Key Takeaway
EPS accretion and cash flow benefits from acquiring Shire could be higher than investors appreciate as we consider the underlying tax rate of ABBV. Inversion risk looks to be the key driver of the ceiling, which we estimate at £55 per share.
Shire bid driven by financial engineering, but there may be other benefits: In the recent M&A environment there appears to be no dispute amongst the investment community that AbbVie’s interest in Shire (SHP LN, 4,371p, Buy) looks to be primarily driven by financial engineering (tax inversion). We see limited synergies between the two companies and limited cost saving potential as a result. However, we have considered that an acquisition by AbbVie may be required to dilute the contribution of Humira over time as well as to prevent AbbVie itself eventually becoming prey to industry consolidation.
Shire deploys bid defense out of the AZN playbook: Both Shire and AbbVie have confirmed the recent offers, with the third and most recent attempt on 30th May, 2014 valued at £46.26 (based on AbbVie’s calculation using the May 29 AbbVie close price) or £46.11 (based on Shire’s calculation using 30-day volume average weighted stock price for AbbVie). Shire’s board has used language familiar to the recent Pfizer (PFE, $29.78, Buy)/ AstraZeneca (AZN LN, 4,470p, Hold) proposal to reject the approach, including:
1. The bid fundamentally undervalues Shire,
2. The company has seen accelerating growth and shareholder returns over the last 12 months following a change in management,
3. Shire will more than double sales to $10bn by 2020, and
4. The proposal would deny shareholders the full benefits of Shire’s growth strategy.
AbbVie can raise materially in our view, but will have to risk-adjust inversion:
We have made preliminary models of various scenarios around AbbVie’s potential merger with Shire. All our models assume c$900m of cost savings from Shire over 3 years to 2018 (c25% COGS; c15% R&D; c20% SG&A), c473m new shares issued to Shire shareholders and use of c$7bn of existing OUS cash as part of the consideration with the remainder made up by new debt issued at 4%. The key determinant of accretion in our hands is the new tax rate attainable by the merged ABBV-SHP entity.
Blue Sky scenario implies bid could go much higher: Referring to AbbVie’s c11% underlying tax rate implied by filings made by Abbott (ABT, $40.85, Buy) prior to its separation, we can see material upside to AbbVie from buying Shire if it were to once again able to access this tax rate for its operations. A weighted average of AbbVie’s underlying and Shire’s tax rates implies a “Blue Sky” pro forma tax rate of c13% by our estimates. On this basis we still see c10% EPS accretion at a raised offer price of £55 per share assuming $7bn OUS cash, c$22.3bn new debt issue and c$25.6bn from shares as consideration.
Inversion risk may cap bid at c£55 in reality: One of our own criticisms of how AstraZeneca’s board handled the Pfizer bid was the desire to absorb too much of the accretion from Pfizer’s use of OUS cash and tax inversion. Shire appears to be going down the same road, though we consider (as we did for Pfizer when we capped what we thought it might offer at c£55 per share for AstraZeneca) the risk of successful inversion failing as a cap on what can be offered. A failure to tax invert optimally and only achieve a pro forma tax rate of c21% may cap what AbbVie can offer at c£55 per share before it becomes dilutive.
Expecting a raised bid up to £55 per share: Considering a worst case of zero EPS accretion, but a PE multiple raise of 1-2 points based on watering down Humira’s profit contribution, we think AbbVie can raise its bid to £55 per share. We remain bullish on AbbVie’s fundamentals and do not see this transaction as indicative of any weakness, but instead as an opportunistic transaction to lower taxes, diversify risk and improve cash flow.
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