Bristol-Myers Squibb's Big Bet on ImClone

ImClone's pipeline of cancer-fighting compounds could fill a big gap in Bristol's portfolio after key drugs go off patent, say analysts

Drug giant Bristol-Myers Squibb's (BMY) $4.5 billion offer to acquire the 83% of ImClone Systems (IMCL) it doesn't already own brings the Big Pharma stalwart deeper into the biotech realm.

The offer, made in a letter Bristol's chairman and chief executive, James Cornelius, sent to ImClone's chairman and biggest shareholder, activist investor Carl Icahn—and supplemented by a voicemail message—had not drawn a response from Icahn by the end of Thursday's trading session.

For the 30% premium to ImClone's closing price on July 30 that it's offering to pay, Bristol would gain the full North American revenue from the colon cancer drug Erbitux, which it has been co-marketing with ImClone since 2001. An acquisition would eliminate the 39% royalty Bristol now pays ImClone, and Bristol would also get the royalty stream from German company Merck KGaA for Erbitux's sales outside of North America. Bristol would also inherit ImClone's product pipeline, which includes additional applications for Erbitux and five other oncology products now in clinical trials, as well as ImClone's biologic manufacturing facilities.

ImClone shares jumped 37.7% to close at $63.93 on July 31, while Bristol shares finished 1% lower, at $21.29.

Enough Cash Flow

New York-based Bristol said its offer isn't contingent on financing or due diligence, given its confidence in ImClone's operations through its marketing collaboration with the smaller company over the past seven years. On a conference call to discuss the proposed deal with analysts on July 31, Cornelius said Bristol will use the $4.1 billion in proceeds it will soon receive from the pending sale of its nonpharmaceutical assets to pay for ImClone. He also said Bristol has sufficient cash flow from operations to continue to pursue other acquisitions.

In a July 31 research note, JPMorgan (JPM) analyst Christopher Schott wrote that given the impending proceeds from asset sales, it's not surprising to see Bristol step up its merger and acquisition efforts. (Schott has a neutral rating on Bristol. Note: JPMorgan either does business, or seeks to do so, with companies covered in its research reports.)

"We much prefer to see the acquisition of an in-market biologic franchise that the company is already familiar [with] as compared to a series of smaller, riskier assets," such as Kosan Biosciences and Adnexus Therapeutics, Schott said in his note. Bristol's $190 million acquisition of Kosan closed in late June, and its $430 million purchase of privately-held Adnexus was completed last year.

On a July 31 conference call with analysts, Jean-Marc Huet, Bristol's chief financial officer, said the acquisition wouldn't have any impact on the company's 2008 earnings outlook of $1.36 to $1.46 a share, which Bristol reaffirmed in May.

Higher Offers?

Given Icahn's reputation as a tough negotiator, ImClone's chairman is likely to hold out for a price higher than the $60 offer, says Howard Liang, an analyst at Leerink Swann & Co. in Boston who has an outperform rating on ImClone. And with the stock trading above the initial offer, the market is clearly anticipating a higher bid, he adds.

Liang doesn't think a Bristol-ImClone deal would trigger a new wave of consolidation in the drug industry, but he does say he has long believed some of the smaller manufacturers would be acquired. "Big pharma and big biotech are looking for products," he says. "Plus, there are lots of economic reasons. [M&A] improves operating efficiencies."

In a July 31 research note for Cowen & Co. (COWN), analyst Eric Schmidt agreed that Bristol's $60 per share offer was probably "an initial bid that provides a baseline value to the stock." The shares could see additional upside if ImClone's board decides to negotiate superior terms with Bristol or if rival bidders enter the auction, the note said. (Cowen and/or its affiliates expect to receive or intend to seek compensation for investment banking in the next three months from ImClone and also make a market in its securities.)

Bristol and others drugmakers are all the more willing to pay substantial premiums for fully integrated biologic manufacturing capabilities, such as ImClone's, because of how scarce they are, Schmidt said in his note.

Merck in the Wings

Bristol's most likely competitor for ImClone may turn out to be Germany's Merck, which licenses the sales rights to Erbitux outside of North America. It would make sense for Merck to protect its investment in Erbitux, since it was the Frankfurt company's own clinical trial that finally persuaded the U.S. Food & Drug Administration to approve the drug, and a new Merck trial has shown Erbitux to be effective in fighting lung cancer as well, says Liang at Leerink.

"Merck knows the drug very well. They know the upside, and there's probably interest by them to be involved in the U.S. market," he says.

In addition, this is a good time for foreign buyers to take advantage of the weak dollar, whose depreciation vs. other currencies seems to be leveling out, Liang says.

While Bristol may have to hike its bid to satisfy Icahn, the deal may not cost the company more than $65 a share, analyst Barbara Ryan wrote in a Deutsche Bank Securities note on July 31. (Deutsche Bank does and seeks to do business with the companies covered in its research reports.)

Vanishing Patents

Gaining control of all the Erbitux revenues would fill a long-term hole caused by Bristol's loss of patent protection, starting in 2012 and 2013, on its heart disease drug Plavix and antihypertension drug Avapro, the JPMorgan note said. Plavix is expected to account for 40% of Bristol's estimated 2008 earnings, while Avapro's projected contribution is 8%, JPMorgan said. Bristol will also probably see reduced economics on its antidepressant Abilify, which is expected to generate 25% of this year's profits.

Ryan at Deutsche Bank reaffirmed her buy rating, saying that over the longer term, the deal could enhance Bristol's valuation, thanks to the positive contribution to revenue and profits from ImClone's products after the patent protection on Bristol's own drugs disappears.

Big Pharma is putting greater emphasis on biotech-like drugs made with recombinant DNA, as opposed to the industry's traditional pills. Often these high-tech drugs command higher margins, but they tend to be geared for niche markets, such as the drugs created to treat rare diseases, says Liang.

What makes them especially attractive is that the marketing requirements can be far less than for traditional drugs, because the target audience is specialty physicians' groups, such as oncologists and virologists, who tend to work at major hospitals in bigger cities and are easier to reach, he says.

That means a substantial reduction in the sales force drugmakers need to deploy, which can save them lots of money, Liang points out.

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