After rather swift negotiations, Japanese pharmaceutical company Takeda (TSE:4502, Financial) has come to terms with Shire (SHPG, Financial), a major biopharmaceutical company (and actually bigger than Takeda itself). For months, Shire has been at the top of numerous industry lists as a potential buyout target, so it was not terribly surprising when Takeda put it into play in April.
Shire was initially reticent, evidently expecting to see multiple rival bids emerge. Yet, the company ultimately jumped on Takeda’s eventual offer of about $62 billion after an abortive attempt by Allergan (AGN, Financial) to get in the running fell apart almost immediately.
The deal isn’t done yet
While the two companies have come to terms, the deal is not yet set in stone. Shire is enjoying a massive premium over its pre-offer market cap of approximately $40 billion, but Takeda is looking at an expensive acquisition. When its shareholders are asked to approve the deal, they may balk.
And the challenges will not end with shareholder approval. There is already some skepticism among analysts about the long-term value of Shire’s assets, as well as near-term operational challenges that must be faced to make such a large merger succeed.
Shareholders do not look enthused
Takeda’s shareholders may scupper the buyout before it ever goes through. Certainly, the market reaction to the terms of the deal has been far from kind. Takeda’s shares have fallen substantially, dropping more than 20% at one stage during the talks. Clearly, shareholders are worried they will be paying an inflated price for Shire’s assets.
It is true Shire has a profitable ADHD business, but its patents are already quite long in the tooth, even as an increasing number of competitors race to develop next-generation market leaders in the segment. Likewise, Shire’s blockbuster hemophilia drug, Vyvance, could face profit erosion much faster than most current models project, thanks to the entry of Roche’s (XSWX:RO, Financial) Hemlibra.
Takeda’s management will have to make the case that these assets continue to have significant cash flow generation power for many years in order to justify this tie-up. While it will undoubtedly see considerable profits, it is far from clear whether they will be sufficient to justify the high cost of acquisition.
A more efficient operation?
That said, Takeda and Shire have identified several ways to cut costs and improve efficiency. The most startling is the planned job cuts, which would see the merged entity shed around 7% of its combined workforce.
While this promises to cut out redundancies in the sales and administration departments, research and development is set to represent a third of the cuts. While many of these job cuts will be at a pair of research subsidiaries that have already been heavily restructured recently, slashing research may end up costing down the line, especially given Shire’s aging intellectual property.
Overall, Takeda promises to carve out $1.4 billion in cost synergies from the merger. That is substantial, but holds execution risks in the near term. It may also mean long-term issues if the efficiencies prove to be too little overall; that is possible, given the high price being paid for Shire.
Will the deal pay off?
Ultimately, the question is whether the deal will pay off, i.e., end up delivering more value than it costs. It certainly looks like the culmination of Takeda CEO Christophe Weber’s dreams of building the company into a major industry player. Indeed, the merged entity will be ranked among the top 10Â global pharmaceutical companies by revenue.
Takeda, in buying the larger Shire, may be biting off more than it can chew. With a consortium of three banks financing the cash element of the deal – worth $31 billion – in the form of a bridge loan, Takeda will be putting a whole lot of debt onto its balance sheet. The bridge loan is supposed to transition into a long-term loan once the merged entity’s credit rating can be determined. Given the sheer quantity of debt about to be piled on, it is probably not going to be a great rating.
Verdict
Empire-building is often not done in shareholders’ interests. The jury is out on this particular deal, but the high cost of the acquisition (and attached debt burden) means there is precious little room for error.
And Takeda's shareholders may well say no. While there are advantages to growth and Shire has valuable assets, passing on the deal may be the safest play for maintaining shareholder value.
Disclosure: I/We own no stocks discussed in this article.
