Is Takeda's Rumored Buyout of Shire Smart?

Takeda (NASDAQOTH: TKPYY) announced in March that it's considering making an offer to buy Shire (NASDAQ: SHPG), and according to U.K. rules, the Japanese drug giant has until April 25, 2018, to submit a bid or walk away. A Takeda-Shire deal would about double Takeda's revenue, but with Shire's enterprise value exceeding Takeda's, this would be more of a merger between equals than an outright acquisition.

In this episode of The Motley Fool's Industry Focus: Healthcare, analyst Kristine Harjes and Motley Fool contributor Todd Campbell take a closer look at these two companies and what this combination means to investors.

A full transcript follows the video.

This video was recorded on April 4, 2018.

Kristine Harjes: 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?

Todd 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.