November 22, 2011 4:38 pm

Gilead’s ‘big bet’ on Pharmasset hinges on future results

This article is provided to FT.com readers by BioPharm Insight—a news service focused on providing insight into the most price sensitive issues in the global pharmaceutical market. www.biopharminsight.com

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Gilead Sciences (NASDAQ:GILD) is unlikely to have been the only party interested in Pharmasset (NASDAQ:VRUS), two industry bankers told Biopharm Insight, arguing that the 89% premium offer is indicative of competitive interest.

On Monday, Gilead announced it will acquire Pharmasset for USD 137 per share in a cash tender offer that values the clinical-stage pharmaceutical company at approximately USD 11bn. The deal, which is projected to close in 1Q12.

The tender offer is not subject to a financing condition.

“One doesn’t give that kind of premium, unless you suspect serious bidding competition,” said the first industry banker. The second industry banker classified the deal as dilutive and overpriced, commenting that it was unlikely to have been a direct sale quarantined from price pressure. Gilead said it expects the transaction to be initially dilutive but to be accretive beyond 2015.

One of these bankers said he suspected Roche (VTX:ROG) was informed of the Gilead/Pharmasset talks far into the companies’ negotiations and could have shown interest in the company.

Roche is working with Pharmasset to develop RG7128, a nucleoside polymerase inhibitors for the treatment of chronic hepatitis C virus (HCV) infections.

There has also been controversy surrounding the rights, if any, that Roche has to PSI-7977 and PSI-938, two nucleotide analog polymerase inhibitors for the treatment of chronic hepatitis C (HCV).

Roche could not comment in time for publishing. Pharmasset declined comment.

A third industry banker said he expected “a lot of big calls will have been made today to check on offers and interests.” However, he downplayed the potential for rival interest on grounds that the HCV space is not a major priority for many firms and smaller players would be unable to match Gilead’s offer.

Two Pharmasset shareholders said the probability of a rival bid for the company was low, given the size of the transaction and the premium of the deal. Although, they noted that Roche, Merck (NYSE:MRK), Bristol Myers Squibb (NYSE:BMY), Johnson & Johnson (NYSE:JNJ), and Novartis (NYSE:NVS) have all mentioned HCV as a target area.

Bankers question takeover premium

The third and a fourth industry banker said the premium tabled by Gilead for Pharmasset was not unprecedented, with one of these bankers noting that premiums for developing biotech companies can range from 50% to 200% given the amount of expected growth. What is unusual about the deal, however, is that this premium was ascribed to such a large transaction, said one of these bankers, adding that this size premium is more typical of smaller transactions.

While Gilead has a smart managerial track record and scientific expertise around the deal bodes well for the company, Pharmasset remains a development stage company, which adds much more potential downside to the company, said two of the bankers. All of the bankers described the proposed deal as a big bet for Gilead, that opens the Foster City, California-based company up to substantial risk.

This deal will be an “enormous risk” for Gilead, a fifth industry banker said, explaining that the company is betting one-third of the company’s current valuation on Pharmasset, a biotech that has three clinical candidates for HCV. Although the drugs span HCV Genotypes 1-3, none of the agents have finished Phase III trials. In December 2010, Pharmasset was trading between USD 21 to USD 23 per share.

“When you look at the size of the deal relative to Gilead’s market cap and the fact that its all unapproved product...its a precedent setting deal,” said the fourth banker. The Pharmasset deal is more than one third of Gilead’s nearly USD 27bn market capitalization.

To fund the deal, Gilead will use cash on hand and USD 6.2bn in debt provided by BofA Merrill Lynch and Barclays Capital. The company has said it is committed to remaining investment grade and expects to return to a 1.5x debt to EBITDA ratio a year out from closing.

As of 30 September, Gilead had USD 2.2bn in cash and short-term securities and USD 3.9bn in long-term debt. It has around USD 4.2bn in ttm EBITDA.

Pharmasset’s key asset, PSI-7977, is a HCV nucleoside with two Phase III studies in both Genotype 2 and Genotype 3 patients, the fifth banker said.

Both studies are for 12-weeks of HCV therapy, which would shorten the treatment timeframe from the current 48-weeks of HCV therapy. There will be a third Phase III study in HCV Genotype 1 patients evaluating ‘7977 in a 12-week study, he added. A 12-week Phase II study of PSI-7977 plus ribavirin alone (ELECTRON) , reported 100% SVR in 10 patients.

“You can’t just close your eyes and do a valuation with just Phase II results,” said the first industry banker, noting that it remains to be seen whether Pharmasset’s Phase III data for PSI-7977 is going to be as impressive as Gilead is betting it will be. The same banker referenced the towering initial valuations for Genentech’s oncology drug, Avastin. Late last week, the US Food and Drug Administration (FDA) revoked its approval of Avastin in breast cancer, citing a lack of evidence in this indication.

Roche acquired Genentech in 2009 for over USD 44bn, with a majority of the valuation hinging on future revenue streams for its lead major franchise, Avastin.

While the third industry banker acknowledged the risk associated with Gilead’s proposed deal, he said the anti-infectives space is one of the “lowest risk” categories, outside of vaccines. This is unlike oncology drugs that may report promising results in earlier-stage testing, but fail in late-stage trials, said the same banker.

The amount of competition for drugs that treat HCV is also likely to be a risk for Gilead, said the same banker, commenting that the company will face future competition from Vertex Pharmaceuticals (NASDAQ:VRTX), Inhibitex (NASDAQ:INHX), Achillion Pharmaceuticals (NASDAQ:ACHN), and Idenix Pharmaceuticals (NASDAQ:IDIX). Vertex’s Incivek and Merck’s Victrelis, both new protease inhibitors, are currently marketed for the treatment of HCV.

“If you’re paying USD 11bn, you better make sure you have a winner here,”

the fifth banker said. If the Pharmasset deal goes through, it will set the stage for an industry showdown between Merck, Vertex and Gilead in HCV, he added.

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