AbbVie: Barclays Is Late To Upgrade, Using Highly Favorable Assumptions

| About: AbbVie Inc. (ABBV)


Barclays turns bullish on AbbVie's prospects.

This is driven by a positive Humira outlook and optimistic assumptions regarding a potential Shire acquisition.

I do not see compelling value at these levels.

Shares of AbbVie (NYSE:ABBV) added to its recent momentum on Wednesday, as analysts at Barclays were positive about the company's prospects. This is despite being more cautious on the prospects for the entire industry.

In my eyes, Barclays is a bit late in the game, after shares have risen nearly 10% in recent weeks on the hopes of a potential deal with Shire and after the company hiked its full-year earnings guidance.

I remain cautious on the back of in my eyes aggressive assumptions which AbbVie is using for the future. This includes low single-digit tax rates and aggressive accretion estimates.

Barclays Turns Bullish On AbbVie...

Analyst Mark Purcell upgraded his rating on AbbVie from equal-weight to overweight. Purcell raised the price target towards $69 per share, suggesting another 19% upside from Wednesday's closing levels.

Key to his optimism is the anticipated performance of AbbVie's blockbuster Humira which threats arthritis, among others. Purcell recognizes that branded and biosimilar drugs pose a competitive threat. Yet the proposed deal with Shire PLC (NASDAQ:SHPG) could unlock value by resulting in better diversification, thereby easing concerns about concentration on Humira.

Regarding a potential deal with Shire, Barclays believes that a possible transaction could be up to 18% accretive to earnings as far away as 2020. Even if a bidding war might break out, Purcell anticipates the deal to be accretive to levels as high as 64 Pounds per share, based on "conservative" tax rates of 22%.

With regards to his estimates, Purcell anticipates sales of Humira to come in around $15 billion by 2020 which compares to consensus estimates at $12.3 billion.

...While Being More Cautious On The Sector

The timing of the upgrade is a little remarkable as Purcell has turned neutral on the wider sector. The main reasons to be more cautious on the US pharma majors are the increased valuations, modest growth prospects and priced in pipeline expectations. Purcell also notes that the biopharmaceutical industry is becoming more of a crowded competitive field.

Purcell also believes that the focus on "quality" and "defensive" stocks in this current stock market environment will result in an underperformance versus more cyclical sectors.

Purcell's Upgrade Is Driven By Diversification And Strong Humira Performance

A few weeks ago it was announced that AbbVie has made an offer for Shire with talks having ended ever since. This is the reason why CEO Richard Gonzalez has met with some of Shire's shareholders over the past weekend. This news implies that AbbVie might even go hostile to acquire Shire.

After hiking its initial offer, AbbVie was willing to pay little over 46 Pounds in a potential deal which would value the company at roughly $46 billion. It now seems that in order to acquire the business an offer of at least $50 billion might be required.

With the deal, AbbVie could add nearly $5 billion in annual revenues while adjusted earnings came in at about $1.4 billion last year. The multiple at 9 times sales and 30 times earnings was by no means cheap. A potential deal would diversify AbbVie's revenue base and perhaps boost growth prospects following Shire's acquisition of Viropharma.

Shire's contribution would come on top of AbbVie's annual revenues of $18.8 billion on which the company posted earnings of $4.1 billion. Note that Humira made up 57% of total revenues over the past year with revenues coming in at $10.7 billion in 2013. Following a potential deal with Shire, the reliance on Humira would fall to 45% of sales which is a noticeable drop, but still does not bring real diversification.

Purcell's prediction of $15 billion in sales by 2020 implies a compounded annual growth rate of roughly 5% per annum for the drug. This projection is very debatable with Humira's patent set to expire by December of 2016 in the US and one and a half years later in Europe. As such, any potential sales targets will have to bake in the impact of the expiration which is essentially just a guessing game.

To see so much growth in Humira's sales until 2020 seems very ambitious given the upcoming expiration of patents by 2016 in the US and 2018 in Europe.

Potential Benefits From Shire

The battle for Shire could have some potential benefits like the diversification as discussed above, as well as anticipated tax synergies. While Shire is domiciled in Ireland its effective tax rate of 16.4% for 2013 was above the official rate of 12.5% and not so much lower than AbbVie's rate of 22.6% as reported for 2013.

Despite this, shares of AbbVie have seen some recent momentum following news about a potential deal despite the steep premium being offered for Shire. In a recent presentation, AbbVie furthermore stresses the usage of AbbVie's global infrastructure which could result in even more synergies which would justify a 46 Pound offer for Shire. This came after shares were trading at just 30 Pounds around the turn of the year.

AbbVie anticipates that a potential deal at those levels could be accretive to 2020's earnings to the tune of $1.00 per share. Given the current adjusted earnings of $1.4 billion reported by Shire and nearly $50 billion in funding, which is at least required to finance the deal, this assumption is rather optimistic and assumes Shire's earnings to grow very rapidly in the future.

Note that the company is using highly optimistic assumptions to calculate the anticipated accretion. Most prominent is an effective tax rate of as little as 13% by 2016. This is much lower than the effective tax rate of both companies at the moment and is just 50 basis points above statutory tax rates.

Good News In The Meantime

Investors were comforted during this news flow by a solid guidance and slight hike in the full-year earnings guidance. Non-GAAP earnings are now seen between $3.06 and $3.16 per share which is six cents higher than its previous guidance, while GAAP earnings are anticipated to come in between $2.69 to $2.79 per share.

The outlook excludes any potential contribution from the hepatitis C (HCV) therapy which has been granted an accelerated review by the FDA. AbbVie sees huge market potential for HCV, if approved, estimating a potential $12 billion contribution by 2015, as it will compete with Gilead's (NASDAQ:GILD) successful debut of Sovaldi.

Final Takeaway

About two weeks ago, I checked out the prospects for AbbVie following news reports regarding the potential deal with Shire.

I concluded that the market was being very optimistic regarding a potential deal despite the fact that AbbVie raised its offer reportedly three times in private negotiations.

Given the run-up in AbbVie's shares on top of the proposed premium for Shire, the market was attributing a big premium as a result of the potential deal driven by strategic rationale, being the diversification effects, and relatively modest potential tax synergies which I then estimated around $325 million.

Since that time, shares have risen some 10% on the back of the positive comments for full-year earnings guidance and aggressive accretion targets of $1.00 per share resulting from a potential deal by 2020. The higher than anticipated tax synergies have been helpful as well, just as the general strong momentum in biotechnology and pharmaceutical names.

This has pushed the valuation to roughly $92 billion, or roughly 5 times sales and 22-23 times earnings. I remain a bit skeptical about some of the aggressive assumptions being used by the company to defend the long-term rationale of a potential deal. Given these assumptions, I won't rule out a new increased offer for Shire which would be a clear negative in my option.

While the short term looks good, driven by continued growth in Humira and a potential introduction of HCV later this year or next year, I am worried about the patent cliff impacting Humira. As such, I fail to see the compelling upside at these levels unlike Barclays.

Disclosure: The author is long GILD. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.