Description

Pacific Biosciences (PACB) Merger-Arb

The current risk/return of Pacific Biosciences could be compelling (Gross spread = approx. 25%).

Pacific Biosciences (PACB) is currently in the process of being acquired by Illumina (ILMN) in an all-cash deal for $8.00/share. Shareholder approval has been achieved and two regulatory approvals remain outstanding for the transaction’s close. Using an end of December close, PACB’s current $1.60 (25%) spread to deal price represents potential annualized return of around 50%.

Remaining Condition for close:

• The UK Central Market authority announced its investigation of the transaction in mid-April and following the companies’ response to inquiries soon will confirm whether the review will proceed into a Phase II investigation: “The CMA has decided, on the information currently available to it, that it is or may be the case that this merger has resulted or may be expected to result in a substantial lessening of competition within a market or markets in the United Kingdom. This merger will be referred for a phase 2 investigation unless the parties offer acceptable undertakings to address these competition concerns. The full text of the decision will be available shortly.” UK CMA 2019

• The FTC 2nd request became public around the start of this year. Companies have just recently pushed their closing guidance to Q4 2019 after consistently guiding a mid-2019 close and have stated that the HSR 2nd request from the FTC was the expected outcome.

Spread history:

• October-December: Its tightest levels following the deal’s announcement $7.60-7.80 (2.5-5% gross spread)

• Late January:  Falling below $7.00 after the transaction had received the FTC 2nd request as well as PACB shareholder approval.

• February to Mid-May: Settling in a consistent range of $7.25-7.40 (8%-10% gross spread) until a couple weeks after the UK CMA had announced its decision to investigate and PACB missed earnings estimates.

• Mid-May to present: Around $6.70 (19% gross spread) falling to $6.40 (25% gross spread) after the UK CMA’s comments (shown above)

Difference in Technologies: Why the deal could potentially receive approval?

• The gene sequencing products of both companies could be viewed as complimentary in nature and used for different applications. Illumina’s gene sequencing is focused largely on what is referred to a short-read sequencing and PacBio’s offering is one of long-read sequencing. Although some instances/applications exist in which it may be advantageous to use both PacBio and Illumina’s short and long run sequencers (such as de novo gene sequencing), the advantages could be viewed as complimentary and not overlapping in nature.

• One could also argue that PacBio’s products will better scaled once under a large market player like Illumina ultimately benefitting any current in-common customers.

Merger Agreement Provisions

• Under the provisions in the merger agreement, Illumina is not required to divest any assets in order to appease regulators. While this could be viewed as concerning in other contexts, concern over divestitures also begs the question: under what circumstances would a divestiture be necessary given the two different technologies of PacBio and Illumina?

• In addition to the lack of divestiture obligations, the merger agreement also includes a reverse termination fee $90 mm possibly indicating that acquirer (Illumina) does not expect antitrust authorities to ultimately deny approval of this transaction.

Timing

Companies are currently guiding a Q4 2019 close. An end of year closing date could still provide a potentially attractive rate of return. A UK CMA Phase II review could push this timing out further.

Risks

• UK CMA seeks to protect Illumina competitor Oxford Nanopore and conduct a lengthy Phase II review, lowering the potential annualized return.

• FTC review drags on as with other recently delayed FTC approvals (NXTM/FMS, ESND/Staples) lowering the potential annualized return.

• Either regulatory body could block the transaction.

Downside Case

PACB’s unaffected pre-deal price was around $4.00/share. In the event the transaction is terminated due to antitrust failures, PacBio will be owed a $90 mm reverse termination fee (representing a pre-tax impact of about $.60/share).

Catalyst

FTC and UK CMA approval