Bloomberg News

Pharmasset Poised to Pay 20% With Gilead Deal Closing: Real M&A

December 07, 2011

Dec. 6 (Bloomberg) -- After attracting a record windfall for a drug takeover, Pharmasset Inc. is now offering the biggest annualized return of any U.S. deal for traders willing to bet on smooth development of its experimental hepatitis C treatment.

Gilead Sciences Inc. agreed last month to buy Pharmasset of Princeton, New Jersey, for $10.8 billion, 94 percent more than its 20-day trading average and the highest premium on record for a drug takeover of comparable size, according to data compiled by Bloomberg. After the shares fell 3.4 percent in the last week, the $137-a-share price tag would deliver an annualized return of at least 20 percent if the purchase closes in the first quarter as projected. That’s the highest potential gain of any pending U.S. deal greater than $1 billion, the data show.

Pharmasset posted a bigger slump than 99 percent of companies in the Russell 1000 Index last week as some investors grew concerned that Gilead will walk away from the takeover if Pharmasset faces delays in the development of its oral drug for hepatitis C. While Pharmasset’s 234 percent advance this year prior to the deal had topped the Russell 1000, last week’s drop is now giving Pharmasset shareholders the chance to profit again by betting the deal will close, said Wall Street Access.

“It’s a real fat spread,” Keith Moore, an event-driven strategist at Stamford, Connecticut-based MKM Partners, said in a telephone interview. “If there’s negative news Gilead can walk away from the deal. But the likelihood of that happening is very low.”

‘Serious Adverse Event’

Chris Kittredge, an outside spokesman for Pharmasset, and Amy Flood, a spokeswoman for Foster City, California-based Gilead, declined to comment on Pharmasset’s trading and investors’ concerns about the deal closing.

Last week Pharmasset fell 3.6 percent while the Russell 1000 and the Standard & Poor’s 500 Index posted their biggest weekly rallies since March 2009. Pharmasset dropped 0.1 percent to $128.59 at 12:37 p.m. in New York today. Gilead slipped 0.8 percent to $39.85.

The decline last week pushed Pharmasset shares $8.56 below Gilead’s bid as some investors worried that the potential losses from a failed deal are too great to justify wagering on the acquisition’s completion. Gilead specified in a regulatory filing last month that Pharmasset can’t experience any “serious adverse event” during clinical trials for its drug PSI-7977. Such events include injury to trial subjects that lead to a hold on development by the U.S. Food and Drug Administration or “significant” delays.

Paid for Risk

The offer represented a 6.7 percent premium to Pharmasset shares on Dec. 2, the widest gap since the deal was announced Nov. 21, data compiled by Bloomberg show. After rebounding 21 cents yesterday, the deal still offered a 6.5 percent premium, which is the equivalent of a 20 percent annualized return if the deal closes March 31. Betting on the takeover presented the largest annualized return of any pending U.S. deal valued at more than $1 billion, the data show.

“It’s one of the more attractive situations out there because you are getting paid for the risk,” Peter Lobravico, New York-based vice president of merger arbitrage trading and sales at Wall Street Access, said in a phone interview. “As the stock goes down, the risk-reward gets more attractive.”

The annualized return would be even higher if the deal closes before the end of the first quarter. Lobravico and MKM’s Moore project a January completion, which would yield at least a 50 percent profit based on Pharmasset’s price yesterday.

Hepatitis C Drug

Pharmasset is developing an oral drug for hepatitis C, which is now largely treated with injections. The viral infection, for which there is no vaccine, can lead to liver cancer. As many as 170 million people globally carry hepatitis C, which is transmitted through exposure to infected blood, and more than 350,000 die from related illnesses each year, according to the Geneva-based World Health Organization.

Its leading product, PSI-7977, is entering two phase 3 studies in patients with genotype 2 and 3. A third study in genotype 1 patients will start in the second half of next year and could lead to initial regulatory approval in 2014, according to a statement from the companies. Genotype 1 is the most common and hardest to treat.

Gilead, the world’s largest maker of HIV medicines, is buying Pharmasset at a premium that’s more than three times the average 25 percent paid for drug takeovers greater than $500 million, data compiled by Bloomberg show. The deal handed shareholders a $4.7 billion increase in market value the day it was announced. Gilead said it expects the purchase to close in the first quarter, and the tender offer already has committed financing.

The tender offer, which began today, is set to expire Jan. 12, according to a regulatory filing.

‘Significant Downside’

While there’s only a “slim chance” of Pharmasset’s drug causing an adverse event that would prompt Gilead to back out, the investment may still have proven too risky for some shareholders, according to Michael Yee, a San Francisco-based biotechnology analyst with RBC Capital Markets.

“I do not foresee any serious adverse event or issues that are likely to arise,” Yee said in a phone interview. Still, “there’s significant downside for the stock if it were to happen,” he said.

If the deal is canceled because of problems in the drug trials, the shares may drop to half of their $72.67 value before the takeover was announced, said Wall Street Access’ Lobravico.

Inhibitex Inc. said last week that its INX-189 drug, a hepatitis C treatment similar to the one Pharmasset makes, showed a “significant increase in antiviral activity” when used in combination with ribavirin. The positive results mean that Inhibitex may be able to “truly” compete with Pharmasset, Brian Skorney, an analyst at Brean Murray Carret & Co., said in a note to clients Nov. 29.

‘Huge Bet’

Inhibitex “had pretty good results, which means Pharmasset is not that much ahead of the rest of the market,” Nils Hayat, a Tel Aviv, Israel-based risk arbitrage analyst with Makor Capital, said in a telephone interview. The Pharmasset spread widened because the increased competition means the stock will drop even further if the deal falls apart, Hayat said.

Even before the acquisition was disclosed, Pharmasset had gained 234 percent this year, twice as much as any other company in the Russell 1000, as its drug trials advanced.

Pharmasset reported last month that 40 patients who received PSI-7977 were responsive after 12 weeks. About half the patients had been followed up to 24 weeks and were all cured with no significant adverse events. The drug was tested in combination with ribavirin, which is currently used in treating the disease in patients with hepatitis C genotypes 2 and 3.

While the spread has widened, Gilead is still likely to close the deal to capture the potential growth in the market for new hepatitis C treatments, according to Lionel Melka, co- manager of Paris-based Bernheim, Dreyfus & Co.’s Diva Synergy Fund, which focuses on acquisition targets.

“We’re very confident that this deal will go through,” Melka said in a phone interview. “It’s a huge bet that Gilead knows what it’s doing. You don’t put $11 billion on the table if you don’t know what you’re doing.”

--With assistance from Meg Tirrell in New York. Editors: Sarah Rabil, Daniel Hauck.

To contact the reporter on this story: Tara Lachapelle in New York at tlachapelle@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net.


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