I have received a few snotty emails the last couple of days regarding my commentary about Bionomics (ASX : BNO). Fair enough. Yes, I accepted face-value information about chemical composition instead of trawling patents, and yes I am anal-retentive about “mechanism of action” details for CNS drugs.

So shoot me. At least someone is asking questions.

Amidst the various exchanges, I was asked my opinion about the BNO-Merck deal. I think it is a sufficiently interesting – and complex question – that it warrants comment. So here goes…

My personal opinion is that the best pipeline deal between a “baby” biopharma and “big” pharma is a clean deal, unsullied by equity ownership. The truth is we will never know the nitty-gritty details of the Merck deal, and we will never know what discussions happened in the board room. But what I can tell you is that Merck is an incredibly conservative company and $9m is, to a first approximation, chickenshit. Merck doesn’t make these kinds of investments in strategically important areas because they don’t end up “owning” the asset and then also end up disclosing their “interest”. Nobody wants to do that if an asset is strategically important.

My guess is that Bionomics was owed a chunk of change and they cut deal that made financial sense. It’s fairly palatable to pay a 29% stock premium when the Australian dollar has depreciated – oh – about 29% on what was presumably a USD contract when it was signed in 2013. My view is that it is just a stunt.

But hey – I am speculating here.

More robustly, here are some good reasons why dirtying up an asset deal with equity is mostly a dumb idea. Firstly, Merck will never have to worry about the optics of buying BNO’s stock. When you are a public company and a potential acquirer decides to take a position, there is a lot of strategic defensive and negotiation value in disclosure thresholds. Obviously, most proper M&A activity happens in the board room, with bankers, and not through taking measly $9m stock positions (and there are plenty of ways for a non-Australian acquirer to effectively sneak around those thresholds besides). But now Merck is “out in the open” and guess what? It’s friendly! They don’t need to worry about the stock price running out of control when ownership disclosure thresholds are reached. The market is now effectively neutralised to the concept.

Somewhat related is the issue of BNO’s valuation. By agreeing to pay a 29% valuation premium, Merck has effectively set – and successfully tested – a valuation benchmark to acquire the company, should they wish to. This was a total giveaway and it was a poorly considered giveaway because if Merck does want to buy the company, they now have the premise of an entirely reasonable offer. Instead of having to pander to retail investor expectations of a stratospheric valuation for the rest of the beast, they now have a management team-sanctioned “cap”. Even if that’s not how it actually panned out, it’s how it looks, and it is not very pretty.

Merck also now has a very powerful negotiation tool in their future dealings with the company, namely the ability to sell BNO stock. When a company is mostly owned by institutional investors, this kind of a stunt doesn’t have much value. But when a stock is significantly held by retail investors that don’t really understand the company’s technology (frankly, as a semi-literate biotech aficionado, I don’t understand most of the company’s technology), Merck selling a cheaply acquired position in the company could cause a fairly rapid de-valuation when all the lemmings have a tandem freak out. It’s a bit squiffy, but it is a Sword of Damocles no less.

The truth is, if you are a shareholder, you want to see that a public company is always for sale. As a public company. Not some kind of shonky backroom deal as part of an existing licensing relationship. I don’t consider the 29% premium to be a victory for shareholders – frankly it isn’t much of a premium if you think about what Merck would have had to pay at a market rate to pick up ~22m shares for a stock where most days a couple of hundred thousand shares trade.

And frankly, I don’t buy the $200m market cap “threshold” argument* that has been touted as a “plus” for the deal. That’s a pretty unsophisticated reason for engineering a deal like this. One could even interpret it as meaning that the management doesn’t have any good news to tell any time soon – certainly the BNC210 results announced last month didn’t make a lasting impact.

Rightly so.

*The idea being that a $200m market cap means that some of the bigger/more discriminatory funds will take a look because the company is less of a “micro cap”. Mostly mythology, especially for biotech…

– oOo – 

The feature image is derived from a very striking work by talented Chinese artist and political commentator Red Pepper.

2 thoughts on “Merckonomics

  1. Thanks for your thoughts, Chris.

    I have a few comments.

    You and I often view ASX biotech antics differently because you focus more on the underlying business quality and I focus more on how to make money out of a good share trade! That said, we aren’t in too much disagreement here.

    1. I listened to the teleconference where BNO CEO, Deborah Rathjen, discussed the latest Merck deal. It was annoying for me as a prospective share buyer to hear all the calls coming in with callers asking obvious, legitimate questions seeking clarification of the Merck deal and last year’s loan from Silicon Valley bank and other stuff for Deborah to have to keep on giving vague answers and to end each response by saying she can’t say any more.

    It’s hard for me to try to put a value on Merck deals and projects and bank loans that have to be paid back in 20 months time ( or else!) if I don’t know anything other than the general sentiment that “everything’s super – -trust me!”

    2. I think BNO seems pretty expensive at ~ $200m market cap based on not knowing more about the Merck milestones and the Merck project progress.

    3. I did find it interesting, when DR was asked whether Merck often buys an equity stake in small biotechs, that she said to her knowledge there was only one other small US-based biotech that Merck had a stake in. This tells me as a prospective shareholder that if Merck starts buying more and more shares, that is a possible future takeover signal and should their stake hit the 19.9% mark, then I had better buy some as a punt!

    I guess what I’m saying is that, like you, I have no idea why Merck bought that $US9m stake at a premium price, but I will definitely keep my eye on any future buying by them.

    4. Having Merck buy the shares at a premium price could have triggered a price re-rate. Maybe it was a bit of a stunt – but it hasn’t worked yet to lift the rest of the shares to that higher price.

    5. Regarding the “hitting the $200m mark” comment, maybe some funds prefer to buy companies with a minimum of $200m market cap. Most funds probably regard even $200m as a tiny market cap!

    My conclusion? BNO sounds too expensive for what I know about it. i don’t want to “trust” them about the Merck deal and secret Merck projects and the Silicon Valley interest rate and the lack of peer-reviewed scientific papers, etc.

    I hope wonderful things happen for them. And it will be annoying if the share price explodes without me, but I can’t buy it today without knowing more details.


    • Hi Anne,

      As always, your comments are very interesting and reek of grey matter.

      Your comments are fair – and you are right, I elect not to see the world through the lens of a day trader because as you say, the rules of the game are different.

      Generally your comments are about value investing principles, and I agree.

      As for Merck taking a position, you won’t necessarily see them accumulating a position until the next disclosure threshold if they are using a nominee.

      As for Merck buying equity stakes, my perception is that they do it all the time – they even have dedicated funds for making strategic investments into baby biotechs. I frankly don’t see what the big deal is, and if this investment is just the management team “repositioning” part of a milestone payment, then the whole thing is an outright charade.

      Thanks for reading!


Say something useful (or at least interesting)...

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s