PFE - Merck: Going After Prometheus Biosciences

2023-04-21 16:28:07 ET

Summary

• Merck & Co., Inc. has reached a near $11 billion deal to acquire Prometheus Biosciences, Inc.
• The deal adds to the pipeline, badly needed as Keytruda reliance is high and growing.
• The transaction comes after Pfizer acquired Merck's former target Seattle Genetics a couple of weeks ago.
• It is hard to say what the impact of this deal is, and despite a multi-billion dollar deal tag, this really is largely a bolt-on deal for Merck.

In February, I concluded that shares of Merck & Co., Inc. ( MRK ) were running a bit hot. The company has thrived on the success of Keytruda, which actually creates a potential new dependency risk as well, all while shares have seen a re-rating over time.

As the company did not guide for growth in 2023, amidst tough comparables on the back of a pandemic-related contribution in 2022, I was a bit cautious as shares kept rising in recent times.

A Recap

Pre-pandemic, Merck & Co., Inc. was a $47 billion business in 2019, posting earnings of $5.19 per share. An $80 stock traded at 15-16 times earnings, as the outlook for 2020 was not that inspiring, with Merck anticipating modest growth.

In the end, the company grew 2020 sales by 2% to $48 billion, as sales of Keytruda were up 30% to $14.4 billion, thereby increasing the reliance on its top-selling drug, with non-Keytruda product sales being down.

The company guided for 2021 sales to rose to $53 billion, yet this was ahead of the spin-off of Organon & Co. ( OGN ) in a transaction set to cut sales by $6 billion to $47 billion, as pro forma earnings would fall by about a dollar to $5.50 per share.

In the end, the company did post 2021 sales at nearly $49 billion with adjusted earnings coming in at $6 per share, even after the spinoff, as the share of Keytruda sales rose to 35%. The company guided for 2022 sales to rise further in a convincing manner to $57 billion, with earnings seen around $7 per share, as shares rose to the $100 mark in the autumn of last year on the back of these projections.

Amidst this momentum, the company was rumored to offer $40 billion for Seattle Genetics in 2022, but in the end peer Pfizer Inc. ( PFE ) acquired Seattle in a $43 billion deal about a month ago. Instead of acquiring Seattle Genetics, Merck reached a $1.35 billion deal to acquire Imago BioSciences in October of last year, but otherwise no large deals were announced.

In February of this year, Merck posted its 2022 results , with revenues reported at $59.3 billion and full year earnings of $7.48 per share. Important to realize is that $5.7 billion of these revenues were generated from Covid-19 drug LEGEVRIO as sales from this drug are expected to fall to just a billion in 2023.

Amidst this pullback in sales, the outlook for 2023 look quite steady. After all, organic growth is seen with sales expected around the $58 billion this year, while earnings will fall to $6.80-$6.95 per share.

Given the size of the operations and the profitability, net debt of $18 billion was modest, yet expectations had risen a bit. Shares were up to $110 in February, pushing up the valuation to 16 times adjusted earnings seen this year, all while growth was not too exciting and higher interest rates hurt prospects for valuations across the board. This made me decide to earmark some funds into other pharmaceutical names which have been lagging in recent times.

And Now? Another Big Deal

Since the release of the fourth quarter results in mid-February, news on Merck & Co., Inc. has been limited other than some updates from the FDA, among others. The 2.55 billion shares now trade at $114, largely in line with the levels seen in February, granting the company a $279 billion equity valuation, or close to $300 billion if we add back net debt.

Amidst this background, and with Merck missing out on Seattle Genetics, the company announced a big deal by mid-April. The company agreed to a deal to acquire Prometheus Biosciences, Inc. ( RXDX ) in a $200 per share cash-deal. The transaction is valued at $10.8 billion, which is a huge dollar amount, but only works down to about $4 per share based on Merck´s share count.

The deal is earmarked to increase the exposure of the company to immunology. Promotheus is a clinical-stage biotechnology business which focuses on precision medicine approach to discover, develop and commercialize immune-mediated diseases.

This includes the lead candidate PRA023, a humanized monoclonal antibody which is targeting tumor necrosis factor, associated with intestinal inflammation and fibrosis. This candidate is showing promise and strong efficacy across primary and secondary endpoints in phase 2 trials. If all goes well, the deal is expected to close in the third quarter.

Given the nature of the deal the transaction is set to dilute adjusted earnings to the tune of a quarter of a dollar per share, just over $600 million in dollar terms. This is the composition of the operating losses of the acquired business and incremental interest costs.

Concluding Remarks

The Prometheus Biosciences, Inc. deal is set to increase the Merck & Co., Inc. net debt load quite a bit, to about $29 billion on a pro forma basis, as the market hardly reacted to the deal announcement. That is not surprising, as this is a relative small addition to the pipeline. For investors in Prometheus, the deal has been very lucrative as this was just a $50 stock early in December, ahead of the Phase 2 trial results, but this is even ahead of the Phase 3 outcome!

The overall impact on Merck & Co., Inc. is that net debt will increase a bit, being still very manageable for Merck. In the meantime, Merck & Co., Inc. shares have added a few dollars since February, as the company sees a quarter of a dollar in dilution, increasing the earnings multiple by more than a time to 17 times earnings.

All this makes me still cautious on Merck & Co., Inc., as I reiterate my more cautious stance from February. That said, it will be interesting to see how this deal pans out, but in reality this is a relatively small deal, even if the absolute dollar amount is very substantial.

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