RXDX - Prometheus Biosciences: 8.5% IRR And Closing In A Month

2023-05-30 22:04:25 ET

Summary

• Merck has agreed to acquire clinical-stage biotech company Prometheus Biosciences for $200 per share in cash, with the deal expected to close late in Q2 or early in Q3.
• The acquisition will advance Merck's presence in immunology, focusing on late-stage studies for ulcerative colitis, Crohn's disease, and other autoimmune conditions.
• Despite the nominal gain of 0.7% on the stock, investors can achieve an 8.5% IRR if the deal closes by the end of June, with the main risk being the merger not closing.

Why would anybody buy a stock that is trading at $198.60 that is going to be bought for $200 cash in a merger expected to close in less than a month? I'll get to that later in the article.

The Merger

On April 16, Merck ( MRK ) agreed to pay almost $11B to acquire Prometheus Biosciences ( RXDX ), a clinical-stage biotech focused on immunology, for $200.00 per share in cash. RXDX was trading around $113 at the time and was $36 less than six months ago. The deal was considered to be extremely safe according to analysts.

About Prometheus

Prometheus advances late-stage studies for ulcerative colitis and Crohn’s disease, and other autoimmune conditions.

The agreement with Prometheus will accelerate our growing presence in immunology where there remains substantial unmet patient need-Robert Davis, Chief Executive of Merck.

According to reports , AbbVie ( ABBV ) and Bristol Myers Squibb ( BMY ) were interested in buying RXDX as well.

The Horizon News

All was progressing normally until exactly one month after the merger announcement, when the Federal Trade Commission said it would challenge the Horizon ( HZNP )/Amgen ( AMGN ) merger. That unexpected piece of news sent shares on other biotech stocks down, including RXDX., which fell almost $5 intraday.

HSR

Last Tuesday , despite some fear from the Horizon situation, the HSR period expired. Prometheus now expects its sale to Merck to be completed late in Q2 or early in Q3. Shareholders will vote on the merger on June 15.

IRR

So back to my original question. Why would anybody buy a stock that is trading at $198.60 that is going to be bought for $200 cash in a merger expected to close in less than a month?

The nominal gain of approximately 0.7% translates into 8.5% IRR if the deal closes by the end of June.

By selling covered calls against one's position one ca further juice the return. Assuming the deal closes at $200, the 200 strike calls will expire worthless. As of Friday they traded at 20 cents and a colleague actually received 30 cents. The addition of the calls brings the prospective gain to .8% and a 9.7% IRR.

Risks

The main risk is the merger doesn't close. With HSR done, that seems incredibly unlikely. But this type of trading isn't for everyone. Position sizing is crucial in merger arb as one big loss can wipe out several gains.

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