Alkermes is a Dublin-based biopharmaceutical company offering a range of products that address mental health illnesses. The company recently announced plans to acquire Avadel Pharmaceuticals, the producer of sleep drug Lumryz (used to treat narcolepsy) for up to $2.1 billion in cash. The acquisition comes at a time of a global rise in M&A deals associated with loosening legal barriers and reducing interest rates. This announcement has garnered both applause, as many look to the strategic benefits and potential synergies, and criticism, as many worry that Alkermes is paying too much of a premium for a gamble. 

This acquisition directly complements Alkermes’s existing therapeutic drugs for schizophrenia and bipolar disorders by adding a product treating another mental illness, particularly one that is often overlooked by neurological medicine and instead left to be treated by physiological medication. The acquisition of Avadel advances Alkermes’s entrance into the sleep medicine market, a sector that is projected to grow at over 10% (CAGR) annually over the next decade, with growth driven by increased sleep disorders due to heightened stress alongside more frequent diagnoses of such disorders. Alkermes is currently in the process of producing another sleep drug called Alixorexton, which is expected to obtain regulatory approval in about two years. Acquisition of the production mechanisms, patents, and customer base of Lumryz will better position Alkermes for a stronger launch of this drug in the future.

Some analysts valued Avadel at $1.6 billion, but this valuation is likely undervaluing Lumryz, and (by extension), Avadel. The stronger expected launch of Alixorexton as a result of this acquisition combined with other overarching horizontal synergies, which could contribute to greater cost reductions, create added strategic value for Alkermes. The given intrinsic valuation also assumes $650 million in peak annual sales for Lumryz. With expected revenues of $270 million this year, Alkermes is paying 7.8 times annual sales for Avadel, whereas the average multiple for pharmaceutical companies is typically around 6.5x. However, a similar sleep drug (Xyrem) produced nearly $2 billion in annual sales at its peak, and the sleep medicine market is only expected to grow, so Lumryz could likely produce far greater sales than predicted. If Lumryz reaches even half of that in annual sales (around $1 billion), it will bypass predicted peak sales by over 50%, and the valuation would be much greater. Lumryz, in particular, differentiates itself from other competitors in the sleep medicine market through its unique once-per-night dosage (whereas all other drugs require multiple doses). Thus, the valuation to revenue multiple will decrease in the years to come, making Avadel’s valuation seem more reasonable.

Additionally, the all-cash purchase at $20 per share of all outstanding Avadel shares represents a 12% premium on the closing share price prior to the announcement. This is very close to the bottom end of the spectrum of average M&A deal control premiums, with most ranging between 20–30% and with many biotech acquisitions involving an even higher premium. Of this $20, $1.50 has a contingent value right (CVR) attached to it, so Alkermes will only pay the base price of $18.50 upfront, and the remainder payment will only become due if Lumryz receives FDA approval for another use by 2028. The low control premium indicates that either Alkermes secured a very strong deal for the acquisition or the market had high expectations for future growth for Avadel even before the acquisition was announced.

A key risk, though, is the reliance of the intrinsic valuation of Avadel on the predicted future FDA approval of the use of Lumryz to treat idiopathic hypersomnia. While the $2.1 billion valuation stems from Alkermes paying $20 per share, which will only happen if the FDA approves this usage of Lumryz by 2028, failure to receive approval will definitely decrease expected profits by far more than the Alkermes will save from the $1.50 attached to the CVR.  There are no strong indicators that the FDA will not approve the drug, so this risk should not pan out. However, even given that it may be a gamble, the alternative would be to develop a new drug from scratch. Novel drugs that reach beginning clinical trial stages generally have a success rate around 10%, and ideas for potential medicines have an even lower rate of success. Meanwhile, Lumryz’s previous success with expanding its approved patient base to include children as young as seven years old indicates that it is a strong contender for receiving approval for this new use.

Some risks come along with the actual mechanism of the deal, as well. The all-cash set-up significantly eats into liquid capital Alkermes could otherwise use for research and development of other, new drugs, especially ones in different areas of the therapeutic pharmaceutical space. This inhibits potential diversification of products and market share. However, any new drugs have significant upfront research and development costs and do not generate revenue for years until regulatory approval is achieved. This acquisition ultimately allows Alkermes to not only bypass the delay between research costs and revenue generation, but also enable Alkermes to potentially earn more money during the earlier days of the launch of Alixorexton. The increased debt Alkermes will take on to finance the deal could limit its operations and ability to take on additional debt moving forward as its debt-to-equity ratio increases from about 35% to over 100%. This will make other acquisitions nearly impossible in the near-future, but the purchase of any completed drug worth acquiring would have a similar effect on Avadel’s financials. If this acquisition pays off, it will better position Alkermes as a leader in the therapeutic biopharmaceuticals space. 

Only time will tell whether Alkermes overpaid for this acquisition, but given current data and predictions, Alkermes is making a well-planned strategic expansion into a growing therapeutic area that will likely pay itself off in the long run.