Putting The Imclone Acquisition Under The Microscope

By Ben McClure | October 07, 2008 AAA

Some call it "the winner's curse". When companies vie for an acquisition target, one bidder, over-eager to snatch the deal, sharply overestimates the value of the target. As the winner looks more closely at its trophy, it may discover that its winning bid was costly indeed. (To read more about acqusitions, check out Analyzing An Acquisition Announcement.)

On the surface, Eli Lilly & Co.
(NYSE:LLY) is a winner. Its $70 per share, or $6.5 billion, offer for ImClone Systems (Nasdaq:IMCL) beat Bristol-Myers Squibb's (NYSE:BMY) $62 a share offer for the cancer drug maker. Indeed, the unexpected acquisition may strengthen Lilly's push into cancer drugs and its presence in producing lucrative biotech drugs.

However, in my view, Lilly pushed its bid too far. The deal, which comes with strings attached, is not the slam-dunk that Lilly might like investors to think it is.

Here's The Scoop
For starters, the $70 per share offer looks over-the-top. It is 13% higher than Bristol-Myers' offer and 51% higher than where it stood before acquisition news broke July 28. Bristol-Myers refused to budge from $62 per share. (To dig even deeper into the subject of acquisitions, see How The Big Boys Buy.)

It's hard to fathom why Lilly topped its rival's offer. After all, Bristol-Myers gets 61% of U.S. rights to Imclone's sole product, the cancer treatment drug Erbitux. Meanwhile, drug giant Merck Germany owns 90% of Imclone's international drug distribution rights.

The deal might make sense if investors could be certain that Lilly would get full rights to the promising successor to Erbitux, EMC-11F, now in Phase III trials. Until recently, Imclone said it had licensed them to Bristol-Myers. Later it said it had not. Those rights surely make up a big part of Imclone's value. I'm sure Bristol-Myers won't give them up easily.

Drugs Won't Add To Net Earnings For Years
At the very least, investors should brace themselves for years of earnings dilution to result from the payout. Lilly doesn't expect the ImClone drugs to contribute to net earnings until 2012 at the earliest.
That $6.5 billion seems an awfully high price to, basically, share in profits that won't be seen on the bottom line for quite some time.

In today's tight capital and credit markets, the all-cash $6.5 billion offer will be a stretch, even for a company as big as Lilly. As of June 30, Lilly had $5.2 billion in cash and liquid securities on its balance sheet, which means the deal will require at least a couple of billion in debt financing. Eating up much of Lilly's cash reserves, the acquisition could severely curtail Lilly's options for pursuing other acquisitions to fill its pipeline. (Speaking of cash, be sure to read Spotting Cash Cows.)

To pay such a high bull-market price just as the credit crunch enters full swing demonstrates Lilly's need to get drugs to fill its development pipeline. Some of Lilly's best-selling drugs are scheduled to lose protection and become exposed to generic competition within the next several years.

Bottom Line
At the end of the day, it's Lilly's way of telling the market that it will play the price-premium game - grabbing new products for its pipeline by playing bid-'em-up. That can be a perilous game to play.

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