Damage caused by Shire deal

Reason for opposing M&A with Shire plc

In the M&A proposal, Takeda evaluated Shire stock as 7,424 yen (49 pounds) per share and pays 3,295 yen (21.75 pounds) in cash and 0.839 shares of Takeda, which is to be newly issued and equivalent to 4,130 yen (27.26 pounds) . Takeda's current number of shares outstanding is 790 million. The number of Shire's outstanding shares is presumed to be 940 million to make a merger ratio 50:50. The following five items are explained as reasons for opposing.

1. Unfairness between Takeda shareholder and Shire shareholder

The price of 49 pounds per share to be paid to Shire 's shareholder is 64% higher than Shire' s stock price on March 23 just before the M&A rumor started. After that Shire 's share price has risen by 25%, but Takeda' s share price has fallen by 19%. It is clear that this transaction is markedly unfair between shareholders of both companies and an excessive burden on the Takeda side.  (Report p. 3).

In the merger scheme announced on April 20, it became clear that Takeda shareholders were suffering loss, while Shire's shareholders were gaining a windfall profit. As a result, in the market, arbitrage transaction to buy Shire stock and short sell Takeda shares was attracted, and the stock price fell by 10% in 5 days. The induction of short selling seemed to be solved by the revised proposal announced on April 25 as well as by uncertainty of  such an unfair deal to be completed. 

The revised proposal ignored the problem of the merger scheme itself that caused the 19% drop in Takeda's share price to the date, and used the April 25 price to value the offer for Shire.  The large cash portion in consideration for Shire shareholders, is the cause of the inequity. This problem is more prominent in the burden of new company's impairment loss. 

Shire was a mid-sized company with annual revenues of around 700 billion yen until three years ago (2015), but the revenue became 2.4 times larger in the past two years through M&A of Baxter's blood business subsidiary Baxalta and various bio-ventures in rare disease research. 

As a result, the operating profit margin has declined sharply due to rise in the cost and burden of amortization associated with sharp increase of intangible assets. Merger synergies (mainly cost reduction) are not realized as expected, and recovery of profit margin seems taking longer than anticipated.

Making the situation for Shire worse, bispecific antibody developed by Roche (Chugai Pharmaceutical) for the treatment of hemophilia was approved in November 2017. Shire's sales of haemophilia drugs as the mainstay are expected to decrease sharply. Shire has bought this blood product business by paying 12 years of EBITDA profit estimated at 300 billion yen / year.

When it is found that the acquired business revenue does not last for 12 years, more than 1 trillion yen of Shire's intangible asset of 6 billion yen will be damaged. On the right-hand side of the balance sheet, it is 1 trillion yen out of 2.8 trillion yen recorded as "additional paid-in" capital. Additional paid-in capital arises from capital transactions such as M&A. For shareholder, the amount does not exist in tangible asset and can not be returned unless the company dissolves. 

Shire's shareholders will be able to recover all of the additional paid-in capital that has the risk of impairment by cash premium of 3 trillion yen paid by Takeda. On the other hand, intangible asset of new Takeda will surpass 11 trillion yen and interest bearing debt will exceed 6 trillion yen, and if intangible assets are damaged, even bankruptcy would become a concern.

2. Remarkable increase in borrowings

Takeda's debt at the end of December last year was 1.1 trillion yen, but it exceeds 6 trillion yen after the integration. It is borrowing equivalent to two years' sales of the merged company (* note), the risk that it becomes impossible to repay becomes large but explanation about repayment plan is not yet explained. In this regard, the credit rating agencies, S & P, Moody's, and R & I all have expressed downgrades in creditworthiness. President Weber has stated that he will maintain investment grade, but its basis is unknown. It seems that the rating agency is under consideration with suspicion. 

(*Note) Existing borrowings as of the end of December 2017 amounted to 3.2 trillion yen (Takeda Pharmaceuticals 1.1 trillion yen and Shire 2.1 trillion yen), borrowings (about 3.1 trillion yen) for merger cash payments = 6.3 trillion yen (report p .19)

3. Decline of profitability

"Goodwill and intangible assets" will increase by 3 trillion yen through integration. The interest payment for 3.2 trillion yen of new borrowings to bear will amount to 120 billion yen (interest rate 4%) every year, and if we sum the interest rate increase of the conventional borrowings (2.8 trillion yen, interest rate 3%), the financial expenses will increase by 150 billion yen To do. Furthermore, amortization expenses of intangible assets will be estimated at 100 billion yen (estimated) and integration costs will be around 100 billion yen. In total, the new company after the merger will be an additional burden of 350 billion yen annually, and the net profit is expected to drop to nearly zero (about 2 billion yen). The EPS per share forecast for FY2017 of 177 yen (upward to 201 yen in the third quarter announcement) has a risk of falling to 1 yen. The profit for fiscal 2017 is raised by 100 billion yen in profit of the sale of Wako pure chemicals. Besides health care, large-scale assets available for sale are bottoming out. 

According to the article of the Nihon Keizai Shimbun on May 10, President Webber said that EBITDA (before tax, before interest payment, before amortization) tripled after the integration, but the tonschin can also be tremendous, I believe that ignorance is revealed. The source of dividends is GAAP (net basis) net income, which is the EPS per share.

President Weber says it will maintain a dividend of 180 yen (a total of 140 billion yen), but we have to distribute 180 yen to the shareholders of Shire who had previously had a dividend less than 40 yen. It is necessary to pay dividend of 280 billion yen per year, but it is obvious that the dividend level can not be maintained in the earnings situation mentioned above. (Report p.20)

4. Evaluation of pipeline

Shire has publisized 40 projects in its R&D pipeline from Phase 1 to the application stage. Although its total number is comparable to mega pharma, most of them are life-cycle management (LCM) projects such as hemophilia (4 items), familial angioedema (6 items), attention deficit / hyperactivity disorder (ADHD, 3 items). We can not expect an increase in sales from LCM projects in rare disease. There are only 10 items of development items other than LCM in Phase III and beyond the possibility of launch within 5 years, the sales potential in 5 years (2022) is the best case with $ 2.1 billion (230 billion yen ), And it is $ 1 billion (110 billion yen) after risk adjustment that multiplied the success probability. Total with existing products (15.3 billion dollars, 1.7 trillion yen) is expected to increase only 2.0% annually. (Report p. 35 - 36)

The number of patients in the rare disease area in which Weber has expressed expectations is extremely small, penetration of new treatment medicines will become 100% shortly after launch and the market will not expand. Because prices are expensive from the beginning, price increases are not allowed.  In addition, there are problems such as competing products appearing faster than expected by the support of government and academia. It is unrealistic for major pharmaceutical companies to rely on rare disease as a source of long-term growth. (See reports p.38-40)

5. Restructuring plan

Takeda's President, Mr Weber, pledged to compensate the with a cost reduction of 150 billion yen in total (* Note). Although this is not enough, the more important issue is that Takeda is the center of restructuring. Shire was a medium-sized company with sales of around 700 billion yen up to three years ago, but in 2016 we bought Baxter's blood business etc. to make the sales scale 2.4 times. The reaction rate has raised the cost of sales ratio, and the profit margin has decreased sharply. The merger synergy (cost reduction) was not realized and it seems that the profit margin which deteriorated greatly has not recovered, the stock price of the beginning of the year was a situation that it falls by 20% by the end of March when Merger with Takeda is presumed (P. 29).

This M & A is felt even as if Shire has takes in Mr. Weber and sees Takeda as a food. President Weber's business situation deteriorated so far and the hardship and patience of Japanese employees has reached its limit. We strongly oppose to weaken the domestic management base further. (*Note) Nikkei Biotech dated May 9

Conclusion

Based on the above problems,  the purchase price, which would amount to 7 trillion yen in stock value and 9 trillion yen to include financial liabilities from Shire, is not reasonable.