Lung Cancer is the number one cancer killer globally, claiming approximately 1.2 million lives annually. Non-Small Cell Lung Cancer (NSCLC) is the most common, accounting for 85% of lung cancers. Abraxis Bioscience was a biopharmaceutical company that was recently purchased by Celgene Corp. (CELG). Abraxis developed a treatment for metastatic breast cancer called Abraxane which is already approved and being sold in 35 countries, including the United States, Canada, the European Union and China. Abraxane’s use for cancers other than metastatic breast cancer has been explored with significant results.

As part of the acquisition of Abraxis, CELG issued Contingent Value Rights. This will be significant for any reader of Joel Greenblatt’s You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits which discusses the value opportunities commonly found in securities created as part of acquisitions. The reasoning behind these value opportunities is largely a result of the fact that many of the institutional shareholders are forced to sell these securities because they do not fit their mandate, and many shareholders (both institutional and otherwise) sell because they are perceived to add little value relative to the amount of work that must go into understanding them. As such, when I first read about the presence of these Contingent Value Rights, I decided to look deeper.

CELG’s CVRs are structured in such a way that they will lead to payoffs to their holders in the future of any or all of certain milestones are achieved. Those milestones and payments are below, along with the value per CVR based on 43,273,855 CVRs outstanding:

1. Milestone 1 Payment: $250 million ($5.78/CVR) if the FDA approves Abraxane for treatment of Non-Small Cell Lung Cancer before the fifth anniversary of the merger
2. Milestone 2 Payment:[list type=A]
3. $400 million ($9.24/CVR) if the FDA approves Abraxane for treatment of Pancreatic Cancer before April 1, 2003
4. $300 million ($6.93/CVR) if the FDA approves Abraxane for treatment of Pancreatic Cancer after April 1, 2003 but before the fifth anniversary of the merger

Net Sales Payment: Payment to CVR holders based on Abraxane’s net sales for the year (this extends by default through December 31, 2025, renewable each year until 2030 unless the net sales have not been greater than $1 billion):

1. 2.5% of net sales between $1 and 2 billion
2. 5% of net sales between $2 and 3 billion
3. 10% of revenue > $3 billion

[/list]The CVR initially traded for $5.55 on Oct. 18, 2010. By Dec. 10, 2010, it was trading for just $4.47, a decline of 19.5%, seemingly validating Greenblatt’s conclusion on merger securities.

As mentioned above, Abraxane has already been approved by the FDA (in early 2005) for treatment of breast cancer. Its sales in millions have grown from $134 in 2005 to $315 in 2009. The approval of Abraxane for the most common lung cancer would result in a significant increase in revenues. What are the expectations of this occurring?

A large, 1,052 patient study across 102 sites globally, found Abraxane to be a better treatment than the current treatment, Taxol, with an overall response rate (ORR) of 33% vs Taxol’s 25% (this difference was found to be statistically significant). At the American Society of Clinical Oncology meeting, one observer stated that ORR is a less useful metric than Progression-Free Survival (PFS) and Overall Survival (OS), which is information that has yet to be released. So, while this is good news, we don’t have a complete picture. The same observer notes elsewhere that “One other key advantage of Abraxane that is cited is that it doesn’t need to be given with steroids and spares patients some Taxol-related side effects.”

So, is there a value opportunity present? Unfortunately, assessing the likelihood of FDA approval is well outside my circle of competence, so I have presented this predominantly to show that the possibility might exist, especially as the CVRs continue to decline (and I think this case validates Greenblatt). At the current price, I’m not a buyer, but in the future as more information is released about the efficacy of this drug and its progress through the FDA approval process, I’ll keep my eye on it. It helps to have a list of lightly followed securities that might lead to value opportunities one day.

Sidenote: See this post at MrMarketBlog with some additional analysis (though, take the calculations with a grain of salt – there is no certainty here)

Talk to Frank about CVRs

Author Disclosure: No Position.

Frank Voisin
[www.frankvoisin.com]

About the author:

Frank is an entrepreneur who owned four restaurants by the time he was twenty. He sold his businesses and returned to school, completing a concurrent Law / MBA degree. At the same time, he successfully completed all three levels of the CFA exams. He now invests full time with a focus on value investing. Frank Voisin writes about value investing topics at http://www.frankvoisin.com.

Visit Frank Voisin's Website

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