I usually do not get interested in risk arbitrage situation unless there is the potential to earn out-sized absolute return. Most risk arbitrage offer around 15-20% annualized returns, and actually less on large deals. However this one offers great odds for the price of participation.
The idea is not mine it was emailed to me from a reader so hat tip to G&B.
Emergent BioSolutions (EBS) is acquiring Trubion Pharmaceuticals (TRBN) in a deal valued at up to $135.5 million. Emergent will pay $96.8 million, or $4.55 per share in cash and stock, upfront for the company and issue milestone-based Contingent Value Rights (CVR) worth up to $38.7 million more. Milestones are based on mid- and late stage clinical trials of TRU-016 for the treatment of chronic lymphocytic leukemia and non-Hodgkin’s lymphoma, which is partnered with Abbott (ABT).
The math is simple for this merger arbitrage: there are no returns from the merger cash and stock consideration. However you will get the CVR for free at current prices, well close to it for 2 cents. SO effectively you have a cost free shot at earning $1.9 over the next 36 months. You can’t get better odds than these.
When the deal was announced the implied value of the CVR was 27 cents. However now it is 2 cents. See the progression of the implied value in the table below.
Risks
- Will the merger close:
- financing issues: cash consideration for the financing is $27 million only, while TRBN has cash and short term investment of $45 million on its balance sheet as of June 30, 2010. So EBS is actually getting paid to take the company to ensure its going concern.
- TRBN shareholder’s vote. Management own is 5% of the company and I think there is abig likelihood that shareholders will vote yes for the deal
- regulatory approval: already cleared.
- Will the CVR pay out?
- Pfizer potential for cancellation of their clinical studies as they have cancelled a program before merger announcement in July. The amount at risk is $12million. Pfizer decided to pare the dumped drug, TRU-015, comes as Trubion released trial results showing a higher than usual placebo response in a mid-stage trial, or not so exciting results. Pfizer picked up rights to both drugs as part of its 2009 acquisition of Wyeth. It is possible that Pfizer is paring rationalizing its R&D spending so some of these clinical studies will be canned.
Even a 5% probability of CVR payout will ensure to earn four times your invested capital. I was in at 3 cents CVR implied value.
