The planned merger of two small drug companies was rattled Thursday when a larger company tried to break up the marriage.

Cima Labs

(CIMA)

and

aaiPharma

(AAII)

had agreed on Aug. 5 to a stock-for-stock merger that would have given the larger aaiPharma control over the new company. But on Thursday,

Cephalon

(CEPH)

confounded the wedding plans by making a $26-a-share cash offer for Cima.

In dollar terms, Cephalon's offer is about 5.5% higher than what Cima shareholders would receive in the merger based on Cima's $24.61 closing price on Aug. 4, the day before the merger was announced. But it's clear that investors think Cephalon's bid isn't the end of the story because Cima's stock jumped Thursday well above the offering price. Cima's stock closed up 14%, or $3.27, at $26.85, after rising as high as $27.64.

"The market is saying that Cephalon is making a better deal, but investors seem to be waiting for a better offer," said Anthony K. Green, who follows Cima for the Minneapolis investment banking firm of Craig-Hallum Capital.

Green has a neutral rating on Cima. He had a buy rating until the merger was announced earlier this month. "Most shareholders we spoke with didn't like the merger," said Green.

That lack of enthusiasm spilled over into the market. Until today, Cima's stock had never topped its Aug. 4 close. And aaiPharma's stock has not exceeded its $18.02 closing price on Aug. 4. The stock closed Thursday at $16.67, down 3.6%, or 62 cents.

"It's hard to say what's next," said Green. "Cima can't solicit offers." Green doesn't track aaiPharma or Cephalon. He doesn't own Cima shares. His firm is a market maker in Cima's stock.

Cima offered little more than the bare-bones explanation of Cephalon's bid. The company said its agreement with aaiPharma prohibits its discussing an offer with any third party "unless the Cima board of directors concludes in good faith ... that the proposed transaction is more favorable to the Cima stockholders than the transaction with aaiPharma."

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Jilted Suitor?

Although Cima said very little, aaiPharma said a lot about the "unsolicited proposal" by Cephalon for Cima. "We are confident that the definitive merger agreement ... offers superior value to Cima shareholders," said Philip S. Tabbiner, president and chief executive of aaiPharma, in a prepared statement.

"Our transaction will be immediately and substantially accretive to Cima shareholders," he added. "Moreover, it will be a strategic combination that creates a more powerful science-based specialty pharmaceutical company."

Tabbiner argued that the merger would provide greater value to Cima shareholders, adding that "we do not foresee making any changes in the merger agreement in response to Cephalon's proposal."

In the merger, aaiPharma shareholders would get one share in the new company for each share they hold. Cima shareholders would get 1.3657 shares of the new company for each share of Cima that they now hold.

"I think aaiPharma needs this merger," said David Windley, who follows the company from the Nashville, Tenn. office of the Jefferies & Co. investment banking firm. "They said they don't foresee changing anything. If they changed the (stock swap) ratio, that would make the deal dilutive."

Windley has a hold rating on aaiPharma. He doesn't own shares; his firm is a market maker in the drug company's stock. "Judging from the market, it looks like there will be another bid from someone," he said.

Love Triangle

The three-pronged romance appears to put Cima in the middle of different interests from the two suitors, each with something to like and dislike for Wall Street analysts. First, a brief look at the players:

Cima Labs, based in Eden Prairie, Minn., reported sales of $46.6 million last year. It specializes in developing drug-delivery systems that allow patients to take drugs orally without having to chew the medications or take the drugs with water. The company makes orally disintegrating versions of prescription and nonprescription drugs for several partners. It also is testing its first proprietary product called OraVescent Fentanyl, a version of the narcotic analgesic fentanyl used in treating cancer pain.The company is meeting with the Food and Drug Administration to complete the guidelines for Phase III testing of this drug, and it hopes to file an application for the drug's approval in late 2004.

aaiPharma, based in Wilmington, N.C., reported $230.5 million in revenue last year. The company makes and markets its own drugs and also acts as a contract manufacturer for other drug companies. It focuses on medications for pain management, critical care and gastrointestinal diseases.

Cephalon, based in West Chester, Pa., reported 2002 revenue of $506.9 million. Two drugs -- Provigil and Actiq -- provided nearly two-thirds of sales. Provigil is used to help narcoleptics and other people who have trouble staying awake during the day. Actiq is a type of fentanyl in lollipop form for treating cancer patients' pain.

Analyst Anthony Green said the merger with aaiPharma was attractive to Cima because Cima "always wanted to be a proprietary drug company" rather than one devoting most of its efforts to establishing partnerships. "The merger would have accelerated this because aaiPharma has the R&D budget and the sales force," Green said.

And Cima was attractive to aaiPharma, Green added, because Cima had attractive technology as well as $134 million in cash.

Analyst Michael Krensavage, of Raymond James, was more blunt in his assessment of aaiPharma, for which he has an underperform rating. "Failure to complete the Cima transaction would likely leave aaiPharma's balance sheet burdened with debt," he said Thursday in a research note to clients. "Cima has a significant cash position, while aaiPharma has significant debt." Krensavage doesn't own aaiPharma shares; his firm is a market maker for the stock.

Cephalon's main interest in Cima appears to be Cima's fentanyl research, Green pointed out. With Actiq possibly facing a U.S. patent expiration in 2006, purchasing a potential competitor would solidify Cephalon's cancer-pain role.

Lehman Brothers analyst Jim Birchenough agrees with the fentanyl scenario, as well as the "potentially complementary delivery technology" Cima would provide to Cephalon. He says the acquisition "would not seem to make good strategic sense" for Cephalon.

He told clients in a research note Thursday that "at least 50% of Cima revenues

are at apparent risk from generic threat," adding that the uncertainty and regulatory issues involving Cima's experimental cancer-pain drug raise questions about the takeover bid, from his perspective covering Cephalon. He rates the company as equal weight. He doesn't own shares, but his firm has had an investment banking relationship with Cephalon, whose shares closed at $44.13, down 1.6%, or 73 cents.