Following a number of pharma mergers last year, which included the likes of Actavis and Forest Laboratories, Shire (SHPG, Financial) announced on Jan. 11 that it is acquiring NPS Pharmaceuticals (NPSP, Financial) for $5.2 billion.
Shire is based in Dublin, Ireland and focuses on treatments in the areas of neuroscience, rare diseases, gastrointestinal, and internal medicine. Just last year, Shire was in the opposite position, when it was the target in an acquisition by AbbVie (ABBV, Financial). Illinois-based AbbVie would have relocated the company headquarters to the U.K. and lowered its tax rate. The company backed out of the deal after the U.S. Treasury released measures that would have made tax inversion plans less attractive.
Instead, an analyst at Sanford C. Bernstein said to The New York Times that Shire may be on the buyer’s side for a while, since it’s unlikely a company will pay the premium necessary for Shire after the NPS deal.
Following the announcement, NPS’ stock rose to $45.43 on Jan. 12, up from $41.91 on Jan. 9. To further analyze these mergers, GuruFocus provides the Merger-Arbitrage checklist built on the strategy used by John Paulson (Trades, Portfolio) of Paulson & Co.
In his book, Managing Hedge Fund Risk, Paulson defines the “risk” in risk arbitrage as anything that affects the deal’s completion, timing of completion, or amount of consideration received at completion. Paulson avoids deals that are agreements in principle, those subject to financing, and target companies with low earnings. He instead looks for deals with definitive agreements, no financing conditions, reasonable valuations, and low regulatory risk.
Using Paulson’s checklist, the Shire-NPS merger has a final score of 4 out of 5, though of course, this score may vary depending on the view of each individual investor.
The merger parties have definitive agreements instead of agreements in principle
Shire and NPS do have a definitive agreement in which Shire will acquire NPS for $5.2 billion, or $46 per share. The price is a 51% premium to NPS’ share price of $30.47 on Dec. 16, 2014.
The merger has strategic rationale behind it
The merger will allow Shire to continue its entry into the rare diseases sector, since NPS has two drugs that treat rare conditions. Pharmaceutical companies face high R&D costs, where it is substantially more difficult to create new products consistently compared to other industries. This leads larger pharma companies to absorb smaller, more specialized, firms.
Shire is the more established company with a stronger financial position, placing it in a good position to aquire NPS’ productions, as well as oversee the drug that is currently undergoing FDA approval. NPS’ only approved drug, GATTEX/REVESTIVE, treats short bowel syndrome (SBS) and fits in with Shire’s gastrointestinal experience.
No financing condition
Shire will aquire NPS in an all-cash deal. According to Shire’s press release, the company secured an $850 million short-term bank facility, which in addition to cash assets and an existing $2.1 billion revolving credit facility, will finance the transaction.
No due diligence condition
A Jan. 12 Wall Street Journal article referenced Jefferies analyst Peter Welford as writing that discussions with Shire’s management indicated extensive due diligence was undertaken before the decision. Bloomberg reported the due diligence included looking the NPS’ correspondence with the FDA on approval for Natpara, a drug for a hormonal abnormality called hypoparathyroidism.
Solidly performing target
NPS has a strong balance sheet with a current ratio of 4.45, meaning the company can easily pay its short-term obligations. NPS has also been consistently paying off its long-term debt, which recorded at $123.6 million in FY 2013.
However, several of NPS’ numbers certainly reflect the fact that it operates in an industry with high R&D costs, in addition to the concentration on rare diseases.
While revenue per share has been increasing since FY 2011, diluted earnings per share is consistently negative, and was $-0.14 in 2011. NPS’ free cash flow has also been negative since FY 2004.
Reasonable valuation
There has been enough concern about the valuation of the merger that law firm Tripp Levy is investigating NPS on behalf of its shareholders. According to the law firm’s press release, the price of $46 per share is not an accurate reflection of the company’s value. In addition, if NPS’ Natpara medicine is approved by the FDA, the company’s value will continue to increase.
The current $46 per share is an increase from earlier reports in July 2014, when Shire was considering offering just $40 per share.
Limited regulatory risk
Shire took a risk in acquiring NPS before the Natpara drug is approved by the FDA. If the drug is not approved, Shire will be responsible for pushing the process forward.
Both companies operate in a highly regulated pharmaceutical and life sciences industry. However, since Shire and NPS’ products target a small population of patients, it’s unlikely the merger will face anti-trust scrutiny. Any regulatory risk that faces the merger is standard to the industry in that new products must be rigorously tested and approved.
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