At the annual general meeting of shareholders in late June, in response to a question about ordinary investors' concerns about the impact of M&A on earnings, executives of Takeda Pharmaceutical said, "due to U.K. rules, we cannot disclose earnings outlooks for the new company between the time of the offer and the closing." Here, "U.K. rules" refers to the Takeover Code overseen by the U.K. Takeover Panel.
The Group Thinking about Takeda's Bright Future (TTBF), reported to the Takeover Panel that Takeda violated the rule by disclosing a negative EPS outlook for the first time just prior to the extraordinary general meeting (EGM) of shareholders.
The response we received was:
"The Code does not prevent parties from providing additional information during the course of an offer if the information provided complies with the Code. In this instance, the EPS guidance given is not in breach of the Code and therefore Takeda are permitted to disclose it.”
In other words, the "U.K. rules" that Takeda has cited as its reason for refusing to disclose information have not existed.
Takeda Pharmaceutical Co. announced its plan to acquire Shire on May 8. It will convene an EGM of shareholders on December 5 to approve the acquisition. Takeda plans to issue new shares to cover part of the cost of the Shire acquisition. If two-thirds of Takeda shareholders approve the share issue, the acquisition will proceed. The new share issue would roughly double the number of Takeda shares, to 1.6 billion shares. Unless the new company doubles Takeda's earnings, current shareholders of Takeda will suffer a dilution of their equity interests.
At the same time, current shareholders of Shire stand to receive a total of ¥7,400 (£49), comprising 0.84 share of Takeda (a value of ¥4,100) plus ¥3,300 in cash. Given the ￡30 value of Shire shares, this £49 represents a premium of 64%. Takeda is offering the total ¥7 trillion for Shire acquisition comprised of ¥4 trillion in shares and ¥3 trillion in cash. To do this, Takeda will have to borrow ¥3 trillion.
For Shire shareholders, the deal is a bonus, but for Takeda shareholders it means only dilution of their holdings and the risk that their assets will be devalued. If profit increases in proportion to the increase in the number of Takeda shares, then this risk will disappear, but as we will explain below, our Group believes the merger will not bring growth in either sales or earnings per share (EPS).
Shire shares traded at ￡45 in London on November 16, up 50% since news of the acquisition broke. At this level, plenty of investors should be willing to take their profits and walk away, but technical factors still appear to be providing support, thanks to short-term arbitrageurs and event-driven funds (a category of hedge funds) waiting to squeeze out another 10% as the merger comes to fruition.
Takeda shares, on the other hand, have fallen to ¥4,300 as of November 16. That is a 22% decline since speculation about the Shire acquisition first emerged on March 20 (see reference materials). That sharp drop contrasts markedly with the basically steady performance of the Tokyo stock market in the same period (Nikkei +3%, TOPIX -7%). It is believed that many long-term investors, worn down by short-selling hedge funds, sold Takeda shares to cut their losses. Observers should note that voting at the EGM may be dominated by technical investors interested mainly in short-term gains.
The slump in Takeda's share price reflects two factors: the harm that the Shire acquisition may do to shareholders, and fear of how the stock market may respond in the future. Takeda management's reponse has been to say, "No M&A is risk-free. The refusal to shoulder risk is in itself a form of risk." Takeda management also continues to say the merger with Shire will strengthen Takeda's earnings, tripling EBITDA and increasing EPS from the first year of merger.
The EBITDA (earnings before interest, tax, depreciation and amortization) used here is not a conventional performance indicator based on generally accepted accounting standards. Our Group has already pointed out that Takeda management's use of EBITDA in its explanations regarding the Shire merger is an effort to gloss over the merger's negative effects (see reference materials).
In our October 1 list of open questions, we demanded that Takeda provide information based on EPS projections, a conventional indicator of the future impact of earnings on dividends based on sound accounting principles (see reference materials). Takeda has failed to provide a satisfactory response to this demand. Instead, it announced November 12 it would reschedule to December 5 the extraordinary general meeting of shareholders that had been set for January 2019.
Takeda management has steadfastly refused to respond to our open list of questions, but the invitation to the extraordinary general meeting of shareholders did contain a change that reflects our Group's concerns (see reference materials). Up to that point, Takeda management had said "earnings per share will show a big real increase in the first full business year after the merger is completed." In the invitation, that phrasing changed to, "earnings per share will show a real increase within one year after the merger is completed, and financial EPS will increase within three years." This marks the first projection Takeda has ever released using EPS, the conventional earnings indicator based on sound accounting principles.
Our Group has engaged securities analysts, attorneys and consultants to assist our efforts to analyze the proposed acquisition, and to gauge the future risks, which we think are immense. We have shared this information with the public on our website. Twice now we have communicated our concerns to the company in the form of open questions, inviting them to respond, but their response has effectively been zero. We shared our questions with the media, and in the incisive coverage that resulted, our Group's views have frequently been quoted as expressions of opposition to the proposed deal. We have held meetings with investors in New York and London, urging them to vote "no" on the company's proposal.
In the course of this process, some members of the founding Takeda family have offered us support, and some have even joined the ranks of our Group. Kunio Takeda, former CEO and chairman of the company, and the last member of the founding family to run the company, expressed his opposition to the acquisition in an article published in the Financial Times on November 16. Other individual investors, both in Japan and in other countries, have mounted their own sincere efforts, and we now estimate about 15% of Takeda shareholders will vote against the deal. With the support we have received from the founding family, other former Takeda employees, and ordinary shareholders, we now think we can boost that figure to 25%. We think it will be difficult, however, to reach the threshold of one-third (34%) of shareholders we need to block the merger.
To solidify its base of support, the company has been running around holding meetings with major institutional investors in Japan, as well as hedge funds and other investors outside Japan. It has said it expects to keep at least two-thirds of the votes on its side.
In the additional open questions our Group released on November 6, we revealed that some of the financial institutions acting as advisors on the merger are themselves Takeda shareholders, and that their votes in favor of the Shire deal may constitute a conflict of interest. All together, the group of M&A advisors (securities brokerages, advertising agencies, attorneys, etc.) stand to earn over ¥100 billion from the deal. Add to that the commissions on the newly issued shares and interest on the ¥3 trillion debt assumed, and the result is a massive sum of revenue to financial institutions. Their "yes" vote is the price they will pay to secure these profits. But what of the customers of these financial institutions? Other Takeda shareholders have already suffered the loss of ¥1 trillion in market value, and now they are being made to eat that loss. Our Group's view is that financial institutions with such conflicts of interest should not be permitted to vote at the EGM of shareholders. The Stewardship Code includes this guidance for asset management companies:
If the acquisition happens, the new Takeda will have ¥11 trillion in "goodwill and intangible fixed assets" on its balance sheet, making up 75% of its total assets. Shire's most important products are drugs used to treat hemophilia. Our group fears the biggest risk facing the new company is the possibility that these drugs will lose a lot of their value in the next three years. If that happens, the responsibility (and possible conflicts of interest) of the financial institutions and business advisors that recommended voting "yes" will come under scrutiny.
Shire's sales of the hemophilia drugs Advate and Feiba total ¥400 billion, accounting for 25% of the company's sales, and over 50% of its profit. On October 4, the U.S. Food and Drug Administration (FDA) gave full approval to the Roche/Chugai drug Hemlibra, a revolutionary new bispecific antibody that patients can inject themselves, subcutaneously, once a month. It is expected that this will mean a sharp decline in market share for Shire's competing products, which must be injected intravenously every other day. Advate and Feiba are products that were developed by Baxalta, which Shire acquired in 2016.
It is believed that this transaction accounts for much of the ¥4 trillion in goodwill and intangible fixed assets that appeared on the company's balance sheet in 2016. Depending on sales of Hemlibra, Takeda's impairment loss could exceed ¥2 trillion.
On our Group's website, we invite people to join us in thinking about Takeda's future (see reference materials). Takeda does not really need to rush headlong into this merger. On the contrary, its business enjoys firm support from the ulcerative colitis treatment Entyvio and from Ninlaro, a treatment for multiple myeloma, which is a cancer that affects plasma cells. These drugs have strong growth potential worldwide. Even without the proposed merger, Takeda has among the strongest prospects of sustained medium-term growth of any major Japanese pharmaceutical company. Concerns over the new product pipeline that Takeda executives have been using to fan a sense of crisis are not a problem for Takeda alone. The acquisition of Shire may actually exacerbate Takeda's pipeline problem. After spending ¥7 trillion, how will Takeda hope to raise more money? This will curb its ability to acquire other promising new drugs or forge other business alliances in the future.
If Takeda follows through on its plan to acquire Shire, non-Japanese investors will hold over 70% of its shares. Will these non-Japanese investors fully appreciate Takeda's tradition and history of over 200 years in business, which is the company's greatest strength? Of the ¥7 trillion cost of the acquisition, ¥3 trillion in cash will flow out of Japan. If instead this money were to be invested in basic research in Japan, what important results could be realized? Takeda's top priority should be to value its research and development efforts in Japan, to restore the faith of academic institutions and bioventures in Japan. How can a company that has lost the respect of its home nation hope to survive abroad?
Lastly, we wish to note the decline in Takeda's share price, caused by the excessively high price of the proposed acquisition, which has fueled fears of asset impairment and lower dividends. Individual investors have borne the brunt of this loss, without any compensating benefit in the form of business relationships or special treatment. We call upon all Takeda shareholders, not just former employees, to do something about this. Individual investors make up 25% of the total. Even if "no" votes fail to reach one-third of the total, the company's motion may fail if shareholders with conflicts of interest – which are over 20% of the votes – refrain from voting. December 5 is just two weeks away. Please consider offering us your support.
November 21, 2018