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The Lilly-ImClone Deal Worst-Case Scenario

imclone_new03.jpgSome people were apparently surprised that Eli Lilly has emerged as the mystery $70-a-share bidder for ImClone. BNET readers weren't among them, as I noted a few days ago this is just the kind of bold plan that CEO John Lechleiter seems to favor.

Interestingly, ImClone's stock has hovered around the $65-$66 level all day, suggesting that there's a few people out there who don't think the deal is going to get done.

Assume that it will go through. What could possibly go wrong? Seriously. In all the coverage so far, there hasn't been much discussion of whether this is a good idea or not, despite the fact that ImClone is a company with a spectacular history of lawsuits with its various partners and competitors.

Derek Lowe over at Seeking Alpha/In the Pipeline has poured some cold water over it, suggesting that the Erbitux follow-up benefits will be diluted by Bristol-Myers Squibb's part-ownership of ImClone.

But let's take it further than that. What exactly would Lilly acquire, financially, from ImClone? Heaps of praise have been piled upon ImClone's late-stage pipeline, which is jammed with promising anti-cancer products. In the valuations and assumptions about this deal that I've seen, there's been very little discussion of two factors: What if any of them fail? And what if they succeed but major payors -- such as the UK's NHS -- balk at the price per dose? Not everything goes right all the time, and yet ... there seems to be this unassailable glow around ImClone.

Reuters reported that the deal on the table is worth $6.1 billion. ImClone put out a statement saying that it is not subject to financing. So let's assume that Lilly is just going to pay cash. Lilly has $12.6 billion in current assets and $5.1 billion of that is in cash, so it can well afford the price. But the company is carrying $4.6 billion in debt, and possibly may need to take on more to rebalance its cash assets post-purchase. Debt ratings agency Fitch said it was unbothered by the acquisition plan, which is good news for Lilly. In return, Lilly would receive a company with $1.2 billion in current assets, almost all of it in cash, and zero long-term debt.

On paper this looks quite good ... until you get to ImClone's income and cashflow. Its current net income was just $40 million and has never been higher than $388 million in the last four years. Cash flow is at similar anemic levels. So Lilly is making a big, big bet here -- that somehow its $6.1 billion cash gift will buy a pipeline that must increase net income, cumulatively, by 15 times before Lilly makes it money back. Sure, it's doable if ImClone's drugs are as wonderful as everyone thinks they are. But a lot is riding on the notion that it's all going to go off without a hitch.

That may explain why Bristol-Myers Squibb has been so lethargic about pursuing a deal. On paper, BMS is slightly weaker than Lilly. It has $12.8 billion in current assets, of which $4.4 billion is cash, and $6 billion in long-term debt. Fitch said it was also unbothered by a potential ImClone deal as long as BMS was "disciplined" in its approach. Moody's however, thinks it made BMS more risky. Bottom line: the deal would be a greater financial hardship for BMS to consummate. It might do better to take Lilly's money in a buyout.

One last thought: as I noted previously, it's worth looking at who wants this deal more. Fitch noted that Lilly's patent cliff stretches from 2010-2013, whereas BMS's is only 2012-2013. It may be that Lilly is offering the high bid because it is simply more desperate than BMS for a new pipeline.

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