Is the Reported $400 Billion AstraZeneca-Bristol Myers Squibb Megamerger a Slam Dunk -- or a Disaster Waiting to Happen?

In recent weeks, two pharmaceutical stocks, AstraZeneca (NYSE: AZN) and Bristol Myers Squibb (NYSE: BMY), have become the subject of merger rumors. At the start of the month, the Financial Times dropped a potential bombshell when, in an exclusive report, it reported that the two companies, both considered blue chip stocks, were close to merging in a deal that would create an oncology-focused big pharma powerhouse worth around $400 billion.

Put simply, investors reacted negatively to the proposed deal, pushing AstraZeneca shares down by around 9% after the rumors first emerged. Subsequent headlines suggest that the proposed merger isn't likely to happen.

Still, until confirmed, it may be best to assume that a deal is possible. While on the surface, it may look like a winner, a closer look validates the market's more negative take on the proposition.

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Few cheers for the proposed pharma megadeal

Admittedly, it's not uncommon for an acquirer's stock to fall upon announcement of a megamerger. After all, if an acquirer is paying for the stock with its own shares, it creates the opportunity for merger arbitrageurs to short the acquirer and go long the target, locking in profits from the deal spread.

That said, as there's no announced deal or deal prices, the arbs haven't even entered the trade yet. Blame this decline on criticism of the rumored merger plans. On paper, there are substantial potential synergies between the two companies. Both are currently competitors in the oncology space. If combined, it could create a powerhouse in this segment of the pharmaceutical market.

However, the prospect of the combined entity having such a massive share of the oncology market would make it difficult for the proposed merger to pass antitrust regulators' scrutiny. Potential cost and growth synergies notwithstanding, AstraZeneca would also have to contend with Bristol Myers Squibb's looming patent cliffs or the loss of patent exclusivity for flagship drugs like blood thinner Eliquis and cancer therapy Opdivo.

In short, while possibly a good deal for Bristol Myers Squibb shareholders, investors in AstraZeneca arguably benefit more from a scenario where the U.K.-based pharmaceutical company continues to "go it alone," expanding its geographic and drug-type presence organically rather than through one large megadeal.

Your best move with either stock

Subsequent headlines suggest no pending deal, but stranger things have happened in the world of M&A. Given how negatively investors reacted to mere rumors of a deal, you can imagine what will happen to this stock if the company moves forward with one.

So, what does that mean for investors in either of these two healthcare stocks? Those holding AstraZeneca may want to sell into the strength of the latest relief rally. For reentry, I'd wait for confirmation that the company is no longer pursuing this deal. Shares trade at nearly 16 times forward earnings, a premium to most peers, despite long-term patent cliff concerns. The vagueness surrounding an uncertain and heavily criticized merger plan could lead to further volatility in shares in the short run.

As for the would-be acquisition target, Bristol Myers Squibb? Trading for less than 10 times forward earnings, its own headwinds remain heavily factored into its valuation. If you believe its own game plan to resolve its patent cliff issue will pan out, it may still be a great time to enter a long-term position.

I wouldn't, however, buy this stock merely on the prospect of the company getting acquired. Other "big pharma" companies may not face the same sort of antitrust scrutiny if they proposed a deal for Bristol Myers, but the market could still critique such a deal, given the unresolved patent cliff issue.

Thomas Niel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends AstraZeneca Plc and Bristol Myers Squibb. The Motley Fool has a disclosure policy.