How Could This 3-Way Deal Shake Up an Entire Industry?
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With two simultaneous moves that have set the pharmaceutical world on fire, Cubist Pharmaceuticals (NASDAQ: CBST) has triumphantly announced its arrival on the global stage. The company has received takeover approval from the respective boards of Trius Therapeutics (NASDAQ: TSRX) and Optimer Pharmaceuticals (NASDAQ: OPTR). If everything goes according to plan, Cubist could become the proud owner of these two smaller firms within the next two or three quarters.
It goes without saying that this situation has the potential to affect the pharmaceutical industry's competitive landscape and put a serious squeeze on the profits of many small-cap and mid-cap drug developers. However, it is far from certain that it will come off without a hitch. Disgruntled shareholders have already taken legal action to prevent the two mergers from taking place, and many market-watchers now believe that Cubist will be forced to revamp or discontinue at least one of these deals. Interested investors must take a moment to brush up on the situation's specifics before diving in head first.
Cubist Pharmaceuticals, Trius Therapeutics, and Optimer Pharmaceuticals
Cubist Pharmaceuticals is significantly larger than its takeover targets. With a market capitalization of about $4.2 billion, it is at least seven times larger than similarly sized Trius and Optimer. Its product mix reflects this increased heft: Unlike Trius and Optimer, Cubist markets two lucrative drugs that have carved out small but important niches in the pharmaceutical space. In particular, its injection-only Cubicin drug provides crucial protection against a common type of antibiotic-resistant staph.
By contrast, Trius and Optimer remain focused on experimental and clinical-stage compounds that lack immediate commercial promise. For its part, San Diego-based Trius is in the late stages of clinical trials for a topical antibiotic that has shown promise in treating dangerous skin infections. Jersey City, New Jersey-based Optimer is working through stage-three trials for a number of compounds and drugs that could prove useful in treating a common but potentially dangerous form of bacterial diarrhea. It is in the earlier stages of work to develop drugs that fight certain respiratory infections and breast cancer presentations.
As the only self-sustaining firm in this comparison, Cubist is solidly profitable. Its 2012 revenue of $972 million produced a profit of $100 million and an operating margin of 17%. By comparison, Trius lost $63.6 million on just $20 million in revenue. Optimer posted a loss of $84 million on $77 million in revenue. At current cash depletion rates, both companies have about a year's supply of cash on hand. Meanwhile, Cubist has cash reserves of $1 billion and about $410 million in long-term debt.
The Trius deal
Under the terms of its recently announced deal, Cubist will pay about $707 million for the entirety of Trius' share float. Individual shareholders will receive cash payments of $13.50 per share as of a yet-to-be-determined record date. Depending on Trius' ability to meet certain sales and development targets, its shareholders also stand to receive as much as $2 per share in additional cash payments. Relative to Trius' current per-share price of $13.75, the combined deal provides a premium of about 13%. Without the "contingent value" payments, Cubist's offer currently represents a 2% discount to Trius' market value.
The Trius acquisition will provide Cubist with a promising drug that could fight the hospital-based staph infections that kill thousands of otherwise healthy individuals each year. This could create a significant new revenue stream and position it as one of the world's leading providers of hospital-infection drugs.
The Optimer deal
The Optimer deal has a similar structure. Cubist will issue cash payments of $10.75 per share to eligible shareholders and offer the promise of a $5-per-share "contingent value right." While Cubist has set aggressive sales targets for Optimer, the combined value of this deal is a seemingly irresistible $15.75 per share. Relative to Optimer's current share price of $12.50, this represents a premium of nearly 25%.
Legal complications and other issues
With the help of two shareholder-rights law firms, a number of Optimer and Trius shareholders have filed lawsuits to halt these deals. These suits center around the means by which Cubist valued its two acquisition targets and aim to force the larger company to re-evaluate its position. Unless a judge throws out the suits, Cubist will have to respond in some fashion. Although it is impossible to predict the outcome of such ongoing legal matters, it is entirely possible that Cubist will sweeten one or both of these offers.
Long-term outlook: How the competitive landscape might change
It is telling that Cubist's stock rose by about 10% on the back of this deal. The company already had tremendous momentum, but its decision to "go big" in the booming hospital-infection business will have important ramifications for its competitors. Since hospital-based pathogens tend to mutate rapidly, smaller firms that produce "older" antibiotics may find their competitive positions eroded. Meanwhile, Cubist will be better-positioned to compete with the larger firms that dominate the space.
Risk-hungry investors who wish to leverage Cubist's aggressive sales targets in search of potential arbitrage premiums would do well to look closely at these two pickups. More conservative investors may wish to play the situation's synergies with a long position in Cubist. Although the legal challenges to these deals present a potentially serious problem for rank-and-file investors, it would be risky to bet against either one. Investors who do so could miss out on potentially lucrative opportunities.
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Mike Thiessen has no position in any stocks mentioned. The Motley Fool recommends Cubist Pharmaceuticals. 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!