Health and Healthcare

Why Gilead's Big Acquisition Adds Even More Risk

Jon C. Ogg

Published: September 19, 2020 6:15 am

Last Updated: September 19, 2020 10:01 am

Gilead Sciences Inc. (NASDAQ: GILD) ended up having a rough week in the market on the heels of its 100%-plus premium to acquire Immunomedics Inc. (NASDAQ: IMMU). Gilead is no stranger to acquisitions and partnerships, but it raised eyebrows with a $21 billion deal.

Now the big question is what exactly this means for Gilead. It turns out that the drop in the stock after the initial gains might not be a universal decision about Gilead’s prospects, with or without Immunomedics. This deal will mean that Gilead takes on new debt, will eat into its cash reserves and will come with continued high dividend payments it has to make. It is very possible that Gilead is becoming even riskier during a period of uncertainty.

One consideration here is that Immunomedics is just now becoming a revenue-producing company. Following sales of effectively zero in 2019, the Refinitiv consensus estimates are for revenues to rise to $125 million in 2020 and then to $315 million in 2021. Those figures do not move the needle at all for Gilead and its 2019 revenue above $22 billion with consensus expectations of $24 billion in 2020 and almost $24 billion in 2021.

The question to beg is whether $21 billion was ludicrous or Gilead really is the smartest party in the room. This transaction does bring the potential to change Gilead’s revenue and earnings story beyond remdesivir. That could also bring some much needed multiple-expansion cases, meaning investors will be willing to pay higher prices to own the stock.

The potential total market opportunity for Trodelvy is the play here. Gilead is targeting for this deal to be accretive to its earnings by 2024. The company’s target is for peak sales to come well over $3 billion and an expansion into solid tumor oncology has additional potential targets.

After looking around for more detailed information, Credit Suisse noted that its clients view the deal as cautiously positive. Their report suggested that investors brought up emerging competition from the Daiichi Sankyo and AstraZeneca joint venture that was established in July. They noted:

DS-1062 is also an ADC targeting TROP-2, with some investors worries about potential competition vis-à-vis the price paid (and thus the potential opportunity). Per our European Pharma Team, the Daiichi Sankyo and AstraZeneca joint venture is meant to accelerate the 2L lung cancer program into phase 3 and move other tumor types also into phase 3 trials. Expansion beyond 3L TNBC key to a positive NPV. Per our back of the envelope analysis, peak sales of approximately $3.7 billion essentially result in a net present value wash and a break-even on the deal; thus Gilead will need to successfully develop Trodelvy beyond TNBC.

Credit Suisse’s view is that it sees the peak sales above $3.5 billion as possible, but that will be heavily dependent on clinical data. Credit Suisse also has a Neutral rating and a $70 target price.

Mizuho Securities reiterated its Buy rating and maintained its $81 price target following the acquisition. That firm’s report said:

The two immediate things that jump out here are the perhaps larger than expected dollar price tag and the percentage premium. However, the acquisition also gives Gilead the chance to increase its top-line in a meaningful way, and this is likely what the stock eventually needs to work.

While some investors may be quick to dismiss the news given the price tag, we present the case here that it may deserve a second look and is at least worth investor consideration. The numbers to make this deal work seem feasible.

Other firms made observations as well, with some price target or rating changes:

• RBC reiterated its Outperform rating and raised its target to $86 from $82.
• Maxim raised it from Hold to Buy with an $88 target.
• SVB Leerink maintained its Outperform rating but cut its target to $88 from $94.

Gilead is using about $15 billion in cash on hand to make the acquisition and its piling on another $6 billion in debt to do the deal. S&P Ratings issued a note after the merger news that it was placing Gilead on watch for a credit rating downgrade, which appears to be down to a potential BBB+ from A. S&P noted that this acquisition should move Gilead’s leverage above 2.5 times the expected 2020 earnings before interest, taxes, depreciation and amortization.

Just a few days ahead of the announced acquisition, Oppenheimer had reiterated its Outperform rating and raised its target price to $105 from $90.

Gilead’s shares reached as high as $85 in March and April around the news for remdesivir as a treatment for COVID-19. Unfortunately, this drug takes roughly half of a year to be produced from start to finish, and it has yet to move the needle massively for Gilead.

To put this deal in perspective: Gilead’s market cap as of Friday afternoon was roughly $81 billion. The company already had a total debt load of about $24 billion as of June, and about $21 billion of that was classified as long-term debt.

Gilead’s stock used to be up above $115 at the peak in 2015, and that was long before some of its more high-profile acquisitions, like Forty Seven ($4.9 billion) and the Kite Pharma ($11.9 billion) deal.

Gilead also has a 4.2% dividend yield it is paying out, based on its current share price. Gilead shares ended the prior week at $64.90 a share, and the stock briefly traded above $67 in the two-day period after the merger. Its stock then traded lower each day after the first day and was down at $64.55 late on Friday.

Gilead would not be the first company to pile on more debt to make an acquisition, but it is now eating deep into its cash for this acquisition. Maybe the company knows something that isn’t as obvious here, and maybe study data this weekend and perhaps other pipeline targets for Trodelvy are going to add the firepower to prove this deal’s worth. That said, this now makes for nearly $40 billion in total value being spent on acquisitions recently with no significant recovery in its own shares and no revenue growth.

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