Tax inversions are dead. The Treasury Department made sure of that in September, when it released a shopping list of changes to rein in proposed transactions like the one previously planned between AbbVie (NYSE:ABBV) and Shire plc (NASDAQ:SHPG).
AbbVie courted Shire for months before the two inked a deal in July for AbbVie to acquire Shire for $54 billion in a bid to shift AbbVie's tax address from the United States to the United Kingdom.
However, weeks after the Treasury's new anti-inversion policy was announced, AbbVie walked away from Shire, in the process forfeiting a $1.6 billion breakup fee to Shire.
AbbVie's decision to walk away may not have been a great decision given that Shire just reported third-quarter results this week that mostly impressed.
First, a bit of background
Tax inversions aren't new, but they did see their popularity jump in the past year.
The concept is simple. Create a new foreign entity in a country with a low tax rate and use it to combine a U.S. company that is paying a high tax rate with a foreign company in that country. As long as certain ownership size requirements were being met, the U.S. company could change its tax address, allowing future earnings to be taxed at the new rate. Multinational companies like AbbVie could also use the new foreign structure to recapture income trapped in foreign subsidiaries tax free. Absent an inversion, if AbbVie wanted to repatriate that income it would have to pay U.S. taxes on it.
Since AbbVie has an effective tax rate of 23% and Shire's effective tax rate is just 15%, the appeal of an inversion was substantial. Over the 12 month period ending June, AbbVie's net income was north of $4 billion, so AbbVie's tax savings would have amounted to hundreds of millions of dollars per year.
Those savings appear to have been the main reason for AbbVie's interest in Shire, despite comments made to the contrary by AbbVie's CEO Richard Gonzalez. At the time of the announcement, Gonzalez suggested that AbbVie also coveted Shire's fast growing product lineup, which includes the ADHD drug Vyvanse.
"This is a transaction that we believe has excellent strategic fit, well beyond the tax impact," said Gonzalez on AbbVie's conference call. "We wouldn't be doing it if it was just for the tax impact."
Following Shire's third-quarter earnings release, it would seem that Gonzalez may have wanted to pay more attention to those previous comments before jilting Shire.
Growing more quickly
AbbVie's got a problem on its hands. Its top selling drug Humira is the globe's best-selling drug, but it's slated to lose patent protection in 2016. Humira, which is used to treat a wide range of autoimmune disease including rheumatoid arthritis and psoriasis, had sales of $10.7 billion last year, accounting for 57% of AbbVie's total revenue.
Humira is even more important to AbbVie because AbbVie is relying on Humira's sales growth to offset sliding sales for its other drugs. Despite Humira notching year-over-year sales growth of 22% in the first six months of 2014, AbbVie's total sales have inched up just 5.7% in the period.
The situation at Shire is quite different. While Shire isn't immune to patent threats, it's forecasting that its sales will double from $5 billion to $10 billion by 2020.
Thanks in part to its $4.2 billion purchase of ViroPharma earlier this year, Shire's sales are up 33% year-over-year exiting the third quarter. But even without ViroPharma, sales still grew an impressive 19%. Over the first nine months of this year, Shire's sales are up 25% to $4.33 billion.
Its top-selling drug, Vyvanse, saw sales climb 19% year over year to $355 million in the quarter, but growth occurred across Shire's product line. Sales of Lialda jumped 24% to $177 million, Elaprase sales climbed 31% to $169 million, and Cinryze grew 36% to $145 million. Overall, Shire boasts seven drugs with quarterly sales of roughly $100 million that each grew 19% or more year over year last quarter.
More profitable, too
Shire is also growing its bottom line more quickly than AbbVie. Shire's gross margin is 85.6% and its EBITDA grew from 38% to 45% in the past year. That led to earnings per share jumping 60% to $2.93 in the third quarter.
Based on its performance this year, Shire has also increased its EPS outlook for the full year from expectations for growth in the low to mid thirty percent range to growth in the high 30% range.
Over at AbbVie, the company's gross margin is just shy of 80% and since AbbVie pays more as a percentage of its sales for operating expenses like SG&A and R&D than Shire; its EPS growth is significantly trailing Shire. In Q2, AbbVie reported EPS of $0.82, unchanged from the prior year.
Following its breakup with Shire, AbbVie's challenge remains the same. If it hopes to offset potential Humira headwinds in a few years, it needs to bolster its product line up with blockbuster type drugs, or highly profitable rare disease drugs (like those sold by Shire). Perhaps, AbbVie thinks it can accomplish this on its own by reinvesting the billions it had promised to pay for Shire into R&D, or perhaps AbbVie thinks it can acquire a different biotech that offers Shire-like advantages for less. Either way, it appears that Shire's in a better position than AbbVie.
Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies mentioned. Todd owns Gundalow Advisors, LLC. Gundalow's clients do not have positions in the companies mentioned.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.