September 8 news came out that the Contingent Value Right or CVR (NYSE:BMY.RT) associated with Bristol-Myers Squibb’s (BMY) $74B acquisition of Celgene was down significantly in apparent reaction to management comments at a Citigroup conference revealing that the manufacturing plant for CAR T therapies has not yet been inspected by the FDA. These contingent value rights are strange beasts. This particular one either pays out $0 or $9 apiece. There are no other options except through an undesirable route of litigation.

According to SA:

The disclosure has unnerved investors considering the agency’s November 16 action date for its review of the company’s marketing application for CAR T lisocabtagene maraleucal (liso-cel) for relapsed/refractory large B-cell lymphoma patients who have received at least two prior lines of treatment.

At the special situations report, we’ve basically had exposure since January 2019 to the acquisition of Celgene by Bristol-Myers. I’ve written a publicly available article on the rights when they were trading at $3 and I found them particularly attractive. They subsequently went up a lot, then down, and got smashed the 9th. Which is when I wrote that it was quite attractive at $2.12. Didn’t expect it to stay there but it is actually still at that level.

What went wrong?

If the FDA does not okay liso-cel (JCAR017) (by December 31, 2020) this contingent value right is worth nothing. The only way that would be left for CVR holders to get some value out of these things would be through litigation. To be able to approve liso-cel the agency still needs to inspect the company’s manufacturing facilities. New information from this Citigroup conference call, if it is correct, is that the FDA told BMY that two facilities need to be inspected. One in Brothel, Washington, which was expected but also a vector CMO facility in Texas.

Because of the COVID situation, the FDA has issued guidelines regarding its inspections. The FDA is using its COVID-19 Advisory Rating system to determine what categories of regulatory activity can take place in a given geographic region.

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The COVID-19 Advisory Rating system collects real-time national and state data to qualitatively assess the number of COVID-19 cases in an area. The Advisory Level is based on three metrics: Phase of the State (White House guidelines) and statistics at the county level to reflect the trend and intensity of infection. Key paragraphs (emphasis by me):

Q2: What types of inspections would be deemed “mission-critical”? A2: FDA’s assessment of whether an inspection is mission-critical considers many factors related to the public health benefit of U.S. patients having access to the product subject to inspection. These factors include, but are not limited to, whether the products have received breakthrough therapy designation or regenerative medicine advanced therapy designation, or are products used to diagnose, treat, or prevent a serious disease or medical condition for which there is no other appropriate substitute.

Liso-cel is an investigational chimeric antigen receptor CAR T-cell therapy that can potentially help oncology patients. A potential oncology treatment is likely viewed as mission-critical.

Applications will not automatically receive a complete response letter if FDA cannot conduct an inspection. Decisions regarding applications will be based on the totality of the information available to FDA, including information obtained from use of the tools as described in Q5/A5. If, based on a benefit-risk assessment of the product and based on available information about the facility or site, it is determined that an inspection is needed before approval of the application, FDA would communicate this to the applicant and would generally follow one of the following pathways: • If FDA determines that an inspection is necessary for approval because available information raises concerns about the adequacy of the facility or site, and the inspection cannot be completed during the review cycle, FDA intends to inform the applicant of this issue as soon as possible during the review cycle. Specifically, FDA intends to inform the applicant that an inspection will be needed before the application can be approved, but due to restrictions on travel, the inspection may not be conducted before the action date. If the inspection of a facility that raises such concerns has not been completed by the action date, FDA generally intends to issue a complete response. • If there is inadequate information to make a determination on the acceptability of a facility, FDA may defer action on the application until an inspection can be completed. In such cases, the project manager will contact the applicant.

A complete response basically means the contingent value right is a zero or worth very little. But interestingly the FDA used the following sentence in its guidelines:

FDA intends to inform the applicant that an inspection will be needed before the application can be approved, but due to restrictions on travel, the inspection may not be conducted before the action date

From what I hear about the call the FDA did not inform BMY that the inspection may not be conducted before the action date. That almost suggests that it will be taking place before the action date.

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Both Texas and Washington look like they have Covid trending in the right direction which is helpful to allow the inspections to happen:

Finally, on the call, BMY also communicated that the FDA indicated some of its personnel will be pulled into inspections related to Covid-19 vaccines. This leaves me the impression that COVID vaccine inspections may be treated as something of a top priority trumping even cancer treatments. That wouldn’t surprise me. That’s likely a slight negative.

However, my conclusion after thinking about newly revealed facts is that there isn’t much to go by. The rights dropped a lot in value but probabilities to hit these should remain more or less unchanged.

I believe the combined probabilities of success should amount to about 77%. They currently are trading at $2.12. If we ignore the possibility of litigation these go to $0 in 23% of cases (by my estimate) and $9 in 87% of the cases. If I also ignore the time value of money (timeline is relatively short) the fair value for the rights is about ~$7.83. That’s about a 269% return from here. The problem is in the about 23% of cases and you could argue odds are a bit worse because we’re getting close to the end of 2020 when Liso-cel needs to be approved or the CVR is a zero.

It is also possible to buy the rights now and sell them after one or possibly two of the milestones have been completed. However, the game is over as soon as one milestone is missed. I understand the market is fearful. I don’t think this is a security that I want to go all-in on. There is always the possibility that I misestimated the chances by a wide margin. Please see the earlier article for the data I referenced to get to a baseline. But it seems very attractive at these prices and given the odds of approval. I did add to my position.

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Check out the Special Situation Investing report if you are interested in special situations like spin-offs, share repurchases, rights offerings, activist situations and M&A events. Ideas like this are especially interesting in the current late stages of the economic cycle.

Disclosure: I am/we are long BMY.RT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.