OSI-Eyetech Merger: Vote AGAINST
(Disclosure: I currently hold a small position in Eyetech.) My displeasure with OSI’s takeover of Eyetech really boils down to one thing: It is a slap in the face to stockholder’s who invested in Eyetech at the IPO, believing that Eyetech was in business to “win” in the AMD and DME marketplaces. Eyetech certainly showed all the signs of being a winner back then. They were set to occupy the first market position with Macugen in what will eventually become a crowded anti-angiogenic marketplace for eye disease. They were able to sign a favorable co-marketing agreement with Pfizer. And guess what…investors bet correctly. Eyetech was/is a winner. So, why are investors taking a bath on this merger?
It’s no wonder that a fledgling biotech like OSI, which is largely a one-trick pony with Tarceva, would be interested in an acquisition of Eyetech. But why is Eyetech willing to sell out at a price substantially below the IPO? It’s clear to me that the reason is a combination of fear and greed on the part of Eyetech’s senior management: Fear that they will not be able to maintain and grow market share in AMD after Lucentis is approved and greed reflected by employment agreements giving Eyetech senior management guaranteed jobs with golden parachutes attached if things don’t work out. These are common employment agreements in the workd of M&A, but just because they are common doesn’t mean investors have to support them.
Consider what I view as the single most important paragraph to be found in the proxy statement for the merger (Granted, I haven’t read the whole thing. More power to you if you have.): “Merrill Lynch noted that the discounted cash flow valuation of Eyetech is highly sensitive to changes in Macugen’s assumed share of the estimated future U.S. market for the treatment of neovascular AMD. Merrill Lynch noted that a five percentage point increase in Macugen’s assumed long-term U.S. market share relative to the approximate 20% long-term U.S. market share reflected in the Eyetech management forecasts utilized by Merrill Lynch would add approximately $4 to $6 per share to its discounted cash flow valuation of Eyetech, while a five percentage point decline in Macugen’s assumed long-term U.S. market share relative to the approximate 20% long-term U.S. market share reflected in the Eyetech management forecasts utilized by Merrill Lynch would reduce its discounted cash flow valuation of Eyetech by approximately $1.75 to $2.50 per share.”
A five percent share gain relative to management forecasts of 20% peak share results in a $5 a share increase in fair value using a conservative estimates of 5% yoy sales growth after 2009 for Macugen and terminal value of 15x to 20 x PE on 2011 EPS. Stated simply, a 25% relative increase in projected long-term market share for Macugen yields a 20% increase in the current market value of the company, whereas a 25% relative decrease in share yields only a 10% decrease in current market value. Pretty damn good risk:reward to an investor, I would say.
What the merger terms imply to me is that senior Eyetech management is not willing to bank its future stock options and bonuses on being able to grab this extra slice of market share. Am I being too hard on management? I really don’t think so. Management is supposed to operate in the best long-term interests of the company and its shareholders. How is it in the best interests of Eyetech shareholders to sell out 33% below the IPO price when they have backed a winner with a first-in-class product on its shelves and plenty of cash in the bank? If shareholders had wanted to bail they would have done so already when those fine Lucentis data were announced. Those left holding shares either got in below the IPO value and are looking to turn a short-term profit, or they are in it for the long-haul and are therefore willing to risk their investments on Macugen holding its own against the competition. Macugen’s market position and favorable product characteristics give investors good reason to believe the product will exceed ridiculously low “analyst” forecasts and even the higher management projections that drove the fair-value analysis. History has shown this to be true (Note: I will be publishing a peer-reviewed paper on the topic soon; I’ll let you know where and when this winter). Long-term investors deserve better from management. Vote against the merger and ride the wave or go down with the ship, but don’t bail out now. You are a biotech investor dammit; act like one.
August 15th, 2007 at 4:31 pm
[...] Eyetech, formerly an independent biotech with an aptamer targeting VEGF (pegaptinib, Macugen) that is used to treat wet AMD, was acquired by OSI Pharmaceuticals not long ago. The acquisition price was below the IPO price (details here). It was a new therapeutic area for OSI, and it didn’t work out. Despite the assistance from Pfizer’s ophthalmic salesforce, Macugen couldn’t stand up to pressure from Genentech’s anti-VEGF monoclonal antibodies, Lucentis and Avastin. OSI is now divesting its eye business. As part of the divestiture, OSI has licensed its apatemer targeting PDGF (a related angiogenic peptide) to newly formed Ophthotech. Ophthotech has also licensed development and marketing rights to Archemix’s aptamer targeting the C5 component of complement (an inflammation factor). As you’ll read, Ophthotech is staffed largely by former Eyetech execs. It’s a chance for them to do it all over again. Perhaps this time around they will not sell out the early public-market investors by dumping the firm below its IPO price, while reserving a tidy sum for themselves. Share and Enjoy: These icons link to social bookmarking sites where readers can share and discover new web pages. [...]