AbbVie Inc. Wins the Shire

Pfizer couldn't bag AstraZeneca and Valeant is still trying win over Allergan's (NYSE: AGN  ) shareholders, but AbbVie (NYSE: ABBV  ) has managed to close its major deal. AbbVie and Shire (SHPG) announced on Friday that the companies had agreed to a merger that will see AbbVie acquire the Irish-based drugmaker on the previously announced terms of GBP 24.44 cash and 0.896 shares of AbbVie for each Shire share.

No onerous terms
While Shire management had indicated earlier this week that it was willing to support the offer price that AbbVie proposed, there were still some outstanding issues to resolve. There was plenty of speculation as to what those issues were (my own included), but there really weren't any significant additions when it was all said and done.

For the deal to go forward, 75% of the votes of Shire shareholders must be in favor, while AbbVie needs a simple majority (50% plus one). Shire will be entitled to a break-up fee if the deal doesn't go through, with the exact fee decided by the circumstances (ranging from 1% to 3%). Importantly, there are no contingent value rights tied to any of Shire's products or pipeline candidates, nor are there any provisions in the terms to indemnify AbbVie should the U.S. enact legislation that retroactively changes the rules regarding tax inversion deals.

All of that said, AbbVie shareholders may not like one particular term of the deal. To work as a tax inversion, there will be a "new AbbVie" headquartered in Jersey that will be the surviving company and the nature of the transaction means that the transfer of "new" AbbVie shares for "old" AbbVie shares will be a taxable event for U.S. shareholders.

Paying for lower taxes and better diversification
AbbVie is expected to generate over $19 billion in revenue this year, while Shire is forecast to generate less than $6 billion. While Shire does have a worthwhile pipeline in rare diseases that could generate meaningful sales in 2020 and beyond, AbbVie is not doing this deal to augment its top line prospects, or at least that is not a major reason.

AbbVie is paying $55 billion (or nine times estimated 2015 revenue) in large part to benefit from a lower tax rate; management believes that this transaction will reduce its effective tax rate from 22% to 13% and with a trailing pre-tax annual income of almost $5.5 billion (on a stand-alone basis), nearly half a billion in annual tax savings is not at all trivial.

This deal also brings some diversification to AbbVie, though perhaps not quite as much as you might think from the hoopla over that part of the deal. Humira will go from around 55% of AbbVie's sales to about 40%-less, obviously, but still a very large percentage of the total. Shire will give the company another $1B-plus drug (Vyvanse), but none of Shire's other drugs would crack AbbVie's top five at this point. Diversifying away from Humira is a worthwhile goal given the risks of future biosimilar competition, but I think the deal has to be looked at as an accumulation of multiple benefits more than a "killer app".

I also think it's worth noting that Shire is a pretty good company right now. With this announcement, the company bumped up its earnings release and announced 20% sales growth for the second quarter, slightly topping estimates and with good margins.

A rival to emerge?
It is at least possible that a rival bidder for Shire could emerge now that the terms have been laid out. Pfizer doesn't need the portfolio diversification like AbbVie does, but would still see a significant tax benefit and may like the incremental exposure to rare disease drugs.

Allergan, too, has been frequently discussed as a suitor for Shire, but I see a vanishingly small chance of a successful bid coming from Allergan. Excluding Valeant's hostile rhetoric, an Allergan bid for Shire would likely look a lot (to Shire) like Valeant's bid for Allergan – the strategic overlap is limited, the acquirer doesn't enjoy a particularly good reputation with respect to R&D/product development, and the selling shareholders would be getting a lot less cash and pretty speculative shares in exchange.

The bottom line
Healthcare companies have gotten a lot better about striking "win win" deals in M&A, and I believe the AbbVie-Shire deal qualifies. It wasn't so long ago that Shire shares were languishing below fair value, with Wall Street refusing to acknowledge the same potential in the pipeline that management saw. At a premium of over 50% to the original offer point, Shire shareholders are getting a good deal in this offer.

For AbbVie, the company has reduced some of its portfolio risk around Humira and acquired a strong business and pipeline in rare diseases. I believe it will take additional deals and portfolio additions to really maximize the benefits of the transaction, but it is a good deal for AbbVie shareholders as well.

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