Decision Time Looms for Biotech’s Riskiest Bet

Offshoot of Bristol-Myers Squibb’s acquisition of Celgene will soon pay off $7 billion or go bust

Crunchtime is approaching for an all-or-nothing biotech bet: Will investors pocket nearly $7 billion or come up empty-handed?

When Bristol-Myers Squibb BMY +1.39% bought Celgene last year, the holder of each Celgene share received a tradable security known as a contingent value right, or CVR, as part of the package. Each CVR entitles the holder to a $9 payment if Celgene can win Food and Drug Administration approval for three drug candidates. Specifically, it must win approval for the multiple sclerosis drug ozanimod and cancer treatment liso-cel by the end of 2020, as well as cancer treatment bb2121 by the end of March 2021. That amounts to a nearly $7 billion payout if successful. Failure to satisfy those requirements renders the securities worthless.

Ozanimod was approved in March, which sent the CVR above $4.50. But investors clearly still have their doubts that all three conditions will be satisfied: Today, they trade at just over $2, which is little changed from a year ago. The price implies a low probability of success.

The source of investor concern is clear. The FDA is set to rule on the application for liso-cel in November, but necessary inspections of two key manufacturing plants have yet to take place. In ordinary times, those inspections would occur far earlier in the application-review process, leaving investors to wonder how badly Covid-19 has delayed proceedings. If the required inspections can’t take place or reveal even minor issues, the approval timeline is likely to slip into 2021 and serve investors the kind of doughnut that nobody wants to eat.

Clearly, some caution is in order with any security that can quickly lose all of its value. But not all data points are flashing red: The FDA granted liso-cel what is known as priority review status earlier this year, which is typically a good sign.

And investors shouldn’t assume that approval is a low probability event just because of the low price. Because of the binary nature of the payout, it is logical for the securities to trade below anyone’s intrinsic valuation. After all, at $4.50 a share, the downside risks begin to outweigh the upside, according to biotech analyst Salim Syed at Mizuho. He rates the securities “buy” with a price target of $6.17.

So for investors who place an appropriately small bet, the risks taken can lead to a major reward. If the CVR pays out, new buyers today can make about four times their money in slightly more than six months. The securities also have the advantage of being uncorrelated with a volatile stock market.

This risk is still worth taking—for investors who fully understand their tolerance for pain.

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