hinge on how ISS / Glass Lewis come out re the deal, and in turn how the likes of Vanguard et al vote. It's important to note that in Vanaguard's proxy voting guidelines, they generally defer to management, and in this case it seems like management can make a very strong case that they need this deal strategically.

One other angle that I think is potentially interesting here - the move by Starboard caused the CELG spread to blow out by ~10 pts on Thursday and there was a lot of turnover both on the BMY and CELG sides - I think this has potentially opened up an opportunity for someone else to come in and buy stakes in both BMY and CELG and publicly support the deal.

In summary, I think the current spread of ~18.7% (using $2.50 value for the CVR) is very attractive and likely to compress significantly as fears over the Starboard activism subside. Whether it will be attractive to hold for the duration of the deal or not will depend on the trading dynamics and newsflow going forward.

Risks:

1) deal being blocked by BMY shareholder vote

2) probably the most important risk is someone bidding for BMY - I don't view this as particularly likely given there are only a handful of companies who can bid and they don't seem interested - and there haven't been any rumors of such interest since the deal was announced - but this is certainly possible and would be problematic from the spread perspective of being long CELG / short BMY

3) usual risks associated with M&A deal closing - i.e., relevant regulatory approvals

4) this has become a bit of a consensus trade - given there are not many large M&A deals out there with relatively large spreads, a lot of arbs have been involved in this trade - that said, positioning is obviously less aggressive given the big move on Thursday

If the deal breaks, CELG probably trades to ~$68-$72 - this is based on a few things, namely the IBB rally YTD of ~20%, due in large part to the massive M&A wave in pharma kicked off by BMY initially, and the $3 per CELG share break fee. Additionally, it's quite possible someone else would be interested in CELG if this deal falls through. In this scenario, I would expect BMY to trade up a bit, but some of this has already started to be priced in given the headlines over the last week - I would think BMY could trade to $55-$56 - which means the total risk / reward of the trade is ~1:1 which seems very attractive.

Catalyst

Shareholder votes in mid-April - the record date for BMY was Friday, so it's unlikely anyone new can enter the fray from an activism / voting perspective

Deal anticipated closing in Q3 2019