Bloomberg News

Gilead Bonds Expose Discontent Shares Conceal: Corporate Finance

December 07, 2011

Dec. 7 (Bloomberg) -- Bond investors perceive less benefit than shareholders from Gilead Sciences Inc.’s purchase of a research-stage firm as the world’s largest maker of HIV medicines raises $3.7 billion of debt to fund the acquisition.

A Gilead bond offering yesterday included $1.25 billion of 4.4 percent, 10-year debt that yields 235 basis points more than similar-maturity Treasuries, according to data compiled by Bloomberg. That compares with an average spread of 154 basis points on non-financial corporate bonds with A ratings, Bank of America Merrill Lynch index data show.

While Gilead’s stock has bounced back from a 9 percent drop on Nov. 21, the day the Foster City, California-based company announced the $10.8 billion acquisition of Pharmasset Inc., its bonds haven’t. Trading in Gilead debt issued in March show that investors view the company as deserving a grade in the middle of the BBB tier, belying its ratings of Baa1 from Moody’s Investors Service and A from Standard & Poor’s, according to Julie Stralow, a credit analyst at Morningstar Inc.

“For credit investors, until you have a product in the market and it’s succeeding, there’s a hesitance to give credit for it to companies like this that have so much riding on the pipeline,” Stralow said in a telephone interview. “They may be discounting any benefit from acquiring Pharmasset’s products.”

Raised Bid

Gilead also sold $750 million of 2.4 percent, three-year notes yesterday that yield 205 basis points more than benchmark, $700 million of 3.05 percent, 5-year notes at a 215 basis-point spread and $1 billion of 5.65 percent, 30-year bonds at a spread of 260 basis points, Bloomberg data show. A basis point is 0.01 percentage point.

Nathan Kaiser, a spokesman for the company, declined to comment on the offering.

Gilead couldn’t match spreads obtained by Amgen, the world’s largest biotechnology firm, in a four-part, $6 billion bond offering on Nov. 7, Bloomberg data show. Amgen’s $1.75 billion of 4.1 percent, 10-year notes paid 187.5 basis points more than Treasuries with a similar maturity.

Amgen, rated Baa1 by Moody’s and A+ at S&P, borrowed the money as it increased rewards to shareholders, raising its leverage and putting its bonds at risk for downgrade.

Gilead increased its bid for Pharmasset several times before agreeing to pay $137 a share, or $10.8 billion, as other potential buyers bowed out, filings with the Securities and Exchange Commission show. It first offered to purchase the company for $100 a share on Sept. 2, a 56 percent premium, Pharmasset disclosed yesterday in a regulatory filing.

Hepatitis Treatment

That offer was deemed insufficient by Pharmasset, a company with 82 employees, no marketed products and a net loss of $91.2 million for the fiscal year ended Sept. 30. Pharmasset is developing an oral hepatitis drug.

Gilead made its bond-market debut in March, issuing $1 billion of 4.5 percent of 10-year notes at a 125 basis-point spread, Bloomberg data show. Spreads on the debt widened 47 basis points since Nov. 17, before the Pharmasset acquisition was announced, to 205 as of 11:19 a.m. in New York, leaving the yield at 4.11 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Average spreads on investment-grade corporate bonds have expanded 8 basis points to 256 over that span, Bank of America Merrill Lynch index data show.

Gilead gained 9.4 percent to $39.65 since falling to $36.26 on Nov. 21. That compares with a 5.4 percent gain for the S&P 500 Index over the same period.

‘In the Pipeline’

“On the equities side of things, you’re more likely to get credit for what’s in the pipeline,” Stralow said.

The acquisition will give Gilead access to Pharmasset’s leading product, PSI-7977, used to treat hepatitis C. The medicine is entering two phase 3 studies in patients with genotype 2 and 3 and a third study in genotype 1 patients will start in the second half of next year, potentially leading to initial regulatory approval in 2014, according to a Nov. 21 statement from the companies.

The bond sale will push Gilead’s ratio of debt to earnings before interest, taxation, depreciation and amortization to 2.4 times, according to Moody’s. The rating is based on the expectation that Gilead will use free cash flow to cut leverage to 1.5 times within two years, analysts Michael Levesque and Peter Abdill wrote in a report yesterday.

Buy-Backs Suspended

Free cash flow at Gilead climbed to $3.26 billion in the 12 months ended Sept. 30, from the $3.12 billion pace a quarter earlier, Bloomberg data show. Free cash is money that can be used to repay debt, for company expansion and to reward shareholders through dividends and stock buybacks.

Gilead will suspend a $5 billion share repurchase program it began in the third quarter to focus on debt reduction, Chief Financial Officer Robin Washington said during a Nov. 21 conference call.

“We’ll focus on paying down the debt that we’ll incur associated with this transaction to get our debt to Ebitda ratio back in the range that we’ve kind of projected with our ratings agencies,” Washington said.

The Pharmasset acquisition changes the nature of the company from a value-driven investment, with its buyback plan and steady cash flow, to a growth stock, with the potential for greater revenue in the next decade, said Michael Yee, a San Francisco-based biotechnology analyst with RBC Capital Markets.

“That’s why you had the stock sell off initially, and then you had a lot of growth guys come into the name,” Yee said in an interview.

HIV Drugs

Anti-HIV drugs accounted for 83 percent of Gilead’s $2.12 billion in third-quarter revenue, Bloomberg data show. The company’s Atripla, a three-drug combination pill approved in 2006, is the most widely used AIDS medicine. The therapy mixes Gilead’s two-drug medicine Truvada, approved in 2004, with Bristol-Myers Squibb Co.’s pill Sustiva. Gilead has been developing a four-drug cocktail, called Quad, as a way to expand revenue for patients that can’t take other medicines because of side effects.

Gilead is paying 89 percent more than the closing price for Princeton, New Jersey-based Pharmasset on Nov. 18. The purchase, Gilead’s biggest, will reduce its earnings through 2014 and then add to profit, the companies said in the Nov. 21 statement.

“The acquisition will result in Gilead’s credit metrics falling outside the ranges Moody’s previously envisioned for the Baa1 rating,” Levesque and Abdill wrote. The analysts said they could downgrade the company if its leverage ratio is “sustained materially above 1.5 times.”

--Editor: Mitchell Martin

To contact the reporters on this story: Tim Catts in New York at; Ryan Flinn in San Francisco at

To contact the editors responsible for this story: Alan Goldstein at; Reg Gale at

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