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Gilead announced on 11/21 that they will acquire Pharmasset for $137 per share : http://investors.gilead.com/phoenix.zhtml?c=69964&p=irol...

The transaction, approved by Pharmasset's board of directors, is expected to close in the first quarter of 2012, so up to 3 months from now.

While initially spiking to $134, the price of VRUS has drifted down to the current $129 price. As it stands currently, there is about a 6% gap ($8) between what you'll get in cash if you hold VRUS shares from now till the closing of this deal.

What's the catch outside of time value? 6% return in 3 months is a pretty good deal. What could possible cause this deal to fall through?

According to Gilead's president, there were other bidders as well:
http://online.wsj.com/article/SB1000142405297020444340457705...

...John Milligan, Gilead's president and chief operating officer, said the company took care in evaluating Pharmasset. "It's a very unusual situation where a compound in Phase II going on to Phase III has the kind of data" PSI 7977 has, Dr. Milligan said. There were also other bidders, he said, but he indicated he didn't know for certain who they were. "It was a competitive process, so there were a number of factors that drove up the price," he added.
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I agree it is interesting. As long as the transaction goes through, you get an $8 return on $129, so roughly a 20% return if the closing is at the very end of the first quarter (March 31, 2012). A little better if it closes sooner, say Feb 15, which would be a 33% return.

On the other hand, if the transaction falls through, then I see no particular reason why the shares would not drop back down to $72, where they were before Gilead's acquisition was announced. That would be a $57 loss, or 44% loss (not annualized).

If a Feb 15 closing or a cancellation were the only 2 options, you might say that the market is pricing in a 8/57 odds of the thing falling through, i.e. a probability of 12%.

I can't find any mention of a break-up fee, if Pharmasset gets a better offer, so that might be a chance for a little more upside. The only downside I can imagine would be if Pharmasset's shareholders turned the thing down, but with such a humongous premium, that is exceedingly unlikely.

So I guess the question boils down to, do you think there is less than a 1 in 8 chance of the deal falling through? I would think so. The deal is not conditional on financing, antitrust is almost certain not to be an issue, and I can't think of any other obstacle, short of some terrible discovery that Gilead might make late in the game, e.g. fraud.

Regards, DTM
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Termination fee = $332 million, looks like $4 a share, so there would not be much point in offering less than $141 per share.

dtm
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Hi 4,

Looking at this acquisition as either a) it goes through or b) it dies; by my calculations the market is pricing in these odds:

Current Price $128.44 for Pharmasset.

End Result      Price   x Probability   = Value
Goes Thru 137.00 86.5% 118.51
Deal Dies 72.83 13.5% 9.83
Sum 128.34


The above assumes that if the deal falls through Pharmasset's stock price will fall back to where it was before the acquisition was announced. So, I guess one would need to be convinced that the odds of the deal going thru were much closer to 100% to participate.

Personally, a 6.75% gain compared to a possible 43.3% loss, no matter how remote, just doesn't fit my risk-reward profile.

I'm not saying good money can't be made playing these situations. It can and many like to participate in these. I just like to see a greater upside potential when I put my money at risk.

Rich
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So, I guess one would need to be convinced that the odds of the deal going thru were much closer to 100% to participate.

Personally, a 6.75% gain compared to a possible 43.3% loss, no matter how remote, just doesn't fit my risk-reward profile.



Rich, your math looks fine, with the new, slightly lower current price. So if these two outcomes (takeover at $137, versus fall back to $72.83) were the only possible outcomes, the market would be basically saying that the takeover has a 86% probability, and the deal has a 13.5% chance of dying. If you think that chance is less than 13.5%, then it is a bet with a positive expectation.

I agree with you that you want some margin or error here, so if you think there is a 10% chance of the deal breaking down, then it is pointless to bet money on such a small expected gain. If on the other hand you think there is a 5% chance of the deal not happening (that would be my very rough guess), then it means that you are very likely to pocket a 6.75% gain in the next 3 months. Obviously the very big potential loss (44%, as you say) would make it sensible to limit the size of such a bet to a fairly small amount, says 1-2% of your portfolio.

I see two things that give you a bit more upside. First, there is a very small chance that someone makes a higher bid, say at $150 a share. I would put that at a 1% chance. More importantly, I think that if the deal falls through, for instance if antitrust considerations were advanced (although I think that is very unlikely), then you might reasonably say that the old price of $72 is a bit too low - after all, a very credible and knowledgeable industry player has just said that the company is worth a 79% premium.

OK, it doesn't change much, but say you put in these 3 outcomes, with a 1% chance of $150, and the rest of the probabillity distributed between the deal dying, with a fall to $80, and going through, at $137. Then from Friday's close at $128.44, you get

Prob $/sh Gain
1% 150 21.56
x% 80 -48.44
99-x% 137 8.56


Solve for x, and you get 14.6%. It seems like a worthwhile gap between my estimate of a 5% chance of the thing falling through, and the market's 15% estimate, but since I don't really know much about Pharmasset, a little more premium might be necessary for me to want to take the plunge. Drop the price another $3, to $125, that would mean a >20% chance of the deal not going through, that would probably be enough for me.


Regards, DTM
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Hi DTM,


First, there is a very small chance that someone makes a higher bid, say at $150 a share. I would put that at a 1% chance. More importantly, I think that if the deal falls through, for instance if antitrust considerations were advanced (although I think that is very unlikely), then you might reasonably say that the old price of $72 is a bit too low - after all, a very credible and knowledgeable industry player has just said that the company is worth a 79% premium.


In this particular case, I'd think that the probability of a higher bid is fairly remote because that same knowledgeable industry player said this (from 4's post):


There were also other bidders, he said, but he indicated he didn't know for certain who they were. "It was a competitive process, so there were a number of factors that drove up the price," he added.


One would have to assume that that competitive bidding process did a good job of soliciting bids and that everyone coughed up as much as they were willing to. The bolded phrase tells me that they know they paid too much but if they hadn't paid too much they wouldn't have gotten the prize. So, basing the analysis on there being a greater fool coming to the table does not seem prudent.

I'm way out of my circle but I do know that all compounds that make it to Phase III do not always reach the market. So, while maybe still somewhat remote, an added third outcome should consider the possibility that the compound is found to be unapprovable within the 3 month holding time and making the "value" less than the $72 the stock was trading at before the acquisition announcement.

A final point: I believe there are a countless number of hedge funds and others who play these deals in a very business like manner. They likely keep detailed analysis of every deal and situation and therefore know the probabilities of every scenario based on history. Someone like us trying to assign probabilities based on some gut feel is not likely to have an edge over someone armed with this kind of historical information. So, if one wants to avoid being the patsy in this poker game the best thing to do is to walk, no run, away.

That's just my humble opinion,

Rich
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Thanks for the feedback folks. I will probably pass as well. Risk/reward doesn't suit me either. I did think of an alternative here - writing a put. You can write a FEB $80 VRUS put and get about $3.50 for it. I think its a better play than buying the stock outright. The upside is only $3.50 but you get serious price protection down to $76.50.

Or you can write even a lower strike put, say $70, and get a few bucks for that too...
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Rich,

Your point is well taken about the unlikelihood of a higher bid, and the $4 a share break-up fee makes a higher bid even more unlikely than it was during the auction.


...an added third outcome should consider the possibility that the compound is found to be unapprovable within the 3 month holding time and making the "value" less than the $72 the stock was trading at before the acquisition announcement.

I don't think it is at all likely that that happens, and if it does, Gilead will still have to go through with the deal, since I don't see any language in the offer that allows them to reneg, whatever the interim results might be.


I believe there are a countless number of hedge funds and others who play these deals in a very business like manner. They likely keep detailed analysis of every deal and situation and therefore know the probabilities of every scenario based on history. Someone like us trying to assign probabilities based on some gut feel is not likely to have an edge over someone armed with this kind of historical information.

It's a useful point to keep in mind, but still, it's a bit like the argument about not picking up a $20 bill - it must be fake, or else someone else would have picked it up. I'm happy to pick it up and look at it, and a 10% - 20% implied chance of the deal falling through just seems way too high. Put another way, would you say the same thing if the stock went to $100, in the absence of any new public information? There has to be a point where the bet is worthwhile, even though there will always be a big potential loss and lots of uncertainty. I'd say at current prices it's pretty close.

Regards, DTM
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Gilead has a history of acquisitions. I am not sure any of them have failed to close in the past.

The presentation mentions Other customary conditions ( http://www.gilead.com/pdf/PharmassetSlides.pdf). Does anyone know what those are? Are any results of ongoing trials of Pharmasset a criteria for closing the deal?
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That was quick:

Gilead Sciences, Inc. announced the completion of the tender offer by its wholly owned subsidiary, Royal Merger Sub II Inc. (Merger Sub II), for all of the outstanding shares of common stock of Pharmasset, Inc. at a price of $137 per share, net to the seller in cash...

cashhttp://www.reuters.com/finance/stocks/VRUS.O/key-developments


I ended up buying a couple hundred shares at 129, and they promptly announced problems with one of their products, sending the shares down to 123. That seemed like an even better deal, and I doubled there, unfortunately selling the second half at 127. Then I completely misjudged the timing by selling the rest at 136, two days before the closing at 137. Still, what could have been a 4 months wait ended up being 6 weeks, so my overall 4.2% gain ends up being ok for such a short period. Whether it was an intelligent risk-adjusted bet is harder to say, since one bet of this size that goes sour would wipe out the gains from many good ones like Pharmasset has turned out to be.

Thanks 4foolz for bringing up the idea and tempting my gambler side.

Regards, DTM
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