Pharma Takeover For a Sleeping Drug

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In December of 2012, Pernix Therapeutics Holdings (NYSEMKT: PTX) announced its intention to acquire Somaxon Pharmaceuticals in a stock-for-stock deal that values the smaller drug-maker at about $25 million. Under the terms of the deal, Somaxon shareholders' holdings will be converted into Pernix stock. If no unexpected hurdles arise to derail the merger, it should become final by the end of the second quarter of 2013.

About Pernix Therapeutics and Somaxon Pharmaceuticals

Based in The Woodlands, Texas, Pernix Therapeutics Holdings produces a number of branded and generic prescription drugs for sale in the United States. The company's most popular offerings include an antihistamine and cold medication known as "Aldex," a pure antihistamine known as "Brovex," and a pediatric head lice treatment known as "Natroba." It distributes its products to pharmacies in hospitals, grocery stores and national-chain drug stores across the country. In 2011, it earned $3.9 million on revenues of $64.5 million.

San Diego-based Somaxon Pharmaceuticals engages in the research and development of sleep aids and other similar pharmaceutical products. Its sole FDA-approved product is a branded sleep regulator known as "Silenor." Used primarily for the treatment of insomnia, Silenor's principal advantages include its lack of federally-scheduled substances and its dearth of next-day effects on mood and behavior. Although the company believes that Silenor has the potential to rival Ambien and other blockbuster sleep aids, the drug has thus far seen limited success in the retail environment. In 2011, Somaxon lost $19 million on $12.1 million in revenue.

How the deal is structured

As a stock-for-stock deal, the Pernix-Somaxon merger is somewhat more novel than the typical small-scale pharmaceutical merger. Pernix has earmarked $25 million for the purchase and will distribute a yet-to-be-determined number of its own common shares to current Somaxon shareholders.

The exact number of shares that will ultimately be distributed will depend upon the larger company's average stock price over the 30-day trading period that precedes the merger's official closing date. If Pernix's average price exceeds $9 or fails to reach $6 during that time frame, the company will round to the closer of those two values. A higher average share price will result in a smaller number of shares being distributed to Somaxon's shareholders.

Although some Somaxon shareholders have taken issue with the merger's inherent risk, it actually assigns a fairly strong valuation to the company. The deal values Somaxon's roughly 8.3 million outstanding shares at just over $3 apiece. Relative to the stock's pre-announcement closing price of $1.47 per share, this represents a premium of roughly 100 percent. Relative to its post-announcement average closing price of about $3.05 per share, it represents a discount of less than 2 percent. However, the deal promises long-term gains thanks to the synergies and cost savings that the combined company should enjoy.

Complications and competition

Although the Pernix-Somaxon merger has been approved by both companies' directorial boards, it still requires the approval of Somaxon's shareholders. In addition, it is awaiting the results of a customary regulatory investigation. Given the small size of the deal and lack of blockbuster drugs involved, the merger is not expected to produce any regulatory problems.

Likewise, the stock-for-stock nature of the deal offers solid potential returns for Pernix shareholders. With Somaxon's shares near the middle of their 52-week range, the stock-for-stock exchange assigns a generous valuation to the niche firm. Although a theoretical buyer could step in and make a more attractive bid for Somaxon, such a bid would need to exceed $8 per share in order to sway significant number of the company's shareholders. At this point, that appears unlikely.

Long-term prospects

Given its unsustainable cash flow, it was only a matter of time before Somaxon Pharmaceuticals put itself up for sale. In the current regulatory environment, the company's best hope is to be absorbed by a larger and more profitable entity. The planned merger between Somaxon and Pernix realizes this hope.

Like most pharmaceutical mergers, this deal is not without its risks. Although Somaxon is in the process of developing other drugs, there is nothing promising in its pipeline. Should Pernix prove unable to increase Silenor's sales and render the division profitable, it may have no choice but to take a loss on the purchase within the next few years. Its unwillingness to commit cash or leverage to the deal indicates that Pernix's management team has some misgivings about this merger.

On the other hand, the market for sleep aids is booming. Whereas a major pharmaceutical company like Pfizer (NYSE: PFE) might have little need for a niche sleep product, Pernix is clearly betting that this purchase will eventually enable it to compete with larger players.

Alternatively, Pernix could be betting that its Silenor asset will make it an attractive acquisition target for a company like Pfizer or Merck. Since the pharmaceutical space is notoriously volatile, it would not be surprising to see a multinational firm scoop up within the next few years. Such a deal could involve the payment of a significant premium for the company.

In the short term, this deal will provide excellent value for current Somaxon shareholders. Over a longer time frame, Pernix shareholders may well come out ahead. Depending upon how Silenor fares, the company could have a nascent blockbuster on its hands. The events of the next eight quarters may well determine Pernix's fate.

mthiessen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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