Investors in Jazz Pharmaceuticals (JAZZ) reacted very positively to the announced deal to acquire Italian-based Gentium. Given the very strong track record in making deals, investors in Jazz applauded the company for making the deal, sending shares to fresh highs.
Despite this, the valuation has increased a lot while there are some risks as well, notably as a result of sales concentration. For this reason and the high valuation, I remain on the sidelines.
The Deal
Jazz Pharmaceuticals announced that it has entered into a definitive agreement to acquire Gentium S.p.A. The company will pay $57 per share in cash for the firm in a deal valuing the company at roughly a billion.
Gentium focuses on the development and manufacturing of therapies which treat and prevent a variety of rare diseases. This includes orphan vascular diseases related to cancer treatment. Its leading product Defitelio has been granted market authorization by the European Commission in October of this year, for the treatment of hepatic veno-occlusive disease for adults and children which undergo hematopietic stem cell transplantation.
CEO and Chairman Bruce Cozadd commented on the rationale behind the deal, "Incorporating Gentium into Jazz Pharmaceuticals is a strong strategic fit as Defitelio would diversify our development and commercial portfolio and complement our clinical experience in hematology/oncology and our expertise in reaching targeted physicians who treat serious medical conditions."
The deal has been approved by the board of both companies. In total some 15% of the outstanding share base of Gentium have already agreed to tender their holdings to Jazz Pharmaceuticals.
The closure of the deal is subject to approval of at least 66.7% of the total share base. The deal is furthermore subject to other normal closing conditions, and is expected to close in the first quarter of 2014.
Valuation
At the start of November, Jazz Pharmaceuticals released its third quarter results. The company ended the quarter with $588.5 million in cash and equivalents and $551.1 million in total debt, resulting in a very modest net cash position.
The deal is expected to be financed with cash at hand, an incremental term loan and revolving borrowings under the current credit facility. Barclays committed to a $500 million incremental term loan as well, securing financing for the deal.
Revenues for the first nine months of the year came in at $636.6 million, up 58.3% on the year before. Net earnings rose by 82.9% to $161.0 million. Full year revenues are seen around $872 million, as earnings could come in at $228 million.
Factoring in gains of 8% on Friday, with shares trading around $124 per share, valuing the business at $7.2 billion. This values equity of the company at 8.3 times annual revenues and 31-32 times annual earnings.
Jazz Pharmaceuticals does not pay a dividend at the moment.
Some Historical Perspective
Long term holders in Jazz have seen absolutely phenomenal returns. Shares traded below $1 in 2009 and have swiftly risen to levels around $50 in 2012. As shares have risen some 130% so far this year, they are currently trading around all time highs of $125 per share.
Investment Thesis
Given the strong track record of Jazz Pharmaceuticals, investors are happy with the announced $1 billion deal, giving the company access to Defitelio. Following the deal Jazz gets a hold of a product with short and long term revenue generation, growth and expansion of the multi-national platform.
For now, Jazz relies heavily on sales of Xyrem, and Erwinaze, which combined make up the vast majority of total revenues. Xyrem alone saw its sales increase by 50% in the third quarter to $153.7 million, making up two thirds of total revenues. A potential risk is that generic manufacturers have applied for new drug applications to create and market generic versions of Xyrem.
Xyrem is now being administrated to some 11,000 patients, and is being used to treat excessive daytime sleepiness. It is quite expensive, at an average cost of around $56,000 per patient to keep those patients awake. There is still no permanent solution for the cure of narcolepsy at the moment.
The latest deal is being applauded again by shareholders who like Jazz's track record for deal-making given the very strong run-up in the share price in recent years. Note that the price tag implies that the company is willing to spent about 13-14% of its current market capitalization to acquire the company and get a hold of Defitelio.
Given the strong historical operating and stock performance, even a possible deal in which Jazz would be acquired would not be completely unlikely. Following the 2012 deal of Azur Pharma, the company has been based in Dublin, giving the company a huge tax advantage given the lower tax rates in the country.
On top of this deal came the $650 million purchase of EUSA pharma last year, making Jazz Pharmaceuticals the owner of Erwinaze which is being used to treat life threatening leukemia, as well as other products. Sales of this drug rose to $44.1 million in the third quarter, valuing the deal at just 3.7 times annual revenues, on an annualized basis.
So the strong growth, more diversified operations and tax advantage can all act as possible reasons why Jazz itself could be in the spotlight anytime soon. Adding a premium to the current valuation would imply quite a price tag to any possible deal, and just add to the insane momentum at witnessed in recent years already. While the share price increase in recent years has come on the back of growing operations, valuation multiples have increased as well at the same time.
This makes me hesitant combined with the dependency on Xyrem and applications of generic manufacturers to produce competing drugs. For these reasons I remain on the sidelines.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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