Market Thoughts - 01-10-21

Disclaimer: This post does not constitute financial advice. Author has a long position in Gilead. Do your own due diligence before making an investment.

Hello, everyone. Thanks for checking out Market Thoughts.

People have been asking for updates on the possible Gilead/Roche merger. Instead of writing a new article every time $GILD does something weird, we’ll try this format. (Unless there is enough content for an article.)

This will be bimonthly column (hopefully), but I might post more frequently if something interesting is happening.

I promise you Market Thoughts will not turn into an endless stream of flimsy stock recommendations. It takes a long time to properly research a company. I might only have one or two good investing ideas a year.

This format also allows me to post some quick thoughts on other stuff that’s unrelated to Gilead. (Which would be nice for a change.)

Market Thoughts will only be posted outside of American market hours. Ideally on the weekend. This is so people don’t read something on here, panic, and make a bad decision. You should always take some time to think things over. I never make a big decision without sleeping on it first.

You should always do your own due diligence before making an investment. Everyone’s risk tolerance is different. Just because I’m still holding a position doesn’t necessarily mean you should be. I’ve watched my own big call positions dwindle down to nothing and expire worthless. This doesn’t bother me. Maybe there’s something wrong with my brain. Or maybe it’s because I’m used to the wild swings that come with investing in options.

Some people have been saying I posted this research so I could sell covered calls. This is not true whatsoever. I have never sold a covered call in my life. I have never sold a put in that sense either. The only time I sell an option is to close out a position. I buy calls (and sometimes puts) and sell them before expiration so I don’t get assigned. That’s it. That’s all I do. Sometimes I buy the underlying stock but it’s rare. Options are more fun. If you have a strong thesis then options are usually the better investment.

Okay, that being said, here are my current thoughts on Gilead.

Since I posted the article titled “Gilead is Insanely Undervalued” the stock has gained more than 10%, so I’m feeling pretty vindicated on that one.

Am I concerned about Gilead’s debt? No. Money is cheap right now. Companies should be levering up. Debt is an extremely effective tool when used appropriately. Gilead’s revenue more than covers their debt payments. Any major revenue increases from pipeline assets will make the debt totally irrelevant.

Am I concerned about Gilead spending all their cash? No. Interest rates are so low that cash is losing 2-3% a year just to inflation. Even if their cash is sitting in a “high interest” savings account, it’s still losing value. Undervalued companies with lots of cash should be spending as much as they prudently can on R&D, buybacks and bolt-ons.

$GILD has been climbing steadily since December 31st, 2020. Here is a one-month chart.

@YahooFinance

Pretty solid rebound.

There could be several reasons for this price action:

1.  It could be a merger is imminent, but also maybe not happening.

We shall call this the Short-Term Merger Paradox: When the price action of stock can both support and contradict a merger thesis.

In this article, I showed how the market cap between Gilead and Roche had been widening, and why that increased the chance of a merger. Since then, the market cap spread has been shrinking.

If you accept the original article’s thesis, then you must also accept that the reverse is true. Especially in the long term. If Gilead jumps another 20% and Roche drops 20% or stays flat, then that would be strong evidence that a merger is not happening anytime soon, perhaps ever.

In the short term, price action like this could suggest that the merger has been finalized, details have been leaked, and shorts are covering.

Short term: Gilead’s 10%+ run is bullish for the merger.

Long term: If Gilead continues to run up, it’s bearish for the merger.

2. There could be data about to drop. A study on the nebulized version of remdesivir was originally slated to finish on December 31st, but seems to have been pushed back to March/April. (https://clinicaltrials.gov/ct2/show/NCT04539262)

The initial study on remdesivir was initiated on February 26th, 2020. [Source]

Results from the trial on moderate Covid-19 patients were announced on June 1st, 2020. [Source]

This study only took 96 days. If inhaled remdesivir could be more effective than intravenous remdesivir, you’d think management would put some giddy-up on that that trial. It’s been about 118 days since the inhaled study began so you’d think the results would be in by now. Although the inhaled study is a Phase 1b/2a. That could have something to do with the delay.

3. Gilead might be doing buybacks. Management said they have trodelvy data the market hasn’t seen. (They were questioned about the $22B price-tag for Immunomedics.) [Source]

They probably also have remdesivir data from the nebulized study. If the new data is fantastic, then the board of directors could have decided that buying back their own stock is a better investment than acquiring any more companies. Interest rates are low right now. Gilead’s dividend yield is currently 4.35%. Buying back shares will reduce future expenses if they don’t plan to merge.

I’ve seen some posts saying that a Gilead/Roche merger would be impossible because it would be 120B at the minimum, and that would be the largest buyout in pharma history.

This is ridiculous for two reasons:

1.  Just because something has never happened before, doesn’t mean it’s impossible. Which reminds me of this great scene from Men in Black..

I’m pretty if sure you asked the Capitol police force whether they’d be overrun last Wednesday, they would have said that was impossible. Weird things happen all the time. Don’t be trapped by history.

2.  A merger/buyout play doesn’t have to be 100%. Roche’s initial investment in Genentech was only for 56%. They went hostile to get the rest of it. (https://www.ft.com/content/a97250c0-ee9b-11dd-bbb5-0000779fd2ac) Gilead has done several deals that weren’t 100% buyouts. If Roche were to take a 49.99% stake in Gilead, they’d only need 60B at a 120B valuation. 60B is much more manageable. If they went for a 25% stake it would only cost them 30B. That’s only around 10% of their market cap. Peanuts.

The JP Morgan healthcare conference is this week. Gilead is presenting on Monday, so hopefully we’ll get some color on the company’s direction.

That’s all for now. Have a nice Sunday. – David Stone