Baxalta Shire Merger: Attractive Spread

Baxalta Shire Merger

Baxalta Shire merger: On Jan. 11, 2016, Shire (NASDAQ: SHPG) made the headlines of the pharma news when it announced that it had agreed to buy Baxalta (NYSE: BXLT) for US$32bn in a cash and stock transaction. The spread sits currently at ~7% and below are the key reasons why the outcome should be favorable (i.e. the deal closing)

Baxalta’s shareholders will likely vote in favor of the Baxalta Shire merger – while the Baxalta Shire merger was announced by pharma news outlets in January, the potential for a merger had been disclosed as early as August 4, 2015, when Shire publicly announced it had made an initial offer for Baxalta. The offer premium to the unaffected share price (as of August 3, 2015) of 37.5% is in the typical range of 30 – 40% and should suffice to warrant shareholder support, who would otherwise risk to see the stock falling back to pre-transaction levels of US$33.00 per share. In addition, the Board of Directors of Baxalta seems to have done its job of negotiating the best offer for shareholders, getting Shire to value Baxalta at US$45.57/share with US$18.00 paid in cash from its initial all-stock offer that valued the target at US$41.00/share. Baxalta’s board also made sure to run a parallel sale process to generate alternative offers, without success. With only two large shareholders, the first being Baxter International (the entity that spun off Baxalta) at 13.8% ownership and BlackRock at 5.6%, the vote taking place on May 27 should be a formality and give the green light to the transaction.

The Baxalta Shire merger should not be derailed by the US tax clampdown – when it was reported in pharma news that Pfizer and Allergan’s US$160bn merger was called off due to the White House announcing new rules to prevent corporate tax inversion deals, Shire issued a short statement confirming that the purchase of Baxalta is still on track. Indeed, the deal seems to have been put together for strategic reasons rather than for pure tax engineering, and the transaction will create the world’s largest company focused on rare diseases. Shire expects the deal to generate annual cost synergies of US$500 million and the combined companies to deliver double-digit sales growth with more than US$20 billion in annual revenue by 2020.

There is little risk that the Bxalta Shire merger is blocked by antitrust authorities – the two companies do not reference each others as competitors in their annual reports, the previous recent acquisition of Dyax by Shire has not faced any antitrust scrutiny and the waiting period under the HSR Act has expired on February 29, 2016. The merger still needs to be approved by the European Union, Japan, Jersey, Russia, Taiwan and Turkey, and Shire has the obligation to divest assets up to US$740 million in value in order to obtain such approvals.

The transaction is not subject to financing conditions – Shire announced in a pharma news release that it had secured US$18.0 billion of debt facilities to finance the cash component of the offer.

But… Shire shareholders also need to vote – due to the number of Shire shares that need to be issued to finance the transaction being more than 20% of the current Shire share count, Shire’s shareholders get a say and can block the share issuance (and thus the deal). This makes the transaction slightly less straightforward than it would have been otherwise, given that the reactions to the deals have been mixed (Shire fell 9% upon announcement). Key concerns include risks linked to Baxalta’s hemophilia business, which is to face intense competition from a new breakthrough product from Roche, and potential tax liabilities pertaining to Baxalta’s spin off from Baxter International that will be payable by Shire if the IRS decides that the tax free status of the spin off is threatened by the cash component of the contemplated transaction (independent tax opinions have been rendered estimating that this will not be the case). That being said, it would be such a blow to the management in place if Shire’s shareholders blocked the deal that it probably would have to leave, an outcome that is unlikely to be the desire of the vast majority of investors holding the stock in the first place. Besides, 25% of Shire sales come from its top-selling drug Vyvanse, and the Baxalta acquisition will help diversifying that revenue base.

In conclusion, the Baxalta Shire merger presents an investment opportunity, despite the fact that some of the tax synergies may be gone due to stricter US rules and the risk of facing shareholder resistance on Shire’s side. Another risk to closing that cannot be entirely ignored is the possibility of Shire itself being the target of a bidder such as Pfizer, now that its mega merger with Allergan has been called off. To bet on this merger closing, an investor will initiate a long position in Baxalta and sell short 0.1482 share of the Shire ADR for each share of Baxalta purchased, which allows to focus only on the merger spread, hedging for any industrywide stock price movement unrelated to the transaction. Estimated closing date as of writing: early June 2016. Check the current status of this transaction and others by looking at the portfolio.

Update 1/6/16: the transaction has now been approved by both Baxalta’s and Shire’s shareholders and will close on June 3, 2016. 

Disclosure: Long Baxalta / short Shire.

This article expresses an opinion and the author does not receive compensation for it and has no business relationship with any company whose stock is mentioned in this article; do your own due diligence before making investment decisions.

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