Shire’s merger with Baxalta looks a little peaky

January 11, 2016

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Shire’s merger with Baxalta looks a little peaky. Shire Chief Executive Flemming Ornskov has clinched his deal to buy haematology specialist Baxalta for $35 billion, including debt. The merger brings Shire scale in rare diseases, but offers few cost synergies, plenty of risk and relies on revenue growth that may be optimistic.

Owing to a falling market, Ornskov has not had to increase his bid by much from the original $45.23 mooted in August last year, which Baxalta knocked back. The final price, based on Shire’s recent 30-day weighted average, is $47.50 or roughly a 43 percent premium to the closing price on Aug. 3, 2015.

Shire shareholders also are giving away less of the company. Shire originally proposed an all-share merger to avoid triggering a tax liability at Baxalta, which was recently spun out of Baxter. That would have given Baxalta shareholders 37 percent of the merged company. In this new incarnation of the tie-up, they will get 34 percent.

Still, based on traditional merger metrics, the deal barely washes its face. Shire expects to create value by ripping out $500 million of annual costs, and slashing Baxalta’s tax base to 16 to 17 percent, from its current 23 percent. Assume Baxalta can make around $2.9 billion of operating income in 2020 – suggestive of 8 percent annual growth from now until then. Add back the synergies and tax the result at 16.5 percent, and the return on invested capital is around 8 percent, just about in line with sector averages.

Bettering that means growing revenue faster than the two companies would without a merger, which Shire thinks it can do by selling its drugs in an extra 28 countries, and gaining more clout with healthcare authorities. Still, those advantages look quite nebulous, and the deal brings real risks. Morningstar reckons over half of Baxalta’s revenue in its key franchise of haemotology could come under fire from more competitive products from Roche and Biogen. And Shire is increasing its debt to over two times EBITDA, from less than one currently.

For Ornskov, the deal is about more than just financial returns. He wants a leading position in rare diseases, and a springboard big enough to strike more deals in future. Hopefully those will come with more persuasive numbers.

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