- Our projected takeover valuation of £54 (~$275/ADR) is based on the resulting output of our M&A model using 50% cash/50% stock delivering 3%/7%/8%/11% EPS accretion to ABBV.
- Critically, SHPG will unlock >$18B in cash flow through 2020 for ABBV, and deserves at least some non-cash based valuation for this.
- SHPG has 13-20% upside from current levels and has a tentative floor valuation, as we cannot rule out the possibility of another suitor entering the bidding.
- If the July 18th deadline passes without another offer from ABBV, we anticipate NPSP being acquired by SHPG soon thereafter.
Please see Shire's website here for LSE to ADR share conversion methodology.
With SHPG trading currently at ~21x 2015E and ample capacity to grow through acquisitions, we expect SHPG to preserve its current takeover premium through the July 18 options expiration, and likely for the duration of the year, with the rejected £46 per share offer (~$235/ADR) acting as a conceivable floor for the stock. SHPG only trades at 18x/21x Credit Suisse/Merrill Lynch 2015 estimates respectively, and ~22x 2015E consensus EPS, according to Thomson ONE. We believe the scarcity value Shire (NASDAQ:SHPG) represents more than justifies the modest premium to the 5-year FWD multiple of 17x and skews the risk/reward to the upside, representing a favorable opportunity from the long side on both fundamentals and the inherent optionality as a takeover target, or as an acquirer itself that could drive 15-25%+ EPS growth. Currently, SHPG shares trade at more than a 25% premium to its respective EU sector, but deservedly so, with an expected 5-year EPS CAGR of at least 14% (ex-additional M&A) vs. its sector's forecasted growth of 9%. Furthermore, SHPG trades at ~21.8x 2015E, with a 5-yr. expected PEG ratio of 1.65, well below Novo Nordisk's (NYSE:NVO) 22.3x 2015E and 5-yr PEG ratio of 2.10.
Our projected takeover valuation of £54 (~$275/ADR) is based on the resulting output of our M&A model using 50% cash/50% stock for the total acquisition cost that would deliver 3%/7%/8%/11% EPS accretion to ABBV from 2015-2018 respectively, and generate >$5B in total post-tax savings (~10% of SHPG's current market cap).
Indeed, we highlight that SHPG deserves a scarcity valuation and premium, given the following underappreciated realities of the NewCo.
Scarcity Value for ABBV
- The NewCo would unlock $4.9B in existing cash trapped offshore for AbbVie (NYSE:ABBV), and generate more than $3B in tax savings through 2020E (on current ABBV products, ignores operational synergies and excludes SHPG products).
- The critical variable undervalued by ABBV and analysts centers on the fact that through 2020E, the NewCo would unlock more than $18B in cumulative cash build for ABBV that would otherwise be trapped offshore (~50% of Net-Income) without SHPG.
- The reality is that ABBV will be able to deploy $18B (unlevered), or as much as $36B (2x levered) for share repurchases and/or further M&A. Assuming a 35% tax to repatriate the $18B represent $6.3B in added tax liabilities, compared to only $2.3B with an expected 13% NewCo tax, ~$4B supplementary tax savings. Thus, we calculate that there are at least $3B in tax savings to net income, plus $4B in tax savings circumventing repatriation tax of cumulative cash flows from ABBV's existing product portfolio 2015-2020 and net tax savings of ~$7B, but we reiterate that SHPG enables access to more than $18B that would otherwise be trapped.
- Consequently, SHPG must be valued with these cumulative tax savings, and warrants at least some valuation, not based on cash value but on a multiple of cash that will become available to ABBV. Critically, SHPG shareholders should not underestimate the intangible value this transaction is worth to ABBV, especially given the fact that its "3-DAA" all-oral regimen for HCV in genotype 1 patients is set to enter the market in December 2014. Conservatively, ABBV should generate up to $2B/year in HCV sales alone 2015-2018, and possibly up to $4B/year by 2020, thus the incentives are strong to close this deal ahead of this product launch.
Determining M&A Valuation
Note: SHPG ADR to SHP.LSE conversion is as follows: [ADR divided by 3, then divided by the GBP/USD currency exchange rate (~1.70 currently)].
On June 25th, 2014, AbbVie hosted an investor conference call to defend its case for acquiring SHPG. During the call, ABBV suggested this deal would be "materially accretive" during the first year, and would add > $1.00 EPS by 2020. ABBV could reduce its effective tax rate from 22% (following repatriation into U.S.) to as low as a 13% overall tax rate by 2016, that would unlock significant cash reserves held ex-US for additional M&A and shareholder returns. The NewCo would be incorporated in Jersey with U.K. tax domicile, and have an effective tax rate of 13% by 2016 (NPV of £4-13 or $7-$23/ADR); ABBV believes this transaction is "highly executable" and would represent a strong complementary fit to its specialty pharma business. ABBV management stipulated some pre-conditions for a firm and final offer; first, due diligence; and secondly, that Shire directors recommend the transaction to shareholders.
Credit Suisse conducted an M&A analysis of this deal showing that ABBV's offer does have room to increase, and the final deal range could climb to the £52-54/share ($265-$275/ADR) range. Using past pharma transactions as a framework for ABBV's current bid ~35% premium over an unadjusted price prior to the deal. Credit Suisse believes that similar deals at 35-45% premium reflect both a premium for control and also for sharing the benefits of uncertain sales and cost synergies
Although, due to the fact that SHPG shareholders can quantify the tax benefits which are expected to drive down the ABBV group tax rate from 22% to 13% by 2016, a higher premium may be required to give them an appropriate share of this substantial and relatively quantifiable stream of income. They conclude that from SHPG's perspective, a £52-54 ($265-$275/ADR) range by adding £22 (~$39/ADR) from the NPV of synergies to the standalone equity value of £24-32 ($122-$163/ADR), based on a range of possible scenarios. From an ABBV perspective, a £52-54 deal implies (13-17% additional premium) and 0.39-0.46 accretion in 2018 (no revenue expansion, ~15% cost savings of the target, 13% tax rate).
One critical element overlooked in this analysis was the fact that ABBV will be able to increase shareholder returns and gain extra financial flexibility from its lower tax to carry out future deals. This is something not able to be modeled reliably by analysts, but greatly increases SHPG's scarcity value to ABBV.
In our view, SHPG shareholders meeting with ABBV would be wise to emphasize that any acquisition of SHPG should include a premium value for the enhanced financial flexibility ABBV will gain to efficiently conduct M&A in the future that will certainly translate into revenue expansion (a key assumption in Credit Suisse's model).
During ABBV's conference call on the proposed merger, ABBV cited its desire to access "trapped cash," thus, one can infer that its current 22% tax rate is significantly understated by its need to repatriate cash to the U.S. One key element of this discussion, which has not been fully appreciated by the Street (at least in Credit Suisse' model), is ABBV proclaims that a significant source of value creation from the proposed merger arises from "revenue synergies," given ABBV's "broad geographic footprint" and its "broad global development organization" enabling it to "create superior value" relative to Shire as a standalone entity. Indeed, the analyst forecasts assume no revenue expansion through 2020, but acquiring SHPG enables ABBV to efficiently grow its topline through its global footprint and future M&A, which indirectly should be attributed to SHPG's valuation.
Many have asked "Is this already Priced in?" The simple answer is No.
SHPG's management has stated that ABBV's overtures "significantly undervalue its long-term growth prospects," we are inclined to agree with their viewpoint, and believe ABBV is committed to seeing a deal through that could value Shire at £55-£62 ($280-$316/ADR), according to a conservative analysis conducted by Merrill Lynch assuming 15% SG&A synergies, with an effective tax rate of 14%, which displays that ABBV could pay £62 ($316/ADR) for Shire or >30% premium to today's close at £45.70 ($233/ADR). We estimate that there is at least another ~20% premium required to gain shareholder approval, and as we noted previously, ABBV is anxious in seeing this through before its anticipated 4Q14/1Q15 HCV launch.
Below, we build on Credit Suisse's M&A model, assuming a £54 final offer ($275/ADR), 50% cash/50% ABBV stock vs. CS model 55%/45%, which translates into a 23% equity ownership by SHPG shareholders of the NewCo, with only an additional $83M in pretax interest charge above the current ABBV offer, but dramatically increases the probability of shareholders acquiescing to an ABBV offer from 52%-63% to >100%, assuming SHPG standalone discounted cash flow (DCF) value of £35-£39 ($179-$199/ADR) (see tables below).
The resulting output of our model (see table below) establishes that if ABBV raises its bid to £54 ($275/ADR), 50% cash/50% stock, the deal would be 3%/7%/8%/11% accretive to ABBV 2015-2018 respectively and generate >$5B in total post tax savings (~10% of SHPG's current market cap). This tax savings will be used for future M&A, and deserves some low-multiple based valuation, not a cash-based valuation, as the primary motive for ABBV's efforts are to efficiently deploy offshore cash reserves to grow revenues. Note, in order to enable a tax inversion, SHPG shareholders must own >20% of the NewCo, our £54 ($275/ADR), 50% cash/50% stock structure is above this threshold, at 23%.
Clearly, at least from an accretion/dilution perspective, this deal still has a significant spread between "bid/ask" to profit. Interestingly, this model is based on a 10x multiple to savings accrued to Shire shareholders; please note that the trough multiple for EU Pharma the past 9 years was 9.2x forward earnings, and the 5-yr. mean is ~15x fwd EPS (courtesy of Dr. Mark Schoenebaum, ISI Group). Thus, a more reasonable multiple would be ~12x, that would better account for this disparity between historical valuations and for a discounted time valuation. Applying 12x to the NewCo 2018 est. savings accrued to Shire shareholders of £2.26/share ($11.50/ADR) equates to £27.2 NPV/share ($139/ADR), a delta of £4.60/share ($23.46/ADR) or 10% upside to the current U.K. price of £46 ($234.60/ADR) by simply valuing the savings generated from this acquisition more accurately.
We aren't alone in our expectation of a higher revised bid, Merrill Lynch estimates a theoretical takeout valuation of £50-62 [$255-$316/ADR], assuming benefits are shared equally between Shire and AbbVie shareholders with blue sky valuation at £73/$372/ADR. Their model is based on the following assumptions:
1) Base-case DCF value of £45 per share ($229.50/ADR);
2) Achieving Shire's long-range forecasts of £6+ ($31/ADR);
3) NPV of cost synergies £5-9 ($26-$46/ADR);
4) NPV of a tax inversion £4-13 ($20-$66/ADR).
Jefferies analysis shows that a minimum bid of £50.00 ($255/ADR) is required to get the deal done, or ~8.5% premium to the June 27th close, but notes that their Pharma team's analysis "suggests ABBV could raise its offer up to 6500p whilst maintaining double-digit EPS accretion."
Jefferies has a £52.00 price target ($265/ADR), clarifying that "The premium target multiple reflects scarcity value for high quality assets such as Shire with tax structure advantages. NPVs suggest fair value c.2500p per share ($128/ADR)." Significant upside remains in Jefferies' model, showing that for every £5.00 per share increase to its bid, AbbVie loses c8-9 cents of accretion in 2020E versus the implied >$1.00 of accretion implied at the current stock price (see chart below).
Consequently, after building our own model and reviewing multiple sell-side models, the probability of a bid >£50 ($255/ADR) is almost certain, while a bid >£54 ($275/ADR) is approximately 70%, and anything greater £60 delivering <10% 2020E EPS accretion is unlikely, thus we conclude as our base case £54 ($275/ADR) as the most likely outcome, using a targeted >12% 2020 EPS accretion for ABBV as bogey.
However, if negotiations fail before the deadline, we are still bullish on SHPG, with up to $9B in M&A capacity that could result in 15-25% EPS upside (Shire intends to increase leverage to 2.5-3.0x net debt/EBITDA through acquisitions vs. 0.6x now and zero by year-end), and shareholder approval to expand its borrowing capacity to $12B, we note will only transform it into a more valuable asset to ABBV and others in the future. Importantly, there is plenty of upside as expectations trend toward Shire's guidance on long-term sales targets (15% above ML estimates) with Phase 2 and 3 pipeline readouts coming (see figure below) that could increase confidence in Shire's long-term organic growth and that would translate into a double-digit earnings CAGR through at least 2018E (ex-M&A).
If ABBV fails to offer a higher bid before July 18, we anticipate ABBV returning to the table in 6 months' time after SHPG engages in additional M&A on its own, at which point, the bid/ask will have to reflect SHPG's newly acquired assets possibly from NPS Pharmaceuticals (NASDAQ:NPSP). However, we remain confident in ABBV announcing a formal bid, the company indicated that it is "committed" to carrying out this transaction, but will remain financially "disciplined." Using these two key words as a guideline toward valuation, "committed" and disciplined," shows that both objectives can be achieved between £52.00-£60/share ($265-$306/ADR).
According to RBC Capital Markets, "ABBV will meet with Shire investors shortly, and is likely to have a better idea of what it will take to push this deal through by the July 18th deadline." We anticipate a bid prior to the deadline, but believe there is significant potential for other potential bidders to enter the foray if a "best and final" offer is made by ABBV. A separate possible outcome could be formulated with contingent value rights (CVRS) on various Shire pipeline assets, in addition to the current bid from ABBV.
To allay concerns of a Pfizer/Astra-Zeneca rerun, several distinguishing properties of this deal should assuage investors:
- Higher probability of a competitive bidding process, as Shire is smaller than AZN and is attainable to more U.S. counter bidders.
- Higher risk for activist shareholders to get involved.
- Substantially less political risk with Shire, given its small employee and U.K. R&D base.
- Shire has a higher percentage of U.S. ownership than AZN (60% vs. 42%), indicating that investors may be more willing to accept U.S. equity from a U.S. suitor.
- Shire generates 67% of revenues from the U.S. vs. AZN 38%.
If No Higher Bid from ABBV, then SHPG will Buy NPSP, ABBV (or another suitor) will Return Later
In defense of its standalone strategy, Shire has published its 10-year Strategic Plan arguing that as an independent company, it could more than double its revenue in the next seven years, modeling peak 2020E sales of >$10B, expecting $7 billion in annual revenue from its current products and another $3 billion from its existing pipeline by 2020, implying a DCF valuation of £51 ($260/ADR), the price we see as the minimum acquisition value. ABBV's current offer translates into a 4.6x 2020 peak sales estimates, and Shire is aiming for 2016 sales of $6.5 billion (ABBV bid~7x 2016 sales), and this is where the rub lies.
Price and valuation of the pipeline seem to be the primary impediment to closing the ABBV/SHPG deal, in direct contrast to the fundamental and philosophical divides on strategy between the Valeant (NYSE:VRX) and Allergan (NYSE:AGN) proposed merger. Mr. Ornskov said that Shire did not believe the company's future potential was "reflected in the current share price or the AbbVie proposal," but he declined to comment on whether Shire had been approached by other companies or believed there was a better potential combination than the one proposed by AbbVie.
Q: Price and actual bidder are key elements of M&A. Have you had any other bidders?
A: No comment
One point of disagreement may dwell on the sustainability of Vyvanse cash flows (~25% of NPV) with early patent infringement litigation ongoing; a favorable outcome recently emerged on June 26, 2014, when a District Court Judge granted Shire's motion for summary judgment in its lawsuit against the five generic filers challenging Vyvanse's patents. This ruling prevents the ANDA filers from launching generic Vyvanse until the earlier event of either a successful appeal or the expiration of the patents in 2023, removing a significant overhang on ABBV's valuation, in our view.
We believe there is a greater necessity for ABBV to follow through with a Shire inversion than with other potential bidders given the sustained operating leverage ABBV would gain, and given our accretion to earnings analysis above, we believe there is a high probability for a higher bid from ABBV due to the reality, and that there is a urgent need to diversify revenues away from a Humira-dependent sales base (>55% of sales), hence, the power at the negotiating table remains with Shire, not ABBV. Shire's U.K. domicile and preferential tax rate should be enough to retain the current takeover premium throughout 2014, and we fully expect additional bids to come from ABBV no less than £52 ($265/ADR), but could be as high as £60 ($306/ADR), as it will give management access to more than $4.9B in offshore cash reserves immediately (table below) and enable future access to more than $18B through 2020.
As the potential bid-ask spread for the ABBV takeover of Shire remains wide, we return to management commentary from ABBV and note their model of SHPG "does not reflect the same magnitude of pipeline or GI franchise potential" from Shire. Which conveniently leads us to NPSP. On the Shire conference call, management stated their M&A efforts were "only the start," and we lay out our thesis that an acquisition of NPSP seems highly probable if SHPG is successful in thwarting ABBV's overtures through July 18, 2014 (U.K. takeover law precludes further efforts for a period of 6 months); if this deadline is reached, we believe Shire's management will be under enormous pressure to act to make good on its promises of future growth.
Shire agreed to pay $260 million plus milestone payments for privately-held Lumena, a developer of experimental drugs for a set of diseases, such as primary sclerosing cholangitis, in which the formation or flow of bile is impeded, leading to liver damage, liver cancer, or the need for a transplant. The deal represented the sixth since the new CEO's appointment in October 2012, including the $4.2 billion acquisition of ViroPharma Inc. in November. The CEO, commenting on Shire's M&A strategy, stated, "I always felt the ideal combination would be if we could have our gastrointestinal focus aligned with our rare disease business," he said.
At the end of May, The Financial Times reported that Shire is preparing a $4.2B bid for NPS Pharmaceuticals. We believe that NPSP perfectly suits SHPG's stated M&A interests, and makes it a viable takeover target having exposure to both gastroenterology and rare diseases. Shire has ample financial leverage to pay a premium for NPSP, if necessary, and will retain excess financial capacity for an additional $4-$5B in acquisitions subsequent to any proposed merger.
NPSP's lead product, Gattex, for Short Bowel Syndrome, has strong commercial synergies with Shire's rare disease and GI platforms. Its orphan drug indication will treat only 3-5k patients in the U.S. It had a commercial launch in January 2013, and sold $32m in 2013. But ML forecasts $300m in sales by 2016 and $1bn by 2020. Natpara for hypoparathyroidism (last remaining hormone deficiency condition for which there is no approved therapy) will be targeting endocrinologists, represents less overlap with SHPG's existing commercial infrastructure, but fits with its objective to expand in rare diseases (WW market of only 180k patients, 30-80k are in the U.S.), and is expected to reach sales of $900M by 2020, with the possibility to expand Gattex (Teduglutide), currently in Phase 2 for Crohn's disease as upside drivers. Making sense of a possible NPSP acquisition comes directly from SHPG's presentation of its 10-year plan, where the company hopes by 2020 to achieve revenue of more than $3 billion from its rare diseases product segment, more than $3 billion from its neurosciences segment, and more than $1.3 billion from its gastrointestinal segment. An NPSP addition could help SHPG achieve 75% of its 2020 G.I. sales target ($1.3B) and 30% of its rare disease goal of ($3B).
Merrill Lynch modeled that an NPSP acquisition would be accretive to EPS by c7-9% in 2016 and c25% by 2020, and raise NPV by c5-8%. While NPSP has denied that any such approach from Shire has taken place. We view this as a compelling opportunity to enter into both NPSP and SHPG via the options market, on the premise that both companies have strong prospects as standalone entities and as takeover targets.
It is our view that the best trading approach is to be long both SHPG and NPSP, as both have strong fundamentals and significant upside from current levels. NPSP could reach $40-45 in 12 months if not acquisitioned, driven by its anticipated approval of Natpara (July 24 Adcom, Oct 24 PDUFA), while SHPG has 13-20% upside from current levels and has a tentative floor valuation, as we cannot rule out the possibility of another suitor, such as Allergan or others (see table above), in addition to ABBV engaging in takeover talks.