KRTX - Bristol Myers Squibb: Aggressive M&A A Riskier Strategy To Fix The Growth Challenge

2023-12-23 04:24:25 ET

Summary

• Bristol Myers Squibb is resorting to larger M&A deals to drive new product sales and combat the challenges it faces with the loss of exclusivity of its top-selling drug Revlimid.
• The company's 2023 outlook is tough, with stagnation and a decline in sales expected, along with increasing debt.
• Bristol Myers recently announced a $14 billion deal to acquire Karuna Therapeutics, which is seen as positive by investors but will result in a substantial increase in net debt.

A month ago, I believed that Bristol Myers Squibb (BMY) found itself in a tough, but cheap spot. The company is facing headwinds and challenges related to the loss of exclusivity of one of its top-selling drugs Revlimid, and upcoming expirations of other drugs, driving the need for new product growth.

Despite a transformative deal following the 2019 purchase of Celgene, and subsequent dealmaking, real growth concerns remain, creating a tough near term outlook with a former powerhouse losing power. With 2023 being a tougher year, a year in which reality has kicked in, the company is resorting to larger M&A to drive higher new product sales. This is a riskier strategy, with debt increasing quite a bit.

The Challenge

When Bristol Myers announced a $90 billion mega-deal for Celgene in 2019, the strategy was to create a $37 billion biopharmaceutical powerhouse set to generate $16 billion in EBITDA, from a wider range of drugs (categories). Dealmaking made that net debt ticked up to more than $50 billion, high but manageable.

A mere $40 stock at the time traded at non-demanding valuations with earnings power seen around $5 per share, with synergies and deleveraging efforts having the potential to boost the results on the bottom line.

With the company delivering on its promises, shares quickly rose to the $70 mark in 2021 and actually the $80 mark a year later. There were some moving targets in the meantime, including a $13 billion divestment of Otezla rights to Amgen (AMGN) , while a similar amount was invested in order to acquire MyoKardia, with its chronic heart disease drug mavacamten.

Revenues grew steadily to $46 billion in 2021, with earnings reported around $7.50 per share, although that the three top-selling drugs Revlimid, Eliquis and Opdivo combined made up nearly two-thirds of sales, a dangerous cocktail amidst expirations coming on the horizon.

With Revlimid seeing expiration in 2022, stagnation was seen, although that the company guided for a modest increase in sales to $47 billion, with earnings seen around $7.80 per share. Trying to add to the pipeline, the company furthermore announced a $4.1 billion deal for Turning Point Therapeutics in the summer of 2022.

Despite the expiration of Revlimid, the company originally guided for 2023 sales to rise by 2% and earnings seen topping $8 per share. This marks no real growth, certainly not in an inflationary environment, but it included an anticipated 35% decline in Revlimid sales to $6.5 billion. Moreover, the company started its fiscal 2023 with a net debt load of $29 billion, marking quite some progress on that front since the Celgene deal announcement.

2023 - Thought

A stock which trade in the $70s at the start of 2023 has seen a very tough year, even trading in the high-forties in recent weeks. It is the combination of softer operating performance, concerns on the pipeline and further upcoming expirations which put pressure on the shares. This was complemented by other concerns induced by weight-loss drugs, in which Bristol Myers does not play a role (on the production front), as well as concerns on regulatory bodies and politicians which are looking to curb drug prices.

Over the summer, the company posted a 9% fall in second quarter sales, with adjusted earnings falling by a similar percentage. This was driven by a 41% decline in Revlimid sales, whose sales were now seen at just $5.5 billion this year. This made that the full year earnings outlook was cut from a midpoint of $8.10 per share to $7.50 per share, a wary sign.

In an effort to please investors the company announced a $4 billion accelerated buyback program over the summer, which came on top of the generous $0.57 per share quarterly dividend, while the company furthermore acquired Mirati Therapeutics (MRTX) in a $4.8 billion deal, with the deal still set to close.

Third quarter sales fell just 2%, with adjusted earnings actually increasing modestly to $2 per share, as Revlimid sales held up just fine on a sequential basis. While this looked comforting, the issue was that the company cut the guidance from the so-called new product portfolio.

This group of products generated $928 million in third quarter sales, and its sales contribution was originally expected to rise to $10-$13 billion in 2025. The new guidance called for sales around $10 billion, at the lower end of the range, but only in 2026. This furthermore means that operating margins for 2025 were now cut by 3 points to 37% of sales, essentially implying a big and long term profit warning. This raised real questions, and was the driver for shares to plunge towards the $50 mark.

After all, the company sees revenues fall towards $40 billion at that point in time, which suggests a $15 billion adjusted operating profit number, looking rather dismal compared to a current number around $19 billion. In fact, I believed that earnings power of around $7-$8 per share would fall to $5-$6 by the middle of this decade, assuming a flat share count.

This means that shares trade at 10 times forward earnings in a couple of years, which is the result of revenue declines, but actually still requires real execution from the new product portfolio as well.

Amidst all this, I felt some regret on initiating a position before, as I bought the dip, but lacked the conviction to do so in size. After all, it was really up to the company to start performing now, as execution is exactly what has been lagging.

A Big Deal - And Positive Read

Ahead of taking a look at the latest M&A deal of Bristol Myers, I first observe that the company started December with large capital allocation moves, as it announced another $3 billion share repurchase program, while the dividend was hiked to $0.60 per share on a quarterly basis. Net debt was rather stable at near $30 billion as of the third quarter.

That debt load will see a massive move higher as the company announced a $14.0 billion deal to acquire Karuna Therapeutics (KRTX) . The $330 per share cash deal marks a 53% premium compared to the unaffected share price, with the deal valued at $12.7 billion if we exclude the net cash position of Karuna.

This will result in net debt increasing to $42 billion, but investors are upbeat about the deal, as Bristol Myers will get its hands on Karuna's lead asset KarXT, an antipsychotic with a differentiated efficacy and safety profile for the treatment of schizophrenia. The drug was accepted for review by the FDA with a PDUFA date in September of next year, as the drug might play a big role in schizophrenia as well as Alzheimer's disease.

The deal is set to dilute 2024 earnings by $0.30 per share as a result of the financing costs of the deal, working down to about $600 million in dollar terms. On top of that, Karuna posts operating losses to the tune of half a billion per annum, although that Bristol sees potential to rationalize some of these losses.

What Now?

The deal will result in a substantial increase in net debt, as the $42 billion pro forma net debt load number comes ahead of closing of Mirati, set to increase this number to the mid-forty billion mark. This is getting somewhat worrying amidst the dividend commitment and occasional share buyback program.

Nonetheless, investors for now take it as a positive, sending shares of Bristol Myers 3% higher in response to the deal, adding about $3 billion in value to the firm, on top of the premium paid for Karuna.

Hence, I am performing a balancing act. The deal looks great to bolster the growth profile of the firm, but comes with quite some added debt, as the company has to navigate the desire for dividends, share buybacks, growth in new products, while keeping a close eye on the leverage situation here.

While investors like the deal announcement, and I do to from a strategic point of view, the outcome of this is still uncertain. Given all of this, I am actually still holding to my enlarged position, but likely will be using a further increase in the share price to trim part of my position here in the mid- to high-fifties.

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