Merck And Seagen: For And Against The Deal (NYSE:MRK)

Background

There was information in the media regarding the interest of Merck & Co., Inc. (NYSE:MRK) in buying a biotech company with a focus on oncology. The major candidate for the acquisition is Seagen Inc. (NASDAQ:SGEN). On the back of this news, Seagen shares rose 12.7% on Friday (June 17). As part of my past articles (Seagen: Bad Forecast But Good Investment, Seagen: SEA-CD40 Is The Next Growth Driver), I emphasized the undervaluation of Seagen’s shares. As part of this article, I am going to take a closer look at SGEN’s takeover possibility by Merck.

Looking ahead, I note Seagen may well become a suitable candidate for Merck to acquire. The companies are already collaborating on the development of ladiratuzumab vedotin (LV). The development agreement was signed in September 2020. The drug is in phase II trials for the several types of cancer treatment, both as a monotherapy and as a combo therapy with Merck’s Keytruda. Also under that agreement, Merck bought a $1 billion stake in Seagen (2.7% of outstanding shares). The purchase price was $200 per share (21% higher than the current price). Let’s go forward and look at the arguments for and against this deal.

Arguments in favor of the deal

1) Merck needs to diversify its drug portfolio. Although the company has an expected revenue CAGR of 7% for 2021-2024, the company still needs to move away from the high concentration of sales on Keytruda. Keytruda accounts for about 35% of revenue. Another problem is the end of Keytruda’s patent protection in the U.S. in 2028.

2) Cost synergy. The deal may bring possible cost synergy due to the overlapping of the drug portfolio specialization areas (oncology). The bulk of the cost savings will be on the side of SG&A costs, which are equal to $1.22 billion. With the Seagen takeover, cutting these costs by 30-50% could create synergies estimated at roughly $2.9-4.8 billion in NPV.

3) Revenue synergy. Since both companies specialize in oncology, the deal will further strengthen cooperation in terms of combination therapy developments.

4) The resignation of Seagen’s CEO. Seagen recently lost its CEO due to a domestic violence investigation. During this transition period, management may choose to sell the company instead of looking for a new CEO.

Arguments against the deal

1) With the only cash financing, the debt burden will increase significantly. The current MRK’s net debt/EBITDA is 1.05x. The amount of cash in the MRK’s account is $8.5 billion. If the deal is at a price of $200, the deal will amount to $36.6 billion. So the company will need to issue bonds in the amount of about $30 billion. The net debt following the transaction close will be about $53 billion, and Net debt/EBITDA will be at the level of 2.4x. Although several competitors, AbbVie (ABBV) (2.36x) and Amgen (AMGN) (2.35x), have the same level of leverage, given the tightening of monetary policy, investors may perceive this deal negatively. I note that the calculation does not include the potential SGEN’s EBITDA (it is now negative). In my opinion, the preferred option for the deal financing would be a combined form of payment (cash + shares) or financing only through stock financing.

2) Relatively high multiplies. Seagen is trading at 9.6x on Forward EV/S (2023), while the sector’s average historical buyout multiple is 12x. While SGEN’s multiple is below historical, there are several companies in the sector that are trading substantially lower multiples and have comparable growth prospects. They can become more lucrative acquisition targets. However, Seagen’s premium valuation is explained by Seagen’s uniqueness as an asset. The uniqueness is connected to the advanced ADC-platform that the company has. This technology combines chemotherapy and targeted therapy features. Using this technology platform, the company has already got approval for three drugs.

3) The company may choose to make one or several smaller acquisitions. Merck has done no particularly big deals in recent years. Since 2009, the only transaction over $10 billion has been the acquisition of Acceleron Pharma, closed in November 2021.

4) The possibility of the partnership expansion. As before, the company may not acquire the entire company. Instead, it can increase its stake in Seagen and expand key areas of cooperation. Increasing the company’s stake will reduce the likelihood that an asset like Seagen will go to another buyer. This reduce possible future competition and leave an option for future M&A.

The final thoughts

Given the arguments for and against the deal, I suppose there is a moderate possibility of a takeover. In my estimation, the value of SGEN’s current business is approximately equal to the current market capitalization. However, the possible takeover could be in the $200-$240 range, which gives me reason to believe Seagen’s stock is undervalued at its current level.

So I keep my bullish view on the company shares. In this article, I did not dive into SGEN’s drug portfolio in detail. This part of my analysis can be found in my past articles (Seagen: Bad Forecast But Good Investment, Seagen: SEA-CD40 Is The Next Growth Driver). Regarding Merck, I have a neutral view at the moment.