Sirtex sides with China

We can't help but feel a bit sorry for Varian Medical Systems. In early May, just days before shareholders were set to vote on the company's bid for Sirtex Medical, it was aced by a left-field offer from Chinese fund manager CDH Investments. 

Varian and Sirtex were peas in a pod, both specialists in internal radiotherapy for the treatment of cancer. If the deal went through, Sirtex would benefit from Varian's established hospital relationships – the company is some eight times larger – and Varian would add a liver cancer therapy to its list of treatments. 

‘Varian is very disciplined in its business development approach and we do not see value beyond the $28 per share we offered for Sirtex,' said Varian's chief executive following the Chinese offer. We agree. It was a fair deal at a fair price, which is why we were happy to Sell. 

Nonetheless, Sirtex's board has flip-flopped on its initial acceptance of the Varian deal and is now backing the $33.60 bid from CDH. Being all cash and materially higher, the CDH offer is superior to Varian's takeover bid, so you can't blame them. 

Initially, the higher offer price wasn't enough to convince the board, but CDH has modified its bid – it will now jointly acquire Sirtex with a mid-sized Chinese pharmaceutical company, China Grand, offering some extra assurance that the deal will go through. Sirtex is also entitled to retain $200m should the merger fail, which is being held in trust at an Australian bank.

However, that deal-sweetener is also a warning. The $200m retainer is multiples of the $16m break-fee that Varian was required to pay had it pulled out. Presumably, the board thinks there's a higher chance that the deal will fall through and so doesn't want to be left empty-handed. The fact that Sirtex's current share price is 8% below CDH's offer price also hints at that possibility. 

America first

There are several deal conditions that could stop the merger, such as various regulatory hurdles and approval from the Foreign Investment Review Board. Sirtex also needs approval from the Committee on Foreign Investment in the United States (CFIUS) because the bulk of Sirtex's operations are in the US. 

That last rubber stamp may not come easily. CDH is a Chinese asset manager, while China Grand is a Chinese healthcare provider. Sirtex has access to American patient data and is dealing in radioactive materials, albeit in tiny quantities. President Trump's ‘America First' administration has encouraged CFIUS to block several proposed Chinese acquisitions in the interests of national security. Add those three truths together and you can see why this deal is no sure thing.

In Friday's investor briefing, Sirtex's chief executive, Andrew McLean, said that CFIUS is unlikely to reject the deal, noting that Sirtex isn't in the technology or defence sectors. Nevertheless, given the strained US-China trade relations and the three points above, it can't be ruled out.

No need to wait

Sirtex will now prepare a Scheme Booklet for review and the board expects to put the deal to a shareholder vote in late August, with the merger finalising in September, should it be approved. 

However, we don't think it's worth holding out. Yes there's another couple of dollars per share (potentially) on the table if you wait for the vote and it's approved, but sales growth is now a quarter of what it was a few years ago and competition is on the rise with new oral chemotherapies gaining traction. Sirtex's potential market has shrunk 70% following last year's failed clinical trials, and there are two class-action lawsuits against the company for alleged compliance breaches.

Sirtex trades on a forward price-earnings ratio of 30 based on consensus estimates for 2018 earnings, while the CDH offer price is equivalent to a PER of 34. We think that's generous given the company's current condition.

There's a good chance the deal will get across the line, but if regulators get in the way or CDH pulls out, the share price is likely to drop significantly, depending on Varian's next move. 

We recommend forgoing the CDH offer altogether and selling on the open market. You'll get cash within a couple of days, rather than wait months, and avoid any pain if the deal flops. SELL