Late on Monday, Endo Pharmaceuticals (Nasdaq:ENDP) announced that it was acquiring its small partner Penwest Pharmaceuticals (Nasdaq:PPCO) for $5 per share, all of which is to be paid in cash. Normally, this would be a "no big deal" type of announcement - little deals happen all the time, and there would not be much significance to the deal beyond its impact on just the two companies.
This deal is a bit more curious, though.
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Somebody Seemed to Know Something
If you look at the behavior of Penwest's stock and options prior to the announcement of the deal, you too may find your eyebrows lifting a bit. The press release for the deal hit the wires at 3:30pm, but Penwest's stock started moving relatively early in the day on Monday, continuing a move that began roughly in the middle of the day on the preceding Friday. Keep in mind, this was a stock that tended to plateau for a few months at a time, so it was not as though big moves were normal.
Now, perhaps one could argue that this was just part of a longer move that began earlier last week - a move that was prompted by Kevin Tang becoming Penwest's Chairman of the Board. Mr. Tang has something of an eye for value in the space, having done quite well for himself with a position in Vanda Pharmaceuticals (Nasdaq:VNDA) - though it should be mentioned that Mr. Tang had been agitating for Vanda to liquidate itself; a move that would have cost shareholders dearly ahead of the surprising FDA approval of Fanapt earlier this year.
Not only had Mr. Tang been fairly clear about an intention to pursue a deal for Penwest, but the board also made various changes to its policies on August 5, 2010 - changes that were largely aimed at making it easier to sell the company. Accordingly, you could argue that there was a basis for people to go long the stock last week.
But wait, there is more...
A more ominous detail comes from the options market. Penwest options were among the most active last week, posting volumes on par with far larger companies like Pfizer (NYSE:PFE) and General Electric (NYSE:GE). Now perhaps someone was just trying to make a bet that Mr. Tang's involvement in the company was going to significantly increase the odds of selling the company.
The problem, though, is in the nature of options. Options offer a great deal of leverage to investors, magnifying the winnings of a correct call in exchange for the risk of a total loss (if the options expire worthless), but timing is critical. To buy options on Penwest, then, an investor was not only betting on a deal for the company, but a deal within a specific timeframe.
No Harm; No Foul?
Investors who have not been involved in an investment banking transaction may wonder how such a thing could happen. In point of fact, I am surprised it does not happen more often. For starters, there are numerous people involved in the deal, including bankers, lawyers and company personnel. While these folks usually are wise enough to keep their mouths shut, it is not hard to see how accidental leaks can take place. All it takes is someone mistakenly leaving a sheet of paper out in the open or a company employee noticing a sudden influx of lawyers through the front door.
A bigger question is whether anybody will bother to investigate this matter. While the timing of the stock moves and the options volume are suspicious, the SEC cannot do much in the absence of a smoking gun. Moreover, I really doubt the general public cares about this kind of insider trading - if some call options writer lost money, who cares? I do not happen to agree with that perspective (illegal is illegal), but I cannot recollect all that many cases of serious SEC enforcement in similar situations.
The Bottom Line
I do not mean to suggest that the deal itself is an afterthought. Acquiring its partner for Opana ER (a pain reliever) is common sense move for Endo Pharmaceuticals, and the price is reasonable. Moreover, there is something of an arms race between Endo and other companies with pain franchises like Cephalon (Nasdaq:CEPH) and King Pharmaceuticals (NYSE:KG), so it makes sense to lock up worthwhile assets. Beyond that, Endo is a very profitable company and a stock that seems cheap enough to be worth a closer look. (For related reading, take a look at Pharma Patent Trolls: Cheap Drugs At A Steep Price.)
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