Baxalta Could Help Boost Shire Shares More Than 25%
The purchase will fill the biotech’s pipeline with products that will help earnings and revenues for years.
Since its $54 billion sale to Abbvie unraveled in 2014, the Irish pharmaceuticals company Shire has gone back to its tried-and-true formula: making acquisitions.
Best known for its drugs such as Adderall XR and Vyvanse that treat attention-deficit hyperactivity disorder, or ADHD, Shire (SHP.UK) has jumped back into action with several purchases, most notably Baxalta, which nearly doubles its revenue. The acquisitions have swelled a pipeline already brimming with treatments capable of propelling sales and profits for years.
“If you look across our pipeline and products, we have many first in class, best in class, new to class, so we are clearly playing the innovation game versus the me-too game,” says Shire’s Danish CEO Flemming Ornskov, who practiced medicine before joining the corporate world.
Although the American depositary receipts ( SHPG ) have risen 60% in the past three years, the promise of the new drugs doesn’t seem fully reflected in their recent price of $194. They trade for just 12.6 times estimated 2017 earnings. At the sector average multiple of about 16 times, Shire’s ADRs could be worth about $245, or more than 25% above the latest price. Each ADR is equivalent to three of Shire’s London-listed ordinary shares, which traded last week at 52 British pounds ($64.33).
The shares were hurt by the on-again, off-again AbbVie deal. They climbed on news of the talks in mid-2014 and subsequent higher offers, but dropped more than 20% a few months later when the transaction collapsed after U.S. Treasury officials closed a loophole, making the “tax inversion” much less attractive to U.S.-based AbbVie (ABBV). The company had planned to shift its headquarters to Shire’s Dublin home.
The United Kingdom’s vote to leave the European Union has also unsettled investors. The dollar-based ADRs and sterling-based London shares have at times headed in different directions, based on the pound’s post-Brexit moves. Shire generated almost three-quarters of its revenues last year in the U.S., and it reports in dollars, so the pound’s weakness won’t have much effect on business fundamentals.
But investors may have overreacted. The drugmaker’s recent deal making gives it more long-lived assets, offering sustainable double-digit earnings growth, says Samantha Pandolfi, a portfolio manager at Eaton Vance Worldwide Health Sciences fund (EMHSX), which owns the stock. “I like the way it looks at the moment,” she says.
Shire was formed in 1986 by a team of entrepreneurs, and its first products included calcium supplements to treat osteoporosis. In 2005, it acquired Cambridge, Mass.–based biopharmaceuticals company Transkaryotic Therapies, and adopted its focus on rare diseases. The biotech today also treats specialized conditions ranging from ulcerative colitis, a chronic illness that affects the large intestine, to Hunter syndrome, a genetic disorder caused by a missing or malfunctioning enzyme.
Last year, Shire’s sales totaled $6.4 billion. ADHD treatment Vyvanse, which can also treat binge-eating disorders, accounted for more than a quarter of that. Shire completed several bolt-on acquisitions in 2015, but it bulked up this year with the $32 billion purchase of Baxalta, which will lift 2016 sales to an estimated $11.3 billion.
Baxalta, spun off from Baxter International (BAX) only last year, broadens Shire’s geographical reach to 100 countries and reduces its reliance on its ADHD franchise, thanks to Baxalta’s strengths in hematology and immunology and a growing presence in oncology. By 2017, Shire’s sales are estimated to hit $15.3 billion.
Management is betting the Baxalta combination will allow Shire to crank up sales to $20 billion by 2020. Analysts think that’s too ambitious, with most forecasting $18 billion to $19 billion, but Shire’s chief Ornskov is confident he can win them over.
“As our second-quarter numbers demonstrated that we continue to exceed expectations, I think the gap between our expectations and the Street’s expectations is rapidly narrowing,” he told Barron’s.
Ornskov’s optimism is fueled by a pipeline with more than 50 products in clinical development, including potential new treatments to tackle infection in transplant patients, inflammatory bowel disease, and eosinophilic esophagitis, an inflammatory condition of the esophagus.
Adding to this elixir are products like Xiidra, a treatment for signs and symptoms of dry-eye disease, approved by the Food and Drug Administration in July. In its first three weeks after launch, Xiidra claimed 2.1% of the market that is dominated by Allergan ’s (AGN) Restasis. Xiidra is expected to reach $200 million in sales in 2017, and could attain blockbuster status with sales above $1 billion in 2020.
That’s not to say Shire has a wide-open field. Roche Holding ’s (ROG.Switzerland) emicizumab, formerly known as ACE910, threatens to disrupt the market for hemophilia treatment, where Baxalta has a strong product, Advate.
But the Baxalta deal has the potential to speed earnings growth. Shire recently upped its estimate of operating-cost savings from the combination by 40%, to at least $700 million, over three years. Ebitda margin, estimated at about 42% this year, could hit the mid-40s in 2018, says Deutsche Bank analyst Richard Parkes. Shire is expected to post 2016 net income of $3.3 billion, or $12.90 a share. In 2017, net income could climb to $4.6 billion, or $15.32.
The company, which doesn’t pay a dividend, is focused on reducing the debt accumulated to fund its acquisitions—more than $23 billion, a worrisome ratio of over four times net debt to earnings before interest, taxes, depreciation, and amortization.
Ornskov is confident Shire can cut that ratio to two to three times in 2017, but he could be tempted by “attractive, rare, or highly specialized compounds that are available at interesting prices.” But they won’t be big deals: “Large-scale M&A is not in the cards for us,” says Ornskov. And that should improve the health of the stock.
Drawing a Bead on the Post-Brexit Pound
The Asian flash crash highlights the weakness of sterling since Brexit. Stocks have soared but inflation and the current account could be a problem.
The British pound on Friday tumbled sharply before recouping most of its losses, taking its retreat against the dollar in October to more than 4%. Sterling fell more than 6% in Asian trading, from $1.26 to $1.18, in a move that surprised markets. It recovered and late in the day traded at $1.24.
However, even before Friday’s gyrations, the pound was trading at its lowest level against the greenback since 1985, off 22% from its June high just before the United Kingdom voted to leave the European Union. Weakness in the value of sterling makes U.K. assets cheaper when priced in other currencies. The currency’s frailty has contributed to a stellar performance for British stocks in recent months. London’s FTSE 100 index hit an all-time high this week and closed on Friday at 7044.39, 30 points off the record.
It is bad news for U.K. government bonds, though, as the currency’s weakness foreshadows higher inflation eroding future coupon payments. Ten-year sovereign bonds rose to 0.88%. Bond yields rise when prices fall.
Currency traders struggled to explain Friday’s move, suggesting it could have been the result of “fat fingers”—an incorrect number entered in a computer trading program—triggering algorithm-based trading strategies and automated sell orders that limit losses once prices move beyond a specified range. Timing was another issue. The event occurred at the start of the Asian trading day when market volume typically is thin. “We don’t really know what caused all this, but the basic problem is illiquidity,” says James Binny, head of currency for Europe, the Middle East, and Africa at State Street Global Advisors in London.
Analysts suggest that last week’s decline may have been fed by Prime Minister Theresa May’s speech on Oct. 2 that the U.K. would start the process of exiting the EU no later than March 2017, and that immigration controls are a higher priority than access to the single European market.
BUT SOME EXPERTS ARE SKEPTICAL. The predicted meltdown in the economy following the Brexit vote hasn’t materialized. The Bank of England cut interest rates in August to aid the economy, and it stands ready to take further action if necessary. “As long as there are no more political bombshells, I think we can continue to trade the economic data,” says Mark Farrington, a portfolio manager and head of Macro Currency Group, a specialist currency investment boutique owned by Principal Global Investors.
Farrington and State Street’s Binny both view the pound as undervalued in the longer term. Binny estimates fair value for sterling at $1.50, but he says there could be further downside in the near term as investors focus on the U.K.’s current account deficit. At the end of the second quarter, the current account deficit was 5.9% of gross domestic product, up from 5.7% in the first quarter. The country relies on inflows of foreign capital to sustain the current account, the sum of the trade balance; income, such as interest and dividends; and transfer payments, like foreign aid.
“[The British pound] used to be a relatively simple currency that traded on cyclical events and data, but now it has become a political and structural currency,” says David Bloom, global head of foreign-exchange research at HSBC. “This is a recipe for weakness, given its twin deficits.” Bloom predicts sterling could weaken to $1.20 by the end of this year and to $1.10 by the end of 2017.
Canada Goose Preparing for IPO
Maker of trendy down-filled parkas could be valued at $2 billion and could go public early next year
Canada Goose, the maker of trendy down-filled parkas that cost $1,000 apiece, is preparing for an initial public offering, in a sign that an uptick in the new-issue market could continue.
The Canadian company is interviewing potential underwriters for an offering that could value it at around $2 billion, according to people familiar with the matter. That would put it on track for a debut early next year. There is no guarantee an offering will take place as any number of factors, like a renewed bout of stock-market volatility, could get in the way.
Should Canada Goose pull off the share sale, it would give it broader access to capital for growth and provide a path for private-equity firm Bain Capital to begin exiting its investment in the apparel company.
Founded in 1957 as Metro Sportswear Ltd., Canada Goose got its start making woolen vests and snowmobile suits from a small warehouse in Toronto. Over the years, it found a niche following among film crews shooting in frigid climes. Lately, it has attracted fashion-savvy consumers looking for winter-weather gear and willing to pay a hefty price for it. In May, the company announced its first stand-alone retail stores, in Toronto and in New York’s tony Soho neighborhood.
Canada Goose agreed to sell a majority stake to Bain in 2013 for an undisclosed sum. Dani Reiss, the company’s chief executive and grandson of its founder, Sam Tick, retained a significant minority stake.
Trendy apparel brands have benefited from robust investor demand lately. Lululemon Athletica Inc.’s stock is up 11% this year, while shares of Moncler SpA, a clothing maker that has large network of retail stores, are up 17%. Under Armour Inc. has risen more than twentyfold since its 2005 IPO, though the stock is down from its September 2015 high.
The IPO market is starting to show signs of life after suffering through a sluggish year, with 17 companies selling shares on U.S. exchanges in September, according to Dealogic. That makes it one of the busiest months this year. Yet despite the pickup, U.S.-listed IPO activity is still on pace for its slowest year since 2009.
Should the recent upturn be sustained, it would be good news for firms like Bain that depend on the IPO market to exit investments and return cash to their own investors.
One of the most highly anticipated debuts this year is that of another hot consumer brand, Yeti Holdings Inc., which makes high-end coolers.
Weekly Market Update: US Gets "Goldilocks" Jobs Report; Brexit Redux and ECB Tapering Are Latest Worries for Europe October trade kicked off in an orderly manner but as the week progressed many of the same underlying cross currents returned to the surface resulting in market swings. WTI crude futures gained a foothold above $50 for the first time since early July helped by generally improved ISM data globally and large declines in weekly crude inventory figures. The British Pound continued to fall to fresh 3 decade lows largely on the backs of tough talk from various European officials surrounding Brexit. The move culminated in what many referred to as a "flash crash" into the Asian trading session on Friday. Cable trades briefly printed below 1.20, down some 10 big figures before rebounding into the US open.
Global rates backed up to some of the highest levels since the Brexit vote ahead of the US payrolls report on Friday, spooked in part by a mid-week report that suggested ECB was already discussion QE tapering scenarios. That report was later walked back by several ECB officials but sovereign bond prices never fully recovered. Friday's September payrolls report was described by several analysts, including Fed Vice Chair Fischer, as a "goldilocks" number, not too hot, not too cold. The implication was that the Fed will remain on hold in November and remains on track for a December rate move. The UK 10-year Gilt yield finished the week just below 1% while the 10-year Treasury held near 1.75%. Gold prices careened down through the 200-day moving average weighed on by higher rates and a resurgent US dollar.
Deutsche Bank remained in focus as each day saw vying press reports on the company's travails. Last week's lows held and hopes are the bank, along with US and German government officials can reach a path forward that will allow DB to recapitalize. Twitter shares topped $25 mid-week before sliding on reports that several potential suitors dropped out. The IPO market stayed hot, headlined by Coupa Software's 100% rise on Wednesday and word that the thawing market had both Snapchat and Bloom Energy nearing a filing. The week also saw the launch of Innogy, the largest IPO in the German stock market in nearly a decade. Disappointing annual guidance from Honeywell and Walmart weighed on the major US indices late in the week along with a steady rotation out of higher yielding defensive sectors. The S&P futures saw the 50-day moving average set up as notable resistance throughout the week's trade. For the week, the S&P500 lost 0.7%, the DJIA slipped 0.4%, and the Nasdaq fell 0.4%.