Description

Investment thesis

We are presenting a merger arbitrage opportunity that we believe offers an attractive risk-reward profile. Arena Pharmaceuticals is being acquired by Pfizer for $6.7 billion or $100 per share. Arena stock is currently trading at $92.50 for a spread of 8% over an expected 6-month close from here. The spread can be attributed to antitrust risk. The transaction is subject to shareholder approval and antitrust review.

Background

Arena is a clinical stage developer of therapies for the treatment of immuno-inflammatory diseases. Arena has been successful under its present management with the stock up around 6x since 2016. However, prior to the Pfizer deal Arena’s stock was on a downward trend after its pain drug failed to meet its primary endpoint in a Phase 2b study in early 2021.

At the heart of this acquisition is Arena’s lead drug candidate etrasimod. It is currently undergoing two Phase 3 studies for ulcerative colitis (UC), an inflammatory bowel disease (IBD), and various other stages for other diseases. If the deal closes, Pfizer could bring it to market as early as in 2023.

The trial results may well come out before the transaction closes but have been carved out from the Material Adverse Effect clause. Other carveouts include Arena’s financial performance, COVID-19 and any evolutions or mutations thereof or related or associated epidemics, pandemics or disease outbreaks or other outbreaks of diseases or quarantine restrictions, natural disasters, terrorism or war.

Pfizer has an increasing amount of capital to allocate and management plans to be very active in deal making in the near future. The deal fits well into Pfizer’s current strategy of buying late and early stage drug candidates, knowing that not all of them will work out but being able to add value and complement its internal pipeline. Pfizer has a good record of closing similar deals.

Antitrust risk

The main sources of antitrust risk arising from the transaction in our view is the combination of Arena’s etrasimod with Pfizer’s existing on-market and clinical stage assets particularly in IBD and atopic dermatitis (AD). Arena’s portfolio beyond etrasimod is very different from what Pfizer has in early stage development.

In IBD many categories of drugs are being developed with diverse mechanisms of action. There are antiintegrins, S1P receptor modulators (such as etrasimod), antiinterleukin antibodies, JAK and TYK inhibitors, toll-like receptor agonists and interleukin-10 fusion biologics. Many large pharma companies with substantial disposable resources are involved in development. Figure 1 below illustrates the candidates currently undergoing clinical trials in IBD. Ozanimod (Zeposia) is owned by Bristol Myers, mirikizumab is owned by Lilly, risankizumab is owned by AbbVie, guselkumab is owned by J&J, filgotinib is owned by Gilead/Galapagos.

There is a recent study cited multiple times by FTC commissioners titled Killer Acquisitions (Cunningham, Ederer and Ma 2021). It defines an overlapping drug as one of the same therapeutic class (e.g. antihypertensive) and same mechanism of action (e.g. calcium channel antagonist) as a drug product or project in the acquirer’s portfolio. The study compared projects acquired by overlapping incumbents to those acquired by non-overlapping incumbents and to non-acquired projects.

They found that “projects acquired by an incumbent with an overlapping drug are 23.4 percent less likely to have continued development activity compared to drugs acquired by non-overlapping incumbents. Reassuringly, the development patterns for overlapping acquired drugs are statistically indistinguishable from non-overlapping acquired drugs and non-acquired drugs in the years before acquisition. Projects acquired by overlapping acquirers are 20.9 percent more likely to cease development immediately compared to those acquired by non-overlapping incumbents. Further, we find no evidence that acquiring firms purposefully delay development or are simply slower at developing overlapping projects. Additionally, supplementary analysis of clinical trial phase progression confirms overlapping acquired projects are less likely to move to the next phase”.

Pfizer couldn’t be buying etrasimod only to cease its development for IBD indications with the logic that it currently has Xeljanz (tofacitinib) on the market in IBD and that etrasimod would compete with it. Firstly, etrasimod/Xeljanz couldn’t be deemed overlapping drugs because of a different mechanism of action (JAK inhibitor vs S1P receptor modulator). FTC defines markets by including the mechanism of action. Secondly, Xeljanz and the current JAK inhibitor class in general are subject to some serious safety concerns with FDA requiring warnings due to increased risk of serious heart-related events. S1P receptor modulators are seen as having a better safety profile. Thirdly, it is expected that new and better competition will emerge shortly from clinical trials as the pipeline is full of candidates. Various JAK inhibitors are on the verge of approval. Knocking out one future competitor would hardly benefit Pfizer given the competitive landscape. Fourth, it will likely not be a winner-take-all market because many of the therapies have low levels of efficacy for remission and patients cycle through many of them. So there is space for a number of drugs. Pfizer can by no means lock up this market by acquiring one of the more promising of such candidates and it does not seem justified for the FTC to seek the divestiture of Xeljanz.

Two years ago the FTC investigated as part of its Roche/Spark deal review a situation where Spark had a promising developmental gene therapy for hemophilia and Roche had the leading on-market treatment with Hemlibra, a monoclonal antibody. FTC cleared the transaction stating its investigation did not indicate that Roche would have the incentive to delay or terminate Spark’s developmental effort for its hemophilia A gene therapy, or that the acquisition would affect Roche’s incentives regarding Hemlibra. As there was more competition emerging it stated “Roche would have the incentive to accelerate, rather than decelerate the development of Spark’s gene therapy”.

Source: New targets in inflammatory bowel disease therapy: 2021 (Cohen and Rubin, 2021), Current Opinion in Gastroenterology

Competitive Assessment of the Late-Stage Pipeline Agents that GlobalData Expects to Be Licensed for the Treatment of ulcerative colitis During the Forecast Period. 

Figure 2: source: GlobalData, appeared in Pharmaceutical Technology, December 2020

The AD pipeline is made up of 80 agents under development and this space is a big area of focus for the industry with many big pharmaceutical companies owning assets in the race. The treatment landscape is expected to completely transform over the next decade. Figure 2 below illustrates the candidates currently undergoing clinical trials in AD worldwide. Pfizer’s abrocitinib (marketed as Cibinqo) is one of the JAK inhibitor candidates alongside AbbVie’s Rinvoq, Lilly/Incyte’s Olumiant and Incyte’s Jakafi. Cibinqo has been approved in the European Union, United Kingdom, Japan, and Korea but is still awaiting review by the FDA. Rinvoq already has FDA approval for rheumatoid arthritis.

AD could be an even easier decision because Pfizer’s Cibinqo is already facing plenty of competition and etrasimod has a different mechanism of action.

Figure 3. Source: Clinical Trials Arena.

Given Pfizer’s general appetite for deal-making and the attractiveness of adding etrasimod to its assets we view it as highly likely that Pfizer will close the deal even if a divestiture is needed. Pfizer itself has predicted that when physicians look at the risk-benefit profile, etrasimod’s efficacy, it believes it will be placed before JAK utilization. Etrasimod is also a potential candidate for over 80 high-potential indications, offering a lot of promise for the future.

There is some concern about the deadlock in the FTC having the potential to delay deals which will remain to be seen. We view the departure of Commissioner Chopra as a positive though given the logic expressed in his dissent of the AbbVie/Allergan decision.

While there is a possibility that drug candidates under development by Arena and Pfizer will potentially compete in the future, we believe that antitrust concerns are overstated. Instead, Pfizer’s ownership is likely to substantially accelerate the development of Arena’s various assets and be in patients’ best interest. FTC will weigh this factor if they have any concerns about innovation.

Duration

Arena and Pfizer made the HSR filing on January 4, 2022. It could close in only a few months if the FTC opts not to review, which we deem the most likely outcome. In case of an investigation it may well take a year. The Roche/Spark investigation took 10 months.

Downside

The unaffected price one day before the announcement was around $50. Analyst price targets prior to announcement ranged from $71-120.

Risks

-FTC opposes and Pfizer is unwilling to compromise

-Business risk: e.g. a complete failure or unexpected occurrence in the Phase 3 trial results due in Q1 2022 that would put the whole program in doubt for any indication and prompt Pfizer to rather pay the reverse termination fee than proceed with the deal.

Catalyst

Closing