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Investors in AstraZeneca (AZN) hardly reacted to the company's deal to acquire privately-held Amplimmune. The deal is aimed to boost the future pipeline of the troubled pharmaceutical company but promises no quick fixes to address the company's current troubles.

I remain on the sidelines.

The Deal

AstraZeneca has entered into a definitive agreement to acquire Amplimmune. AstraZeneca will pay $225 million for the US-based biologics company which is focused on developing novel therapeutics in cancer immunology.

Shareholders in Amplimmune will furthermore stand to make $275 million if the company reaches predetermined development milestones.

The acquisition will boost AstraZeneca's pipeline by adding early-stage assets for its immune-mediated cancer portfolio. This includes AMP-514, which is an anti-programmed cell death monoclonal antibody. The drug is in late-stage pre-clinical development and Amplimmune aims to file the drug with the relevant authorities before the end of this calendar year.

The activities of Amplimmune will become part of MedImmune which is the global biologics research and development arm of AstraZeneca.

Vice President of MedImmune Dr. Bahija Jallal commented on the rationale behind the deal, "MedImmune's focus on harnessing the power of the patient's own immune system to fight cancer will be complemented by Amplimmune's innovative work in this area. It will allow us to strengthen our arsenal of potential cancer therapies."

MedImmune has clinical stage programmes including tremelimumab, anti-OX40 mAb and MEDI-4736 to bolster the pipeline of the overall business. The broad range of programs is important as the complexity of cancer requires a combination of therapies in the treatment process.

The deal is subject to normal closing conditions, including regulatory approval, and is expected to close in the third quarter of this year.

Valuation

AstraZeneca ended its second quarter with $9.09 billion in cash, equivalents and short term investments. The company operates with $10.39 billion in total debt, for a modest net debt position of $1.3 billion.

Revenues for the first six months of the year came in at $12.62 billion, down 10% on the year before. The company reported net earnings of $1.84 billion, down 43% on the year before. At this rate, annual revenues are seen around $25 billion, while net earnings could come in around $3.5 billion.

Trading around $50 per American Deposit Right, the market values Astrazeneca at $63 billion. This values operating assets of the firm at 2.5 times annual revenues and 18 times annual earnings.

Astrazeneca currently pays an interim dividend of $0.90 per share, for an annual dividend yield of 5.5%.

Some Historical Perspective

Long term holders in AstraZeneca have made most of their money from dividends over the past decade. After shares have peaked around $65 in 2006, they have mostly traded in a $30-$50 trading range, currently exchanging hands at the high end of that range.

Between the calendar year of 2009 and 2012, AstraZeneca has seen its annual revenues fall by a cumulative 15% to $27.9 billion. Net earnings have fallen by a similar percentage to $6.3 billion. As AstraZeneca has retired a similar percentage of its share base, earnings per share were roughly flat.

Investment Thesis

Shares in the Anglo-Swedish company hardly moved on the news about the deal with Amplimmune, which is rather modest compared to AstraZeneca's own valuation. Even when considering all the contingent payments, the deal makes up less than one percent of AstraZeneca's own market capitalization.

Amplimmune, which was a spinout from the John Hopkins University has no working products yet, but will add to the company's pipeline. Under command of Dr. Jallal, AstraZeneca has been focusing on its future pipeline. So far this year, the company already bought respiratory drug producer Pearl Therapeutics in a $1.15 billion deal and Omthera Pharmaceuticals.

The company's revenues have been under pressure for some time, especially as AstraZeneca has lost patent protection on its antipsychotic Seroquel drug and the cholesterol lowering Crestor drug.

Yet the transition period comes at a price as operating costs keep increasing to bolster the future pipeline, while revenues are under pressure. Interestingly enough, AstraZeneca has been focusing on biologics, even after the $15.6 billion acquisition of MedImmume in 2007 has not been a great success. Yet the deal structure places a lot of risk away from AstraZeneca as upfront payments make up just 45% of the total deal value.

The immediate outlook remains challenging. The revenue declines will stagnate automatically as key patent expirations have occurred over 12 months ago. Earnings remain challenged as key new drugs will take years to make meaningful contributions. Therefore the company has embarked on a $800 million annual cost saving program, to be fully realized by 2016.

I remain on the sidelines. While the dividend payouts are attractive, they require all the funds being generated from normalized earnings. The turnaround strategy will take years to complete and is quite uncertain. The current valuation is not appealing enough for me at this point in stage, given the uncertainty and long horizon before improvements start to kick in.

Source: AstraZeneca - Small Deal With Amplimmune Provides No Quick Fixes