Description

Investment thesis

We are presenting a merger arb idea about Oncomed, a small biotech company listed on the NASDAQ.

Mereo Biopharma (MPH:London) has proposed to acquire Oncomed (OMED:NASDAQ) with unanimous board approvals, subject to Oncomed shareholder approval and estimated to close 1H 2019. In an all-stock transaction, Mereo would issue 23.7 million new shares to be distributed to Oncomed shareholders for trading as ADRs on NASDAQ, accounting for 25% of the combined share count. At the Mereo price of £1.805 and Oncomed of $0.65, shareholders in the latter have a 115% spread. The spread is up from 51% on deal announcement.

Further to the stock consideration the deal provides for 2 CVRs for Oncomed shareholders: TIGIT and NAVI. TIGIT depends on Celgene's option exercisable by Dec. 31, 2019, is payable in Mereo ADRs and the value is $35 million, capped at 40% of total market capitalization. NAVI is payable in cash at 70% of actual milestone payments received in relation to that program for 5 years after deal completion capped at $80 million. While highly uncertain, both of those could be material compared to the current $25.1 million market cap.

Liquidity

We’d mention up front that while the traded volume has picked up since the deal announcement on December 5, the 50-day avg. traded volume is still just over 470k, which at the current price is worth $306k. Given this the idea is probably best suited for personal or smaller accounts.

Background

Oncomed is a clinical-stage biopharmaceutical company focused on internal discovery and development of cancer-related drugs. It has raised $774 million, including $373 million in equity since inception in 2004. This year partner Celgene declined to exercise several options to license its drugs with only one remaining, putting Oncomed’s future in doubt. Oncomed is run by scientists. CEO is a researcher whose last company, Scios, where he spent 17 years, ultimately as VP-Research was sold to J&J in 2003 for $2.4bn. In 2004, he joined Oncomed. Executive Chairman is ex-Celgene. The CEO & Chairman of Theravance Biopharma is on the board.

Oncomed was listed in 2013 at $17 per share. After numerous clinical trial failures and collaboration agreement terminations it is down 97% since listing, including -85% YTD and -58% in a month. We believe the sell-off has been exacerbated by tax loss selling and shareholder base turnover.

Mereo was a new entity started in 2015 for the purchase of a Novartis clinical-stage portfolio. Woodford Investment Management whose website describes its fund manager as "one of the finest of his generation", provided a large part of the initial capital. Mereo management is mostly ex-Nomura with financial backgrounds.

Stockholder approval

Mereo holds a 10.7% stake in Oncomed and its CEO is already on OMED's board. The Mereo CEO is partner in a fund controlling a further 5% Oncomed stock. Her fund doesn't have a significant stake in Mereo. She personally owns 1.19% of Mereo but no direct stake in Oncomed.

At the deal announcement Mereo only committed its own shares to vote for it. Given Oncomed’s steep decline from a billion-dollar market cap there could be stockholder discontent. However, as noted above there has been a significant turnover in the shareholder base as close to half the shares outstanding have turned over since the announcement. Given this we believe that as the new shareholders have a lower cost base the likelihood of a positive outcome in OMED shareholders voting for the deal is now perhaps increased.

Additional terms

Oncomed needs to maintain at least $38 million in cash balance at the closing, on failure to do so, ADR issuance is reduced on a prorata basis.

The break fee is $1.7 million for both parties.

Downside

Oncomed has a net cash balance of close to $71 million (Sep. 30, 2018). It is restructuring operations and making layoffs to reduce cash burn in preparation of the merger.

We believe that even if the deal fails and cash burn continues at the current rate we are buying into OMED at a price close to the cash position less liabilities at the end of June 30, 2019.

Risks

Decline in Mereo stock price.

Oncomed shareholders voting against.

Catalyst

Further progress and clarity on the timelines of the deal closing, proxy statement release

Progress on milestones