By Alex Gavrish, Etalon Investment Research; author of “Wall Street Back To Basics

Idenix Pharmaceuticals, Inc. IDIX

The main beneficiary of a recent acquisition of Idenix Pharmaceuticals Inc (NASDAQ:IDIX) by Merck & Co., Inc. (NYSE:MRK) is Baupost Group, an investment management firm managed by Seth Klarman, a famous value investor. Baupost Group owns a large 35% stake in the company and stands to profit handsomely once the deal completes. While Klarman’s firm was quite a long term shareholder, another, smaller investor had caught our attention. Sarissa Capital, a recently launched activist hedge fund focused on healthcare investments. The fund owned 5.05 milliom shares, valued at $36.5 million based on Idenix’s market price before deal announcement. The fund just started, in 2013, to make investments and one of its main portfolio holding, as of March 31st, 2014, was Idenix. As of March 31st, 2013, position represented 11% out of a total $290 million portfolio. We decided to dig deeper and review the fund’s other holdings.

Idenix buyout by Merck

On June 9th, 2014, Merck & Co., Inc. (NYSE:MRK) agreed to acquire Idenix Pharmaceuticals Inc (NASDAQ:IDIX) for $3.9 billion dollars or $24.5 per share. The price represents a huge 239% premium to a closing price of $7.23 on June 6th, 2014. Idenix Pharmaceuticals, Inc. is a biopharmaceutical company engaged in the discovery and development of drugs for the treatment of human viral diseases. Idenix is headquartered in Cambridge, Massachusetts. Company’s main focus is the treatment of patients with hepatitis C infection.

Sarissa Capital

Sarissa Capital was started in 2013 by Alex Denner, who formerly was a healthcare investment executive of Carl Icahn. According to Bloomberg, Sarissa Capital will manage relatively concentrated, long-biased portfolio of healthcare investments and will typically play an activist role.

Portfolio holdings

According to the latest quarterly SEC filing, the fund’s total portfolio was valued at $290 million (as of March 31st, 2014). Apart from Idenix Pharmaceuticals Inc (NASDAQ:IDIX), which represented a 11% holding at the time, six other holdings accounted for 80% of portfolio. The six holdings and their weight in the fund are: Ariad Pharmaceuticals, Inc. (NASDAQ:ARIA) (33%), Quest Diagnostics Inc (NYSE:DGX) (16%), Bio-Reference Laboratories Inc (NASDAQ:BRLI) (12%), Merck & Co., Inc. (NYSE:MRK) (8%), Mallinckrodt PLC (NYSE:MNK) (6%) and VIVUS, Inc. (NASDAQ:VVUS) (5%). Ariad and Vivus are both “distressed” biotechnology holdings. Over the past year, their share prices declined by 67% and 57%, respectively. Mallinckrodt is a spin-off from Covidien. The company recently announced an acquisiton of Questcor Pharmaceuticals for $5.6 billion in cash and stock. Since its spin-off in June 2013, shares of Mallinckrodt had returned 78%. Merck is a large cap drug manufacturer so we will not discuss it here. Perhaps it was paired in the fund’s portfolio with Idenix, which it acquired, or it could be a stand-alone holding.

The last, and very interesting part of fund’s portfolio is the investment in Quest Diagnostics Inc (NYSE:DGX) (16%), Bio-Reference Laboratories Inc (NASDAQ:BRLI) (12%) and Laboratory Corp. of America Holdings (NYSE:LH) (1%). The three companies together account for almost a third of fund’s holdings. Quest Diagnostics and Laboratory Corp of America are large companies while Bio-Reference Labs is a regional service provider, serving mostly New York metropolitan area. Bio-Reference Labs has an attractive valuation. Net debt is $46 million, and company has a large “surplus” in accounts receivables balance (accounts receivable minus accounts payable equals $174 million). After adjustment for this number, net debt would be a cash holding of $128 million and enterprise value $710 million. Based on last financial year results, company currently trades at an EV/EBITDA ratio of x7. One might also speculate that Bio-Reference Labs can be a takeover target either for Quest Diagnostics or Laboratory Corp of America. An excellent start by Sarissa Capital makes following its portfolio a must.