Shire does shareholders a favor in Takeda deal

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(Bloomberg Gadfly) -- Shire Plc has finally done long-suffering shareholders a favor. After presiding over 18 months of share price falls, the board has coaxed a sweetened $64 billion takeover proposal out of Japan's Takeda Pharmaceutical Co., which it's minded to approve. Assuming a firm offer follows, the European drugmaker's owners must ask if the price is as generous as it looks, and whether Shire is worth more.

Takeda's cash and shares pitch was worth 49 pounds a share based on its April 23 stock price. The suitor is roughly the same size as Shire, so it's borrowing deeply to fund the cash component, and offering about 50 percent of the combined company to cover the rest. That means doubling the number of Takeda shares in issue.

Some Shire investors can't own Japanese equities, so many of these new shares would be sold. The market would choke if all this stock—roughly 360 days' of Takeda's average daily trading volume—was dumped in a hurry.

This overhang must be reflected to a large degree in Takeda’s 18 percent share price decline since the possible bid emerged. Wednesday’s drop trimmed the value of the proposal to 46.55 pounds a share -- effectively removing the benefit of the sweetener.

Suppose, then, that Takeda's battered stock price is a reliable indicator of what Shire investors could cash it in for. The proposal is then a mouthwatering 52 percent more than Shire's value before takeover interest emerged, but only 14 times trailing Ebitda -- cheaper than in the average pharma deal in the last two years.

On its own, Shire can't rival this—at least not under its current management. True, analysts at Bank of America Merrill Lynch recently said Shire could hit 57 pounds a share in 12 months, while their counterparts at Societe Generale said 75 pounds. But most brokers have price targets just below Takeda’s offer, and the shares were trading at less than 30 pounds less than a month ago.

As at recently acquired GKN Plc, investors had been losing faith with Shire before a predator surfaced. Capital allocation—how the company spends shareholders' money—has been a preoccupation of results calls. Disappointment with Shire's $36 billion Baxalta purchase in 2016 probably explains why.

Analysts at UBS plausibly argue that the volatility of Shire shares (a function of its own acquisition borrowings) inflates the company's cost of capital, while investors assume management will reinvest profits in low-return activities like overpriced, large-scale M&A. This has created an “ownership arbitrage” which means Shire's cashflows could be worth substantially more under another company’s management and strategy, even without conventional M&A synergies.

Shire's endorsement of Takeda's price is an admission it can't get the shares to the same level in the foreseeable future. Would anyone have believed it had it said otherwise? GKN showed that out-of-favor management teams can't build much credibility during a bid, however robust their arguments.

At least shareholders are close to having a bird in the hand. Any more will have to come from a rival bidder.

Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

©2018 Bloomberg L.P.

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