ORTX - Orchard Therapeutics: Still An Attractive Merger Arbitrage Opportunity With A CVR

2024-01-19 13:34:10 ET

Summary

• Orchard is trading slightly above the offered cash value at $16.44.
• Market ascribes $0.44 out of maximum value of $1 to CVR.
• This appears rich but may actually undervalue the instrument that's likely to pay out within the year.

Kyowa Kirin Co. (KYKOY), a Japanese pharmaceutical giant with a market capitalization of $8.5 billion, has announced its acquisition of Orchard Therapeutics (ORTX) at a price of $16 per share, supplemented by a contingent value right or CVR of up to $1. Orchard is trading slightly above the offered cash value at $16.44. With only a few days to go until this wraps up, Kyowa Kirin's acquisition of Orchard Therapeutics is still an attractive merger arbitrage opportunity for investors willing to deal with a CVR. The high expected odds of FDA approval (after EMA approval is already in the bag) are especially important.

CVRs are quite common in biotech acquisitions. The total value of the deal, excluding the CVR, is approximately $350 million. Kyowa Kirin can finance this acquisition, including the CVR, from its cash reserves. Kyowa gets around $100 million in cash back that's on the target's balance sheet.

This strategic acquisition follows a period of collaborative research between the two companies on Orchard’s hematopoietic stem cell (HSC) gene therapy. Kyowa Kirin’s decided to acquire and integrate Orchard fully. Meanwhile, Orchard’s board believes that joining forces with Kyowa Kirin will accelerate their research programs more effectively than if they remained independent.

A key here is the CVR that pays $1.00 if OTL-200 receives U.S. FDA approval for MLD treatment by December 31, 2024. Interestingly, OTL-200 has a high potential for FDA approval, considering its prior approval by the European Medicines Agency ((EMA)) and the FDA’s decision to forego an additional advisory committee review. This suggests a streamlined approval process, which makes me think the odds of approval are much higher than they otherwise would be.

The CVR expires by December 2024, and if OTL-200 does not gain approval by then, the CVR won't pay out. That's less than a year away. However, there is a PDUFA date set for March 18, 2024. That's the date by which the FDA is expected to make a decision on whether a new drug is approved for marketing in the U.S. Considering the positive data and prior EMA approval, the likelihood of FDA approval seems highly favorable. Often, to get an idea of the likelihood of approval, I refer to a meta-study of approvals . In this case I believe the prior EMA approval is a superior baseline ( based on this study ) and points towards 85%+ chance of approval.

I see no chance of deal failure here anymore, and the shares are set to be delisted by January 24, and should close soon after. Effectively, this is a situation where we're paying $0.55 to receive $1.

I've written this opportunity up on the Special Situations Report when it was trading at $15.89. However, back in November, there was 1) more uncertainty around the deal's closing and 2) more time to go until closing. Later, I wrote it up publicly when it traded at $16.21.

If approval is 85% likely, the CVR has an expected value of $0.85 (I'm not discounting it for the time value of money, but it should pay out in less than a year if it does). If you're okay with getting $16 per share locked up for a few weeks, you are basically turning $0.44 into $0.85 within a year. I'm simplifying the case a bit here. However, there is 93% upside (within a year) to the $0.44 that's effectively put at risk here. The outcome will be binary, which means this isn't a position I want to put on in huge size, but it is attractive enough there is some room for error in my assessment of probabilities and the fact I didn't adjust for the time value of money on both the initial stake and the cash that gets stuck in limbo until the milestones is checked.

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