How Kite came from a position of strength to get Gilead to boost its buyout price by 42%

Usually when two biopharma companies negotiate a merger and the final price ends up soaring way past the original offering price, it’s because there’s another bidder lurking in the wings, ready to swoop in with a better offer. But Gilead Sciences’ $12 billion buyout of Kite Pharma wasn’t your everyday big bio deal—far from it, in fact.

A look at the prospectus for the merger tells an instructive tale of how Kite CEO Arie Belldegrun turned a single bid into a huge payday by capitalizing not only on his company’s valuable innovation in the red-hot field of immuno-oncology, but also on Gilead’s desperate need to make a game-changing deal.

On Aug. 18, Gilead offered to buy Kite for $180 per share—an 82% premium over the target company’s 60-day average stock price. Gilead had come calling a month before with an offer of $127, which it later hiked to $160. But during that time, Kite filed for FDA approval of axi-cel, its personalized CAR-T treatment for non-Hodgkin lymphoma, and it got the good news that the agency would not require a committee review meeting prior to approval.

Through all of this, Gilead was the only suitor making formal offers to acquire Kite, according to the prospectus. So Belldegrun had little leverage aside from his own confidence and that of Kite’s board—which he used quite well against Gilead CEO John Milligan.

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On Aug. 1, several executives from both companies met to discuss the $160-per-share offer, after which Belldegrun and Milligan met separately. “Dr. Belldegrun expressed his disappointment to Dr. Milligan at the level of the offer, making clear that the Kite board had unanimously rejected the offer and that any future offer would need to be a compelling one. Dr. Milligan indicated to Dr. Belldegrun that he was going to find it very difficult to go back to the parent board and request an increased price,” the prospectus says.

To understand why Milligan was able to go back to his board, ultimately securing approval for the $180-per-share price, it’s helpful to review Gilead’s tough six months prior to closing the deal. In February, during its fourth-quarter earnings report, Gilead told investors to expect 2017 sales between $22.5 billion and $24.5 billion—far short of the $27.7 billion analysts had been expecting. That’s because sales of the company’s transformative hepatitis C treatments, Sovaldi and Harvoni, had fallen by more than a third in 2016 and were continuing to plummet, slammed by a combination of pricing pressure and a dwindling population of patients, most of whom had been cured by the drugs.

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The hep C franchise started to turn around in the second quarter, largely because of strong performance by new entry Vosevi, and Gilead bumped up its revenue expectations for the year slightly. But sales for the quarter, announced July 27, were still down 8% year-over-year, and Milligan continued to be dogged by questions about how Gilead could possibly continue to grow without an acquisition to beef up its pipeline. In fact, investors had been pressuring the CEO to make a big deal ever since 2016, when Sovaldi and Harvoni started showing signs of weakness, and there were no clear-cut replacement blockbusters in Gilead’s pipeline.

During the second quarter, Gilead’s operating cash flow rose from $2.9 billion to $3.5 billion, leading one analyst to surmise that “Gilead is continuing to generate dry powder for a potential deal.” Meanwhile, on Aug. 8, during its own second-quarter earnings announcement, Kite revealed the good news about its FDA filing for axi-cel.

Ten days later, Milligan and Gilead board chairman John Martin met with Belldegrun and offered $176 a share in cash for Kite, according to the prospectus. Belldegrun—now with good reason to be as confident as ever, thanks to the FDA—verbally countered at $180. He backed up the number by reminding Milligan and Martin that Kite has something that many analysts had long feared that Gilead lacked: an early-stage pipeline full of potentially valuable treatments.

Now it will be up to Gilead to realize the value not only of axi-cel but also of Kite’s pipeline, which includes engineered cell treatments for leukemia, multiple myeloma, cervical cancer and solid tumors. This deal “wasn't just a one-and-done kind of acquisition,” said Milligan during a conference call with investors after the announcement. “It was more of a long-term play with multiple product opportunities, and we can see this play out for decades to come as we continue to improve CAR-T and hopefully make cellular therapies a cornerstone for oncology treatment.”