Is the Celgene / Amgen deal for Otezla fair?

Celgene recently disposed Otezla indicated for the treatment of psoriasis and psoriatic arthritis to Amgen in $13.4bn deal. Therefore, the question that is raised at this point is whether the deal was good for both companies strategically and financially.

From a strategic perspective it will provide Amgen with rights of a blockbuster drug with growing revenues and with a patent expiry date between 2024 and 2028. Amgen will also gain future tax benefits valued at $2.2bn the company said (Source: Company press release).

On the other hand, for Celgene, it will pave the way to it’s merger with Bristol Myers Squibb as regulators. Initially, regulators had expressed that the deal might raise anti-trust concerns between Celgene and Bristol in relation to the companies’ anti-inflammatory pipeline (Source: WSJ).

To determine whether the deal is fair financially, one would need to derive the value of the asset. This would allows us to conclude whether Amgen overpaid or underpaid for the deal to happen. An intangible valuation method is appropriate, namely the multi-period excess earnings approach (‘MEEM’). The MEEM approach is very much similar to the DCF approach except for the addition of contributory asset charges (‘CACs’). CACs reflect the contribution of other assets to the cash flow generated by the intangible that is valued. Otezla is an intangible asset which generates cash flows through contribution of other assets such as fixed assets, working capital and workforce. Under the MEEM approach one would deduct the charges from these assets to arrive at the residual value i.e. the value of Otezla. For example, fixed asset CAC is calculated based on the proportion of fixed assets that are attributed to Otezla and the return on a return on fixed assets that one would require if he were to borrow those assets (typically 5% for fixed assets).

The key inputs in the valuation model are future revenues, profitability of the drug, patent expiry, the discount rate and CACs:

– Patent expiry: due to uncertainty on patent expiry two scenarios were developed. Scenario 1 reflects US patent expiry of Otezla in 2024 and scenario 2 a US patent expiry in 2028. Bernstein analyst Ronny Gal suggested a probability of 33% that the patent will be expired in 2028 and 67% for 2024 (see relevant article here). Scenario 3 was also developed for taking into account Otezla approval for the treatment of Behcet disease.

– Future revenues: Otezla revenues up to 2024 were obtained from EvaluatePharma. For the scenario where patent expires in 2028 a stable revenue growth rate was applied (EvaluatePharma assumes revenue growth rate in 2023 at 7% which was decreased to 6% in 2025, 5% in 2026, 4% in 2027 and 3% in 2028). For both patent expiry scenarios, post-patent expiry revenue decline was applied using comparable products (in psoriatic arthritis / psoriasis) that have already expired. In addition, Otezla has also been approved for the treatment of Behcet’s disease, which is highly prevalent in Turkey population (~80 per 100,000) while in the US prevalence is lower (~5 per 100,000). Four scenaria were built for Behcet’s disease indication (no launch – probability at 10%, peak market share of 10% – probability at 40%, peak market share of 25% – probability at 40% and, peak market share of 50% – probability at 10%).

– Profitability: given that Otezla is a relatively large share of the company’s revenue it was assumed that Celgene’s overall profitability is similar to that of Otezla, excluding R&D expense, as Otezla is already on the market. This translates to an EBITDA of ~75% going forward.

– Discount rate: Celgene’s (and Amgen’s) weighted average cost of capital (WACC) is estimated at around 9%. WACC reflect’s the weighted average risk of the company’s cash flows, which includes both pipeline and marketed drugs. It is reasonable to assume that a higher discount rate is driven by pipeline drugs which are inherently riskier from a commercial perspective (note that the discount rate does not consider clinical success rate as this is taken into account when risk-adjusting the cash flows of pipeline drugs using industry benchmarks of clinical trial success rates). As a result, a WACC of 6.5% (a discount of ~30% to the overall WACC of ~9%) was considered as Otezla is a commercial drug.

– CACs: Based on the proportion of Otezla revenue to total revenue fixed assets and working capital items were calculated. A typical return on asset of 5% and 3% were used for fixed assets and working capital, respectively. Working capital CAC was calculated at 0.4% for all scenarios. Fixed asset CAC was 1% for scenario 1, 0.8% for scenario 2 and 0.4% for Behcet disease indication.

Using the assumptions above the outputs from the MEEM valuation model are presented below:

 

 

Valuation results are as follows:

MEEM results in a value of $13.3bn which is well aligned with the actual deal value of $13.4bn and therefore, the deal was fair in terms of valuation. In addition, the impact on the stock prices of both companies was minimal which implies that the market also perceives the deal to be fair.

Now Amgen’s tax amortization benefit (‘TAB’) on Otezla will be examined. TAB refers to the net present value of income tax savings resulting from the amortization of intangible assets.

The step-up factor of 1.20 implies that the tax benefit is 16% on the value of Otezla i.e. 16% of the $13.3bn calculated in the MEEM model which translates to $2.1bn. This is in-line to the company’s estimates as indicated in its press release here.

In conclusion, based on the author’s valuation analysis the Amgen / Celgene deal is considered fair for both sides and Amgen’s estimated future tax benefits also appear to be realistic.

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