Friday, May 26, 2006

Wake Up, Sleepyhead: Sepracor is Buyout Bait

Ever since the FDA shot down Neurocrine Biosciences' (NBIX) Indiplon tablets, rumors concerning a possible Pfizer (PFE) and Sepracor (SEPR) partnership/merger have been flying left and right on Wall Street. Sepracor's call option volume of 42,447 contracts heavily outweighs the put volume of 5,132 contracts. The sudden rush of money into the June 60 calls, for example, suggests that speculators are positioning for a large upside event occurring over the next month.

Sepracor, which makes the insomnia drug Lunesta, has seen its top line explode over the last 12 months as a result of this new drug. Lunesta's advantages over competing products could put the drug's sales in the $1B range within the next 36 months, we think. There is plenty of upside left, too: SEPR trades at a discount to rivals on trailing P/E basis and because no analyst on the Street really knows how much Sepracor will earn in 2007, the potential for an earnings surprise should not be overlooked.

Early last year, Bloomberg reported that Sepracor hired Morgan Stanley (MS) to explore a sale, but nothing ever came of it. The writing is on the wall: Sooner or later, Sepracor won't be Sepracor -- it'll be a division of either Pfizer or Johnson and Johnson (JNJ). And hence the buzz in the options arena.

Disclosure: At the time of publication, author was long JNJ and PFE.

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