Will Shire Be Bought Out?

The clock is ticking for Takeda (NASDAQOTH: TKPYY). Following its announcement late last month that it's considering an acquisition of Shire (NASDAQ: SHPG), it has until April 25, 2018, to present the latter's board of directors with an offer or walk away empty-handed. If it does make a bid, it could create a global company with about $30 billion in sales. However, this deal could be costly. In this episode of The Motley Fool's Industry Focus: Healthcare, analyst Kristine Harjes chats with Todd Campbell about this potential deal and whether it might make sense. 

Also, the two weigh in on news that one of Alkermes' (ALKS -0.46%) most promising drug candidates received a Refusal to File notice from the Food and Drug Administration. Does the FDA's decision mean an end to Alkermes' depression drug? 

A full transcript follows the video.

This video was recorded on April 4, 2018.

Kristine Harjes: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. We're talking about healthcare today, April 4th. My name is Kristine Harjes, and one of The Motley Fool's expert healthcare contributors, Todd Campbell, is joining me on the phone. What's going on, Todd?

Todd Campbell: Hi, Kristine! How are you today?

Harjes: I'm doing great! I'm about to head on vacation tomorrow, so today is my Friday.

Campbell: Fantastic! That sounds like a lot of fun. Are you going to go somewhere nice and sunny?

Harjes: Hopefully. I've been seeing in the forecasts a lot of rain for California and Hawaii, which are the two places that I'm going to. But I'm hoping it's temporary rain, where maybe it's a couple of rain drops at like 04:00 PM, but the rest of the day is sunshine. We'll see.

Campbell: You'll bring the sunshine wherever you go, right?

Harjes: Aww. I hope so. [laughs] That certainly hasn't been the case in Alexandria lately, but that's OK.

Campbell: Well, that's typical for April, right?

Harjes: Yeah, April showers.

Campbell: Bring May flowers.

Harjes: Exactly. Japanese drug maker Takeda announced on Monday that they're looking at buying rival Shire, sending shares of Shire higher and Takeda lower. That's a very typical acquisition announcement reaction, although this wasn't quite an announcement yet that the acquisition is happening. It's just an announcement that they're thinking about it. Todd, what do you make of this?

Campbell: This is great fun, because we actually get to talk about some stocks that aren't U.S. centric stocks, necessarily. You and I and probably most of our listeners don't spend a whole heck of a lot of time thinking about Takeda. And maybe we should. This is a global health company. It's been around for almost as long as the United States of America, that's how long this company has been around. So, maybe a little bit surprising that we don't talk more about it. 

One of the things that I think is interesting, since we're talking about a couple foreign companies here, you have Takeda, which is obviously a Japanese company, you have Shire, which is a U.K. based company, there are some rules that apply in the U.K. that don't apply here in the United States. And the rule, called Rule 2.7 of the U.K. City Code on Takeovers and Mergers, basically applies to everything in the U.K., if you're seriously thinking about making a bid for a company, then you actually need to disclose that, I think it's 28 days prior to an offer being made or walking away from the deal. The idea there is, it gives all shareholders equal insight into whatever discussions may be going on between companies. 

Now, Takeda has not talked to Shire's board as of the time of their announcement that they're thinking about making a bid for Shire, so there's nothing firm on the table that's been presented. But, like you said, that was enough to send Shire shares soaring, I think 17% of the day, and to cause Takeda's to tumble a little bit.

Harjes: Yes. We should get a firm decision by April 25th. Essentially, what their Monday announcement did was start the countdown timer.

Campbell: Right. April 25th, if they make an offer, then it starts another clock. The decision by Shire's board doesn't necessarily need to come on that day, but that's the day that Takeda would have to make the offer.

Harjes: Right, exactly. So, what investors are considering now is, does this acquisition makes sense, and can Takeda pull this off? This is a company that has a lot of debt, on one hand, but as we mentioned, they're based in Japan, and it's a lot easier to get relatively cheap financing in Japan than it is pretty much anywhere else in the world, particularly when it compares to the United States. For example, companies like Takeda can typically get financing for around 0.34% on their debt, which is far below what blue-chip U.S. companies typically pay, which is more in the neighborhood of 3.8%. So, even though Takeda has quite a bit of debt already, $11 billion, it's potentially more doable because of the fact that they are based in Japan than it would otherwise be.

Campbell: The company is also on a little bit better financial footing than it was two or three years ago. They actually have leadership in there now that's doing a good job in carving out some costs and trying to make this company a little bit more profitable. That's one of the reasons that you saw their earnings last year grow at a much faster pace than their revenue. That's giving them a little bit more flexibility to do some deals, too. 

Like we mentioned, they are a global company. They have sales in 70 countries. As a matter of fact, about 70% of their workforce is actually outside of Japan. And their goal is to get even bigger. They particularly want to increase their exposure to the United States market, which makes sense, the U.S. is the biggest market in terms of drug spending. And Shire would do that. Shire gets more than two-thirds of their sales in the U.S. market. So, that's a plus. 

They may also find a willing seller in Shire. If you remember, you and I talked about this back in 2015 or something like that, Shire was in play with AbbVie trying to acquire it. AbbVie tried to buy them for $54 billion, and eventually ended up walking away because tax inversions fell out of favor. The U.S. basically put a stop to those. So, you could end up finding a willing seller.

But, like you mentioned, we're not sure this deal could get done, because Takeda is actually smaller in terms of market cap than Shire. It does a little bit more in revenue. Depending on how you look at currency exchange, it's probably around $16 billion or so in USD, where Shire does about $14 billion. But if you include the debt that Shire has now, you're talking about a deal, I think Shire's enterprise value is about $66 billion. So, this would be more like a merger than it would be necessarily a takeover.

Harjes: Which does make this kind of unusual. I think it falls into the broader story that we've been talking about of atypical M&A. We've seen a lot of somewhat unusual deals either being announced or being considered. For example, earlier this week, we heard that Walmart might be considering something with Humana, whether that's an acquisition or it could end up just being a partnership. But I think a couple years ago, we would have been scratching our heads, like, "What? This is coming out of nowhere." But, when you consider other deals that have been announced recently, like CVS and Aetna, Cigna and Express Scripts, this seems to me just another example of the potential for M&A really expanding into areas that might have otherwise seemed unusual.

Campbell: Yeah. And the timing of this may not be that bad, either, when you think about it. Shire's share price has fallen about 30%, not including the recent spike, because of some generic concerns and some slowing top line growth. They're going to go from high-single-digit revenue growth to mid-single-digit revenue growth this year. And earnings, actually, after growing 16% last year at Shire, are expected to pretty much flatten out this year because of some expenses that they have. So, you have got a company that has the share prices fallen. I think it's trading at only 10X, something like that, forward earnings. So, Takeda might be looking at this and saying, "If we are going to strike and try to do a big deal to boost that U.S. exposure, maybe this is not a bad time to approach Shire."

Harjes: Yeah. And I'm sure AbbVie, as you mentioned earlier, is still looking at Shire and wondering whether they might want to step in here. Pfizer also has been mentioned as a company that might potentially want to acquire Shire. We'll see how this all shakes out. If a deal does come to fruition, that will make this the biggest Q1 for acquisitions in more than a decade, according to Bloomberg, which is pretty incredible to think about. We'll be sure to keep everybody posted.

Campbell: There's one more thing before we jump, Kristine. Investors in Shire or considering Shire might want to recognize that Shire has already announced plans to try to spin off its ADHD medication business, its neuroscience business, so that it can focus on its rare disease business. So, you have got that dynamic at play here, too, with Shire trying to figure out how to get the most value out of its rare disease business, which theoretically by investors should be priced more expensively than it is today. So, there's that in play. 

And also, don't forget that Shire went out and bought Baxalta in 2016 in a $32 billion deal. As a result, they had to take on a bunch of debt. They have about $19 billion in debt. So, if you're looking at it and scratching your head and going, "Wait a minute, why is the market cap of Shire only $44 billion now when the deal didn't get done at $54 billion three years ago?" That's because the enterprise value is actually $66 billion because of the debt. So, you have to keep that in mind as you're trying to figure out what price Shire could trade up to.

Harjes: Yeah, that's a great point. A stock that's covered frequently on fool.com but hasn't made its way onto Industry Focus until now, Alkermes (ALKS -0.46%), the ticker is ALKS, received a refuse to file letter on Monday regarding their drug ALKS 5461 for major depressive disorder. This is not a good look for the company. A refuse to file letter is not a rejection, but rather the FDA handing back the application to a company and saying that they can't evaluate it in its current state. How did Alkermes mess this one up?

Campbell: It's like a slap on the wrist, really. It's like, "You submitted this to me? I'm not going to look at this. This is not the report that you were supposed to submit." We're talking about an antidepressant drug. And I want to thank Alkermes for not creating some weird crazy generic name we're going to struggle to pronounce. 5461 is so much easier, right, Kristine?

Harjes: Yeah, it's so awkward, though. 5461.

Campbell: [laughs] We're talking about a major depressive disorder drug, MDD drug. It's a multibillion-dollar indication, and there really hasn't been a tremendous amount of innovation in this space. And there's a big unmet need, because frankly, there's a lot of people who suffer from conditions where antidepressants are prescribed, and roughly one-third of those patients don't respond to the existing treatment options that are out there. 

So, 5461 was considered in trials for use as adjunctive therapy. So, if you fail to respond to these other existing treatments, maybe you could then go and take 5461. One of the things that I think investors should recognize is, maybe this isn't so surprising, because typically what the FDA likes to see is three trials with two of them succeeding. There's usually a very high placebo effect in depression trials, Kristine, so it's kind of expected that you're not going to get all three to succeed. But in the case of Alkermes' 5461, it actually only passed the efficacy hurdle on one of the three.

Harjes: Right. Back in 2016, it failed to meet the endpoints in two of these Phase III trials. So, for a while, it didn't look like this drug was really going anywhere. But optimism was renewed based on this third trial. I'll also point out, that caused Alkermes' expenses to swell, because they seemed to really anticipate that this one trial would be enough for the FDA to accept the application and then, hopefully, grant approval for this drug. So now, that timeline has completely shattered.

Campbell: Yeah. I think what they were hoping for was, there's a slightly different study design between the first trial that failed and the third trial, which succeeded. And basically, what they did is, if you failed to respond on placebo, you were rerandomized in the trial. The idea was to try and tamp down on the high placebo effect that you sometimes get in these depression trials. And I think maybe that raised some question marks. 

It may also be that, despite the fact that this was studied in over 1,000 patients, so they had a pretty robust amount of safety information they could provide to the FDA -- even if they didn't necessarily have the efficacy from all three trials, they had all that safety information -- there could still be some concerns from the FDA regarding the fact that one of the two active compounds in 5461 is buprenorphine, which is an opiate agonist. So, you have some concerns, perhaps, about what the potential is for risk of abuse. Alkermes has to meet with the FDA and sit down and actually talk to them and figure out exactly what the FDA's concerns are. But one of the things they did say in their press release was, it sounds like they want some bioavailability data on buprenorphine in patients. So, perhaps they're just wanting to make sure that there's no concern there. That and, of course, it appears they want an extra trial to back up that efficacy finding.

Harjes: Yeah. Management sounded a little bit incredulous about this. They seemed to not really understand what the FDA was asking of them and why it was coming now. They spoke to the long history of development of this drug and the rest of Alkermes' drugs. And basically what they said, it doesn't make any sense that the FDA would do this now. This management team is clearly a little bit embarrassed by the refuse to file, and rightly so. And they're not really providing a lot of clarity on what exactly the FDA is asking for. And I don't know whether that's because the FDA hasn't provided that clarity yet, or if it's just management reacting a bit harshly to this news. But, all that is to say, it's not quite clear where exactly the company is going with this particular drug from here.

Campbell: Yeah, there's some egg on the face here. I think their expectation was, the FDA has suggested it's more willing to consider novel trial designs and, I don't want to say set the bar lower, because that's not necessarily the case, it's not like they're trying to approve unsafe drugs, but maybe a more willing FDA. And I think maybe they got caught a little bit off guard by that. 

One of the things you'll have to remember as a listener is, usually you'll have a type A meeting that follows the refusal to file. That should occur within the next 30 days. So, I would imagine, the next time they have an investor conference or presentation on the website or whatever, you might want to tune in if you're an Alkermes shareholder and see if there's any update on that from that type A meeting. 

It's going to be interesting to see what they do now, because these trials are necessarily quick. It's not like they can get this done within three months. And one of the things that is questionable, what do they want to do with this drug? Are they going to continue to spend money on it, hoping for another positive efficacy readout when they had two that failed? The odds seem pretty high for a failure in running another one. And the competitive landscape is going to shift a little bit, too, Kristine, because Johnson & Johnson has a drug for treatment-resistant patients in Phase III trials that should read out data this year and theoretically could go to the FDA this year.

Harjes: Yeah, that could completely change their competitive advantage. One thing that you mentioned that I want to go back to is this broader question of, how lenient should the FDA be, because this refuse to file letter kind of speaks to the way the FDA is thinking about the approval process. I feel like there's been a lot of scrutiny lately, especially with the change in administration, about how the FDA should consider atypical trial designs and stuff like that. You can see that there are other companies other than Alkermes that reacted to this news, because they're maybe considering a somewhat novel trial design, or even just other companies that are working in the same space. For example, Intra-Cellular Therapies sold off about 7%, I think it was, on the news, because they're also working on a central nervous system drug, it's a schizophrenia drug. Because that might be similar to what Alkermes is doing with their drug, there was a little bit of investor fear that maybe the FDA won't be as accommodating as people had previously thought.

Campbell: Yeah. I think, Kristine, another takeaway for listeners might be that, just because you might have one positive Phase III readout, don't assume that's going to be enough to get you across the FDA finish line. I think we sometimes forget that as investors. We see positive Phase III data and we immediately take the leap and think, "Ooh, commercialization opportunity. In 10 months the FDA will say OK, and this will be on the market, bringing all sorts of bucks in for the company." You need to really do your due diligence and do your homework and look back at all the trials that were done, make sure there weren't failures to go alongside with the successes, and take the management's comments with a little bit of a grain of salt, because as you alluded to, management was pretty bullish about their submission to the FDA. And that might have, unfortunately I don't want to say "misled," that's not the right way to phrase it, but it may have informed investors in a way that maybe investors shouldn't have been informed.

Harjes: Exactly. Before we wrap up, I think we should speak a little bit about what else is going on with Alkermes, because this is not a one-drug company. They have several drugs that are already on the market, and they do have a wider pipeline. Todd, I'm curious to get your thoughts on the company as a whole.

Campbell: I've actually been a fan of this company. I like the company. They've shown that they know how to help develop drugs. They get a lot of royalty income. They've been involved in some other really popular multi-billion-dollar drugs and the development of them. I think they'll bounce back from this. I just don't know where they're going to go with 5461 from here. 

So, I think, from an investing standpoint, maybe wait on the sidelines here, see how this all washes out, see what happens with the type A meeting, and then make a decision of whether or not the stock has been beat up enough to whether or not it warrants going out and picking up some shares.

Harjes: Alright, wise words. Some housekeeping notes before we sign off for the day. As we mentioned at the beginning of the episode, I'm going to be out for the next week and a half or so. I'm heading to California for a little bit, and then to Hawaii, Maui specifically. So, next week's cast will be slightly different than usual. You can all look forward to that. As usual, I'd love to receive any travel tips you guys have and want to send our way. Our email address is [email protected]. You can also find me on Twitter @KristineHarjes, or, if you have trouble spelling my name, you can find the show's account @MFIndustryFocus.

As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Todd Campbell, I'm Kristine Harjes. Thanks for listening and Fool on!