A Big Biotech Bet Hiding in Plain Sight

There is an opportunity for biotech-style rewards hiding in an unexpected place: big pharma.

Bristol-Myers Squibb


BMY -0.10%

and

Celgene


CELG 0.05%

are set to close their $74 billion merger before the end of the year. In the meantime, not much is happening to their stock prices: Bristol-Myers shares have rallied 3% over the past three months, while Celgene shares are flat.

There is still plenty of investor excitement to be had with the deal, however. As part of the buyout consideration, the holder of each Celgene share will receive a tradable security known as a contingent value right, or CVR, when the deal closes. Each CVR entitles the holder to a $9 payment if Celgene can win timely Food and Drug Administration approval for three late-stage drug candidates. Specifically, Celgene must win approval for the multiple sclerosis drug ozanimod and cancer treatment liso-cel by the end of 2020, and cancer treatment bb2121 by the end of March 2021.

The securities, which are already available for trading on a when-issued basis at certain banks, were quoted at roughly $1.90 apiece as of Monday, so investors can potentially make more than four times their money in roughly 18 months. That price implies a roughly 20% chance of success. There are certainly some reasons for concern. The securities pay out on an all-or-nothing basis, so any regulatory slip-up will render the CVR worthless. If an investor thinks each drug has an 80% chance of success, the combined probability of all three being successful is just 51%. And, in the case of ozanimod, the drug has a checkered regulatory history: The FDA refused to review an application for the drug back in 2018, which sent Celgene stock into a tailspin at the time. But the FDA has since accepted a revised ozanimod application for review. Celgene has also said it plans to file an application for liso-cel by the end of this year, and for bb2121 by the middle of 2020. Those timelines, should they hold up, ought to have the company in position to meet required deadlines.

SHARE YOUR THOUGHTS ​How do you expect Celgene’s acquisition to play out in the biotech field?​Join the conversation below.

And though Bristol-Myers Squibb will owe nearly $7 billion to investors if the bet pays off, the company still has every incentive to meet deadlines: Cash flow generated from Celgene’s pipeline was a key rationale for Bristol-Myers to do the deal in the first place. Each of the three drugs seem to have the potential to eventually top $1 billion in annual sales. As a bonus, the company could choose to buy out the securities. Analysts at Mizuho point out that at current prices, Bristol-Myers could potentially save about $5 billion off its final bill by buying them all back. This would mean a smaller payoff for investors but would ensure a positive outcome and allow shareholders to reinvest cash more quickly. This unusual bet is one worth taking. Write to Charley Grant at charles.grant@wsj.com

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