24-Hour Impairment: Merck’s Drug Deal with Cubist

We wrote previously about an acquirer recording goodwill impairment charges only two months after an acquisition. While we remarked at the time that there is no defined period of time that must elapse before assets may be subject to impairment, the two month period was one of the shortest periods we had seen. Merck & Company (MRK) broke all land speed records, however, when the market effectively impaired the pharmaceutical giant for nearly the entirety of its pending purchase of Cubist Pharmaceuticals (CBST).

In a deal valued at approximately $9.5 billion ($8.4 million in cash and $1.1 in assumed debt), Merck’s acquisition of Cubist was originally expected to result in significant EPS gains by 2016. At least, that was the plan. Mere hours after Merck’s announcement, a U.S. court invalidated four of Cubist’s five key patents on Cubicin, the antibiotic responsible for 80% of the company’s revenue. The decision effectively allows generic production of Cubicin as early as June 2016, four and half years before the original patent expirations in November 2020.

The reaction in the markets was swift. When the market closed on December 8, 2014, before the court ruling was announced, Merck’s stock price was $61.88 (equity market capitalization of $176.4 billion). The next day, Merck’s stock opened at $59.40 (a 4.2% drop) and its market capitalization had been reduced by nearly $7.1 billion. Almost the entire value of the Cubist acquisition had been wiped out. Though the stock partially recovered to $60.11 by the end of that day, the effect on market capitalization was still a decline of over $5.0 billion. For its part, Merck claims that the court’s decision, which is subject to appeal, does not change the company’s expectations for the transaction and that the acquisition of Cubist will still create strong fundamental value for shareholders.

So did investors overreact? Perhaps. In the month since the announcement, Merck’s shares have risen nearly 2.0%, but it is difficult to tell whether this is due to calmer heads, fundamentals, or other market factors. The FDA did approve another of Cubist’s drugs, Zerbaxa, on December 19^th. In any event, the court’s decision on Cubicin will almost certainly factor into the company’s assessment of goodwill arising from the deal, if it is indeed consummated. Some analysts have noted that it is unlikely that Merck could back out of the deal because a negative legal outcome is not counted as a “material adverse event” in the merger agreement. Cubist’s stock price seems to bear that out, as it has remained just shy of the merger consideration price ($102.00/share) since late December.

Related Links

• Goodwill Impairment: How Long Does It Take?
• Pulling the Trigger: Interim Goodwill Impairment Testing
• Goodwill Impairment: Good, Bad, or Indifferent?