SBHMY - F-star Therapeutics: At A Discount Of 30% To Takeover Offer With CFIUS Approval On The Horizon

Summary

• The odds are now in favor of a successful completion of the Sino Biopharmaceutical/F-star merger as the UK government has approved the deal.
• CFIUS is the final hurdle before the deal can close.
• While CFIUS approval is not a slam dunk, the latest developments point toward conditional approval.
• It is both in F-star's and Sino Biopharmaceutical's interest to see this through.

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invoX Pharma - wholly owned by Sino Biopharmaceutical ( SBMFF ) (SBHMY) - and F-star Therapeutics ( FSTX ) announced on June 23, 2022, that the companies have entered into a definitive agreement whereby invoX will acquire F-star for $7.12 per share in an all-cash transaction. After obtaining national security approval in the UK , where the acquisition target is headquartered and where 90% of its workforce is located as of 2021, the parties are now focusing on CFIUS's (the Committee on Foreign Investment in the United States) review. They still expect the transaction to close in the second half of 2022.

The clock is ticking. The contractual end date is Nov. 19, 2022 ; the offer will terminate on that day unless the parties mutually agree on a different end date. I believe it is more likely than not that the offer will be completed. But if I'm wrong and the offer fails due to CFIUS, F-star could require invoX/Sino Biopharmaceutical to make a $12 million equity investment into F-star in lieu of a breakup fee.

CFIUS: Take One, Two, Three - Action?

While the CFIUS process has been complex and long, it has not been unusual. It started with the parties making a voluntary CFIUS filing in early July. "Voluntary" means that the deal did not fall within the mandatory filing regimes for critical technology, sensitive data, etc. The parties decided to file with CFIUS nonetheless and make this a condition to the offer, which seems wise given that CFIUS could have otherwise called in the transaction at an inopportune time - for example, post-closing.

After the first 45 days had passed in mid-September, CFIUS pushed the review to the investigation phase, which took another 45 days. Again, that was to be expected. But the market only woke up to the national security issue now.

After the price recovered on the back of the UK national security approval at the end of September, the stock started weakening again in late October after CFIUS requested that the parties withdraw and refile - another surprising reaction by the market from where I stand. The request to withdraw and refile is actually a good sign, and is not particularly unusual either according to official CFIUS statistics :

In 2021, CFIUS approved the withdrawal of 74 notices. Parties withdrew two notices during the review phase and withdrew 72 notices after the commencement of the investigation period. In 63 of these instances, the parties filed a new notice in either 2021 (52 notices re-filed) or 2022 (11 notices refiled). In most instances, the notices were withdrawn after the Committee informed the parties that the transaction posed a national security risk to allow the parties additional time to consider CFIUS's mitigation terms . [emphasis added]

If the transaction had no hope, one would expect CFIUS to ask the parties to only withdraw (not refile) or refer the case to the president .

So why is the stock now trading at a discount of >30% to the offer price ($7.12)? Is the pessimism justified?

At What Point Can Sino Biopharmaceutical Walk?

The parties explained CFIUS's request for withdrawal and refiling as follows:

Pursuant to a request by CFIUS, on Oct. 31, 2022, the parties voluntarily withdrew and immediately refiled the voluntary notice in order to provide CFIUS with more time to complete its assessment and to determine whether and to what extent any mitigation steps should be taken.

We do not know what the national security concern is that justifies mitigation, whether it's foreign access to sensitive U.S. patient data, continued U.S. access to the company's R&D output, or something else.

Whatever the concern is, Sino Biopharmaceutical might contractually be under no obligation to accept any conditions on the approval. In other words, Sino Biopharmaceutical could walk if it does not like the commitments that CFIUS requires from them. CFIUS approval is a condition to the offer. And the merger agreement is quite accommodating to the offeror by carving out a broad range of conditions that Sino Biopharmaceutical would not have to accept to get approval. See Section 6.2 of the Merger Agreement (linked above):

((B)) Notwithstanding the foregoing, nothing in this Section 6.2 or otherwise in this Agreement shall require Parent or its Affiliates to (i) negotiate, commit to or effect, by consent decree, mitigation agreement, national security agreement, hold separate order or otherwise, the sale, lease, license, divestiture or disposition of any assets, rights, product lines, or businesses of the Company, the Parent or any of their respective Affiliates or Subsidiaries, (ii) terminate existing relationships, contractual rights or obligations of the Company, the Parent or any of their respective Affiliates or Subsidiaries, (iii) terminate any venture or other arrangement, (iv) create any relationship, contractual rights or obligations of the Company, the Parent or any of their respective Affiliates or Subsidiaries, (v) effectuate any other change or restructuring of the Company, the Parent or any of their respective Affiliates or Subsidiaries and (vi) otherwise take or commit to take any actions with respect to the businesses, product lines or assets the Company, the Parent or any of their respective Affiliates or Subsidiaries.

Also, no reverse breakup fee would become payable if Sino Biopharmaceutical was to walk away. F-star's board had pushed for such a breakup fee initially. Likely because money is tight and F-star needed to strike a deal, the parties settled on something else. Sino Biopharmaceutical might have to make an equity investment of $12 million if the offer failed due to CFIUS :

Throughout the week of June 13, 2022, representatives from Mintz, Shearman, F-star and invoX Pharma continued to negotiate the final terms of the Merger Agreement, including the terms of an equity investment by invoX Pharma into F-star if the transaction were terminated because it failed to satisfy the regulatory requirements of applicable foreign direct investment authorities in a timely manner, in lieu of a reverse breakup fee (the 'Equity Investment').

If that was to happen, the stock would likely trade in the $3 range again. I agree with an earlier analysis on Seeking Alpha that F-star is not the ideal investment for your typical equity holder. So it all hinges on this deal going through.

CFIUS Will Likely Press for Conditions

From the start, an unconditional approval seemed unlikely in this case. The acquirer's parent - Sino Biopharmaceutical - is listed in Hong Kong, and has offices there as well as in Beijing. At least one of the directors on Sino Biopharmaceutical's board occupies roles within the Chinese government , and the company has a significant operational footprint in the mainland . This is likely enough for some of the CFIUS members to sit up and take notice. That the founding and controlling family business reportedly does not come from China, but rather Thailand's private sector, might be a major mitigant. But it's likely not enough for CFIUS to just waive this through. There might also be a few unknown unknowns.

How Will the Story End? Lots of Optionality, but One Golden Route

CFIUS knows that it could keep Sino Biopharmaceutical outside control territory by not clearing the offer, while still allowing F-star to get some of the urgently needed funding from Sino Biopharmaceutical via the $12 million equity investment route. That is a comfortable position for a regulator to be in. Conversely, Sino Biopharmaceutical could walk from the offer if they did not like the conditions CFIUS imposes on them.

But here is the catch: The withdrawal and refile shows the willingness of all stakeholders to close the offer, and I believe they are strongly incentivized to strike a deal. The U.S. business only consists of a few employees and the core of its operations are in the UK. While 2021 revenue stems from U.S. partnerships predominantly, the UK and the U.S. government have a strong intelligence alliance (" Five Eyes ") and the UK will have taken the U.S. angle into account when they approved the deal. Given that the UK has already approved it, CFIUS will be motivated to not throw a spanner into the deal now unless they absolutely have to.

And Sino Biopharmaceutical? While it might not want to subject itself to burdensome conditions, pocketing a CFIUS approval for this transaction - even if conditional - could be a significant strategic win that would make it easier for the company to invest and operate in the U.S. in the future. In the current geopolitical environment, a strong track record of approvals can be very valuable for businesses that want to operate globally. There are templates for that strategy: Late last year, CFIUS cleared Genimous Technology's acquisition of Spigot and Tencent's (TCEHY) acquisition of the Sumo Group , subject to conditions.

Conclusion

I believe the market is currently too pessimistic with respect to the chances of approval; as such, I rate this situation as "buy." While there is a risk that the offer will not close due to CFIUS - the target operates in a fairly sensitive sector (biopharma) and the geopolitical environment continues to be difficult for Chinese investors - the latest developments show that CFIUS's concerns might be fixable, and it should be in Sino Biopharmaceutical's interest to accept commitments and see this through. As things stand currently, I believe an ~15%-20% discount to the offer price would be more reflective of the remaining risks than the >30% we're seeing currently. Given that it's a close call, one might want to consider a hedge. Shorting Sino Biopharmaceutical seems a reasonable hedge given a CFIUS disapproval could hobble the company's U.S. aspirations in the medium term.

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