Merger Arbitrage + CVR – 20% Upside
This arbitrage setup involves a merger between two commercial-stage biopharma companies. Most of the upside comes from the attached CVR. Assertio Holdings (ASRT) is acquiring its oncology-therapies peer Spectrum Pharmaceuticals. SPPI’s shareholders are set to receive 0.1783 ASRT shares per each SPPI + a CVR of up to $0.20/share. At current prices, there is a 3% spread to just the stock portion of the consideration. Plenty of cheap borrow is available for hedging. The CVR provides an incremental 17% upside optionality. The merger will require shareholder approval on both sides with closing expected by Q3’23. The downside to SPPI pre-announcement levels is steep at over 40%.
I expect shareholder approvals on both sides to pass easily. The offer premium to SPPI’s pre-announcement levels is significant, at +84% just on the stock portion. SPPI’s sole commercialized drug, Rolvedon (treatment for chemotherapy-induced neutropenia), was approved only in September’22 and is still in the early stages of commercialization. The company is continuing to rapidly burn cash with only a few quarters of runway left. The merger offers SPPI’s shareholders a way to avoid the upcoming dilution, pocket a significant premium to the pre-announcement levels, and still be able to directly participate in the future potential of Rolvedon.
Approval by ASRT shareholders is also likely. Even though ASRT shares dropped by 22% upon the announcement of the merger, I do not think this price volatility is indicative of ASRT’s shareholder sentiment toward this transaction. The shares have since recovered above previous levels. There was a similar situation back in 2020: ASRT’s stock declined 19% upon the announcement of Zyla Life Sciences acquisition in Mar’20 (covered on SSI here), but shareholder approval passed without any hurdles and the merger closed successfully.
Since acquiring Zyla Life and its key inflammation/arthritis drug Indocin in 2020, ASRT has been kind of a one-trick pony, heavily abusing limited competition in the sector. ASRT doubled Indocin’s price in 2021 and has been generating a large stream of cashflows/revenues from this key drug ever since. Even before the takeover by ASRT, the drug had already seen a number of price hikes by Zyla and previous owners – overall Indocin’s price has gone up from $198 in 2008 to around $9-$10k today. It’s not clear how long this situation will continue as Indocin does not have patent protection and ASRT has recently hinted (see 2022 10-K, p. 21) that other companies have been in discussions with the FDA regarding the development of generic competitors. To mitigate these risks, ASRT has been rolling up other high-potential drugs. There is still a long way to go – the company has a portfolio of only 6 drugs and Indocin is still generating 71% of total revenues. The merger with SPPI is thus expected to significantly diversify ASRT’s revenue base as the acquirer anticipates Rolvedon to eventually generate $225m+ in annual revenues vs ASRT’s total sales of $155m in 2022. Merger parties also expect material synergies with cost savings expected to reach $20m vs $80m of Spectrum’s Q4’22 run-rate operating expenses.
The CVR will payout in two equal $0.10/share parts, the first one if Rolvedon sales reach $175m in 2024 and the second part if Rolvedon sales reach $225m in 2025. Given how fresh the drug is, it is difficult to determine the likelihood of achieving these milestones. I believe at least the first $0.1/share payout is quite likely. Rolvedon has been commercialized in Q4’22 and generated $10m of revenues in Q4’22 and $16m in Q1’23. While the sequential sales growth looks quite positive, a significant ramp-up in sales is expected for the remaining part of this year. Till April, Rolvedon did not have a permanent J-Code (reimbursement code used by commercial and governmental insurance plans) and only received it last month. This has significantly simplified the billing and reimbursement process for clinics and hospitals and is expected to result in a material boost to Rolvedon’s sales.
Rolvedon competes with a drug called Neulasta (which captures 60% of the market) as well as a number of Neulasta’s biosimilars. Neulasta’s US patent expired in 2015 and the drug has seen a rapid deterioration of revenues due to emerging biosimilar drugs – sales fell from $2.3bn in 2020 to $1.7bn in 2021 and $1.1bn in 2022. Rolvedon is the first novel patented competitor to Neulasta and has a different/original J-Code. Thus, there is a chance that clinics will be incentivized to prescribe Rolvedon to pocket potentially higher markups. This advantageous dynamic of clinic economics for Rolvedon has been nicely summarized in the Lake Street Capital Markets’ report:
With studies demonstrating equivalence to the incumbent products, what then is the opportunity for Rolvedon to take share? Rolvedon’s competitive edge relates to reimbursement of Part B drugs and community oncology clinic office economics. Part B drugs, which are purchased by clinics and held in inventory before being administered to patients, are reimbursed on an “average selling price (ASP) plus” basis. In community clinics, the “plus” is 6%: a clinic is reimbursed at 106% of the ASP of that product, creating a profit margin for the clinic. The higher the ASP, the higher the profit margin. This creates an incentive for clinics – assuming patient care is not compromised – to utilize drugs with higher ASPs. Product ASP is calculated by CMS and reported against that product’s J code on a quarterly basis. ASPs are negatively impacted by reportable discounts given to, for example, payers for access. Over the years, Neulasta’s ASP has deteriorated, effectively shrinking the profit margin available to clinics. Rolvedon, which obtained its own J code on April 1, will be reimbursed separately from Neulasta and its biosimilars, offering a greater profit margin opportunity for clinics. That is Rolvedon’s competitive edge.