Description

On January 26, 2017, Johnson & Johnson (JNJ) announced a definitive agreement to acquire Actelion Ltd. via a cash tender offer for US$280 per share, payable in US dollars. 

My investment thesis is that investors are being offered an attractive rate of return on an arbitrage transaction that has very limited risk.

Actelion Ltd. Is a Swiss company, and its shares trade primarily on the SIX Swiss Exchange in Zurich (SIX: ATLN), with the price denominated in Swiss francs. However, the transaction is priced is US dollars. For simplicity, all of my discussion will be based on the Actelion ADRs (ALIOY), each of which represents one-fourth of an Actelion share.

DEAL BACKGROUND

11/25/16 – JNJ and Actelion confirmed that they were in preliminary discussions.

12/13/16 – JNJ announced that it had ended discussions.

12/15/16 – Bloomberg reported that Sanofi was in “advanced talks” to acquire Actelion at a price of about $275 per share, with the possibility of a Contingent Value Right (CVR).

12/21/16 – Exclusive discussions between Actelion and JNJ.

1/26/17 – Definitive agreement between JNJ and Actelion.

The $30 billion transaction is expected to be immediately accretive to JNJ and will be funded with part of the $42 billion cash held by JNJ outside the US.

As part of the transaction, immediately prior to the completion of the acquisition, Actelion will spin out its drug discovery operations and early-stage clinical development assets into a newly created Swiss biopharmaceutical company ("R&D NewCo"). The shares of R&D NewCo will be listed on the SIX Swiss Exchange and will be distributed to Actelion's shareholders as a stock dividend upon closing of the tender.  JNJ will initially own 16% of R&D NewCo and have rights to an additional 16% of R&D NewCo through a convertible note.  R&D NewCo will launch with cash of approximately US$ 1 billion; additional details to follow via a prospectus to be filed by mid-February.

JNJ expects to commence the tender offer in mid-February and close the transaction by the end of the second quarter of 2017.

ANALYSIS

Current purchasers of Actelion would earn a 16.2% annualized rate of return, in what appears to be a relatively certain transaction, along with the potential value associated with a stub stock that had R&D upside and a potential cash balance of per Actelion ADR of $1.59 (2.4% of the purchase price of Actelion ADRs).

The value of R&D NewCo will be hard to determine until the tender offer document is filed, but is likely to be north of zero, thus providing positive optionality. There is value both in the cash and in the R&D in progress, and it is unclear how investors will weigh the value of each of each.

My crude assumption is that the R&D NewCo will trade at between 50% and 150% of the cash balance, or roughly $0.79 to $2.38 per Actelion ADR. This increases the nominal 6.3% return to a range of 7.5% to 9.9%, and the total annualized return to between 19.3% and 25.5%.

Why so cheap? It is unusual to see returns this high if an acquisition is considered to be safe. For the first three days after the deal was announced, the ADRs traded at over $68, or less than 3% below the acquisition price. My theory is that many longtime investors are selling to lock in their large gains. Actelion’s stock price was roughly half the current price just before the U.S. elections. One year ago, the ADRs were at $31. The large size of the deal may also exceed the arbitrage capacity for one deal, which would otherwise narrow the spread.

COMPANY BACKGROUND

Actelion Ltd. is a leading biopharmaceutical company focused on the discovery, development and commercialization of innovative drugs for diseases with significant unmet medical needs.

Actelion is a leader in the field of pulmonary arterial hypertension (PAH). The company’s portfolio of PAH treatments covers the spectrum of disease, from WHO Functional Class (FC) II through to FC IV, with oral, inhaled and intravenous medications. Although not available in all countries, Actelion also has treatments approved by health authorities for a number of specialist diseases including Type 1 Gaucher disease, Niemann-Pick type C disease, Digital Ulcers in patients suffering from systemic sclerosis, and mycosis fungoides type cutaneous T-cell lymphoma.

RISKS

There is always the risk that the deal does not go through, which seems unlikely in this case. There is no financing risk. Additionally, unlike the Pfizer-Allergan deal, this is not a tax inversion transaction. Also, Sanofi had expressed interest in acquiring Actelion, and was reportedly close to an agreement at one point.

Another risk is a delay in closing, which would reduce the annualized returns.

Catalyst

Intermediate - release of the tender documents in mid-February should narrow the spread

Final - closing of the deal by the end of the second quarter of 2017