Vice President: Pratyush Singh
Analysts: Callum Ewart, Fintan, Josh Green, Gal Gazit
Deal Overview
Acquirer: Merck & Co., Inc
Acquiree: Prometheus Biosciences
Deal Size: $10.8 billion
Buy Side Advisors: Morgan Stanley & Co (Financial); Paul Weiss, Rifkind, Wharton & Garrison LLP (Legal).
Sell Side Advisors: Centerview Partners LLC and Goldman Sachs & Co. LLC (Financial); Latham & Watkins LLP (Legal).
Introduction
Merck, through a subsidiary has acquired all outstanding shares of Prometheus Biosciences for a price of $200.00 per share in cash, with a total equity value of approximately $10.8 billion (Merck & Co., Inc, 2023). The acquisition of Prometheus Biosciences by Merck is classified as an asset acquisition. Merck is confident this acquisition will accelerate their presence in the immunology sector, while also expanding and diversifying the company’s pipelines. In addition to this, the research laboratories at Merck look forward to working with Prometheus to develop a new model of precision for immune diseases. Chief Executive of Merck, Robert Davis added that this acquisition is critical for Merck to strengthen their sustainable innovation engine and drive their growth in the future (Philippidis, 2023). Overall, the purpose of this deal is to save and improve lives efficiently.
Merck Overview
Founded in 1981, the company is a global health care company, delivering innovative health solutions through its medicines, vaccines, and animal health products. Merck has three main business segments. The Pharmaceuticals segment includes human health pharmaceutical and vaccine products, the healthcare services segment offers services and solutions that focuses on engagement and clinical services to improve the value of care that patients receive, the animal health segment discovers and manufactures animal health products (Merck & Co., Inc., 2023).
With approximately 69,000 employees, the company has a rigorous pipeline. This includes a wide range of products across each phase of development. There are approximately 80 programs in Phase 2, this phase means clinical trials test the vaccine or medicine in 100 to 500 volunteers and aim to evaluate how well the product works. Additionally, there are more than 30 programs in the 3rd phase which tests the product between 1,000 and 5,000 volunteers.
Merck’s 2022 global sales were up 22% from the previous year at $59.3 Billion.
It’s drug Keytruda which generated the largest amount of revenue in 2022. Keytruda’s sales increased to $20.9 Billion, its sales grew by approximately 27% [not including the impact of Foreign Exchange]. The company’s second highest revenue generating drug Gardasil has sales grow to approximately $6.9 Billion (Merck & Co., Inc., 2023).
Merck’s revenue by region for FY2022 is shown below, with the most revenue for the company being generated from the United States [46%], followed by the EMEA region [25%]. The Asia Pacific region generates a relatively small amount of revenue of only 6%. The reason for this large difference between the US and other regions is mainly because of the United States consumer demand for pharmaceutical products, alongside the countries access to drugs.
Revenue by region, FY2022 in billion U.S. dollars
Prometheus Biosciences Overview
Prometheus Biosciences is a clinical-stage biotechnology company. The company was founded in 1995 and is headquartered in San Diego, California. Prometheus Biosciences works on discovering and developing, alongside selling therapeutic drugs to treat immune- mediated diseases. These include inflammatory bowel diseases. It has developed a precision medicine platform, named Prometheus360 which is used to identify therapeutic targets through bioinformatic databases and sample biobanks. The company’s lead product, PRA023, is a humanized IgG1 monoclonal antibody [mAb] that has resulted in the blockage of the tumour necrosis factor. Currently, it is being developed to treat other diseases including Crohn’s disease. It has other product programs such as the PR1100 program that targets the receptors for a pro-inflammatory cytokine that is known to be related to a variety of immune-mediated diseases (Market Screener, 2023).
Prometheus Biosciences has seen a consistent rise in Net Income in recent years. 2022 saw the largest increase in Net Income to $141.8 million, an increase of 57.2% (Companies Market Cap, 2023).
Net Income of Prometheus Biosciences in US millions
Industry Overview
Both Merck and Prometheus Biosciences operate in the Global Pharmaceutical Industry. The industry research, develops, produces, and distributes medications globally. The pharmaceutical market plays an important role in how people get medication and the price they pay for medicine. Pricing for pharmaceutical drugs is a constant debate in the United States. It is outlined in a report from the Office of Science and Data Policy found that prescription drugs in the US cost 2.5 times more than in other developed countries (W. Mulcahy, 2021).
Globally, the United States is the leader in the market for pharmaceuticals, generating 58% of drug sales (Pistilli, 2023). They are followed by emerging markets including Brazil and India. The Latin American region accounts for the lowest of the market’s revenues. Europe is the largest exporter of pharmaceutical drugs, with total shipments in 2021 reaching US$307.4 billion.
The market has experienced exponential growth during recent decades, with worldwide revenues totalling 1.48 trillion U.S dollars in 2022, rising slightly from 2021. It is expected that global prescription drug sales are projected to reach US$1.6 trillion by 2028, with one of the highest-performing sectors being biologics.
Revenue of the worldwide pharmaceutical market from 2001- 2022 [in billion U.S dollars]
Key drivers of growth in the pharmaceutical market that may have contributed to this revenue growth is R&D. This enables companies to develop new medicines and the market is highly reliant on it, investing over 20% of sales in it (Anzen_Exports, 2022). Changes in consumer demand for pharmaceutical drugs has also contributed to the increase in global revenue, as customers are now more educated and have greater access to drug information. Lastly, branded drugs and speciality medicines are driving innovation and growth in the sector.
Financial Analysis
Stock Analysis:
Merck is one of the largest players in Pharmaceuticals, being the 4th largest firm within this industry. They have an enormous market capitalisation at $288.4bn, trading at a 50-day average of $113.68 per share across the period of May-July 2023 and in FY2022 they had an EBITDA of almost $60bn.
Comparable Companies Model:
Comparing Prometheus Biosciences to its industry peers we find that they have a below average Price/Sales multiple at around 15.8x compared to the median value of 29.3x, the typical conclusion to draw from this is that Prometheus Biosciences was an undervalued stock which is reflected by the share price estimate of $37 which is almost an 100% increase on the figure that Merck has agreed to pay. However, it is important to note that within this sector of MedTech value is driven by potential of their research alongside capabilities opposed to business performance, not a single one of these companies has had a profit-making year in their history hence why EBITDA figures and multiples are left out, therefore you could argue that Price/Book values are more applicable in this case as they are a more direct measure of the firms R&D capabilities compared to Price/Sales. Analysing this multiple we find that Prometheus Biosciences is over 3x the industry average at 15.9x compared to 5.3x, so in this case we could argue that Prometheus biosciences has been grossly overvalued as should only be worth $66.62 a share. Bringing our two different parameters together, we find an average implied value of $218.40 a share which is only a 9.2% increase to the real value. Therefore, from this model it implies that Merck paid an industry representative price for Prometheus Biosciences.
Precedent Transactions Model:
Looking at a list of transactions from the previous 5 years within the MedTech industry, Prometheus Biosciences key multiples indicates a different story when compared to their active peers. Their Price/Book Ratio sits somewhere just above the 25th at 15.9x compared to the industry average 27.5x, compared to in the comparable companies’ model where they were in the 50th-75th percentile. However, matching the comparable companies model their Price/Sales multiple is below the average, in fact it is the lowest on the list of companies. Brining this together we find an average implied value of $36.7b, a 71% increase on the final agreed fee.
Deal rationale
Cost synergies:
Merck’s M&A splurge will allow the firm to utilise Prometheus’ technology and gain huge strides within operational efficiencies. Through the integration of back-end operations, Merck’s supply chain and manufacturing processes, Merck can optimise Prometheus’ operations and achieve cost savings. Streamlining administration and gaining large economies of sale would result in improved efficiency and profitability.
With previous success within creating a quick pipeline, when the firm acquired Acceleron Pharmaceuticals in 2021, Merck’s ability to optimise production and manufacturing streams will be vital when exploring cost synergies for Prometheus Biosciences.
Revenue synergies:
Building Merck’s portfolio within the immunology space that Prometheus operates in, the firm can expect to combine Prometheus’ specialised treatments with their global reach to secure larger quantities of sales and revenue streams.
Merck has been searching for the right deal to protect itself from eventual revenue loss as patients on its blockbuster cancer immunotherapy Keytruda begin to expire towards the end of the decade. Given the time to implement Prometheus’ treatments into Merck’s supply chain, this acquisition could allow for a smooth transfer of revenue streams from the previous treatment, cementing Merck’s revenue.
The main security Merck will get from this deal, mainly a larger portfolio of treatments, market reach and access to new technology, will not only secure present revenue streams when outdated treatments expire but will also build a solid foundation for future revenue streams ; Merck will need to quickly adapt to utilising Prometheus Biosciences’ in order to reap to gains previously mentioned.
The deal is expected to hit Merck’s profit by 25 cents per share in the first 12 months.
Other Synergies:
The $10.8 billion deal brings not only the aspect for future revenue but also for sustainable growth and market share. The pharmaceutical industry is populated with aggressive deals to strengthen firms’ manufacturing and supply processes. For instance, GSK’s acquisition of biopharmaceutical BELLUS Health in April of 2023 was done with the intention of reinforcing GSK’s portfolio of treatments within the respiratory space. This deal for Merck will cement them as a strong, global force, hoping that it will deter competition with other large pharmaceuticals within immunology and cancer treatment space.
Moreover, looking at the moves within the healthcare market over the past 3 years, Merck has seen a sharp decline in COVID related sales for 2023, leading to a fall in confidence in stakeholders. Globally, as consumer behaviours swiftly move away from the threat of Covid-19, an acquisition such as this one, is vital in preserving shareholder confidence within the industry, along with securing potential growth streams.
Risks
One key aspect mentioned within the deal’s rationale is revenue creation, with its patient on Keytruda’s cancer immunotherapy drug running out at the end of the decade, however this puts large pressure on the success of the ongoing development of the PRA023 drug designed to treat various forms of inflammatory bowel diseases. However, crucially this space is not just targeted by Merck, Pfizer have also gotten themselves involved.
We can draw questions towards why Merck paid a 91% premium for the firm as there is a potentially large desperation factor that could be involved in this statistic. Prometheus Biosciences were not the initial candidates to provide this needed revenue, instead there was a failed acquisition of Saegen Inc earlier this year. Before talks could advance, Pfizer swept in and made an offer of $48bn which was accepted. This could be a key reason behind the size of the premium as Merck look to get the deal done quickly. But this premium is over 3 times the MedTech industry average of 31% according to Deloitte. On the contrary the value of the stock did rise 140% throughout 2022 possibly justifying the large premium as Prometheus Biosciences likely has extremely strong projections.
Pfizer was the main rival of Prometheus Biosciences regarding development of a drug of these capabilities, however after Pfizer believed they were falling behind based of data released by Prometheus Biosciences at the end of the 2021, so they chose to partner with Roviant to push the technology into stage 3. The success of the development of RVT-3101 relative to PRA023 will most likely determine the success of this deal in the long run as although Prometheus biosciences claims that the drugs are “equivalent and differentiated based on all meaningful metrics evaluated”, if RVT-3101 is approved first they will gain from being the first entrant to the market, drastically reducing the earning potential of PRA023 which could expose potential holes in the revenue sources of Merck as one of its most valued patents runs out. Ultimately there is a large dependency on this deal to be successful which is far from guaranteed with such strong competition in this space.
Furthermore, the traditional risks of any MedTech deals must be considered such as the integration of Prometheus into Merck’s large operation, alongside the required level of R&D funding to allow the project to become profitable and successful in its main aims. This could potentially increase substantially compared to the forecasted amount if unforeseen issues arise during the development of PRA023.
Conclusion
Overall, this is an extremely strategically important deal to Merck with huge potential and limited risk relative to the MedTech industry. Prometheus Biosciences will gain the support and investment needed to move their PRA023 drug to stage 3 of testing from one of the industry’s largest firms who have a track record of success as shown in their Acceleron Pharmaceuticals Deal in 2021. Equally, Merck are efficiently mitigating future risk by diversifying and expanding their portfolio to deal with the projected revenue loses of the Keytruda patent running out at the end of the decade whilst simultaneously moving away from the dwindling market surrounding COVID-19.
References
Anzen_Exports (2022) Factors driving innovation & growth in the pharmaceutical industry - Anzen, Anzen Exports PVT.LTD. Retrieved from: https://anzen.co.in/factors-driving-innovation-growth-in-the-pharmaceutical-industry (Accessed: 30 June 2023).
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