Not Cheering Shire Deal
Board: Value Hounds
I owned Abbott and after the split kept both ABT and AbbVie. Knowing that Humira was coming to the end of its patent in just a couple of years I went ahead and sold AbbVie. Humira has always made me a little nervous as it becomes a bigger percentage of revenue. As part of the combined company its impact was somewhat lessened although it was a serious contributor to profits. With the split, Humira has become a blessing and a terrible curse for AbbVie. In 2016 the patent expires and I know that at least Mylan has the bioequivalent on their list of things to do this year.
[See Post for Tables]
Humira is a great franchise and has had an amazing run for Abbott. All good things come to an…? It won’t go to zero on day one and since it's a biologic, it may hang on longer than a small molecule patent expiration. But with the high sales, there will be pharmas working on it and not just Mylan. However it goes down, the potential loss of nearly 60% of revenue is an event investors and the company need to plan for.
AbbVie has a pipeline now and parts of it have potential to make up for the Humira losses. The Abbott pipeline was always a little weak and revisiting it now through AbbVie shows vast improvement. AbbVie's pipeline includes more than 20 compounds in Phase II or III development individually or in collaboration. Of these programs, approximately 10 are in Phase III development or registered.How long trials take
Preclinical 3-6 years
Phase 1,2,3 6 to 7 years
Phase 4 up to 2 years
A drug in Phase 3 could be within a few years of coming to market and just in time to help with the Humira expiration. Humira will ramp down and new drugs take time to ramp up. The offset isn't guaranteed. There is a good chance AbbVie will see declining or at least flat revenue.
Phase 3 medications include a few potential blockbusters that could help soften the loss from Humira. I would expect Humira to drop 50% in year one if a suitable bioequivalent is marketed but less so if no bioequivalents show up. That’s a little over $5 billion and it’s possible just the HepC drug could fill that void the first year. It’s due in 2014—even better for AbbVie. they expect several Phase II programs to transition into Phase III programs during 2014.
Humira indications are being expanded with Phase III clinical trials for hidradenitis suppurativa (HS) in the United States are expected in 2014. HS is a nasty inflammatory response that affects the groin and underarms and has no treatment. Not likely to be a blockbuster with a small patient base but extends Humira's life at AbbVie.
Their biggest potential blockbuster (several billion dollars worth at least in year one) is the hepatitis C combination of three medications. AbbVie expects to complete regulatory submissions in the United States and the European Union in the second quarter of 2014 and anticipates commercialization in the United States before the end of 2014. It will go head to head with Gilead and the new ledipasvir/Sovaldi medication at a more patient friendly one pill once per day. However the cure rate for the AbbVie is nearly 100% and that will bear heavily on prescription rates.
• Elotuzumab is an antibody that is used in combination with Celgene’s Revlamid for multiple myeloma (MM -- blood cancer) It’s indicated for use in MM that breaks through standard treatment. It won’t be a blockbuster like Revlamid because it’s not first line but it should do a few hundred million $.
• ABT-199, a next-generation Bcl-2 inhibitor for chronic lymphocytic leukemia. This drug helps cells commit suicide in essence. AbbVie anticipates results from the Phase 3 trial in early 2015. Blockbuster potential since other treatments aren’t optimal and/or are second line treatment for refractory cases.
AbbVie's renal care pipeline includes atrasentan, for the treatment of diabetic CKD. In 2013, a Phase III study was initiated to assess atrasentan, when added to standard of care, on progression of kidney disease in patients with stage 2 to 4 CKD and type 2 diabetes. This global registrational study is expected to be completed in 2017. Atrasentan will potentially be the first compound launched to treat diabetic nephropathy by specifically targeting
albuminuria and slowing the progression of chronic kidney disease.
The acquisition of Shire adds some firepower
It was an expensive deal
Shire's board recommended the offer—which comprises £24.44 ($41.78) in cash and 0.8960 AbbVie shares per Shire share—just hours ahead of a deadline Friday set by the U.K. takeover panel. Shire had resisted AbbVie's advances for more than two months and rejected four previous offers as too low. Shire is based in Dublin and incorporated on the U.K. dependency of Jersey, a tax haven.
Shire will diversify AbbVie a bit and help them only slightly dilute the impact of Humira on revenue. In 2013 Shire revenue was $4,758 B and added to the 2013 AbbVie revenue, using 2013 Humira sales, we still get AbbVie relying on Humira for 45% of its revenue. The AbbVie pipeline will help offset the Humira losses more than the Shire acquisition. The nearly $5 billion Shire brings doesn’t do a lot for diluting out Humira. It also brings its own heavy reliance on one class of drugs for attention deficit disorder. Vyvanse is their biggest selling drug at $1.2 billion (something of a slacker compared to Humira) and 25% of total Shire revenue. It won’t make much a dent in the combined company at 5% of sales.
The other big business at Shire is metabolic storage diseases like Fabry’s, Gaucher’s and Hunter’s (all eponyms). This is the same area that Genzyme is famous for. These are specialized medications often replacing enzyme abnormalities and address a small population of patients with the advantage they are protected by orphan drug status exclusivity.
Shire in its own way is heavily concentrated in just two areas with nearly 70% of their revenue coming from around six drugs. Interestingly, margins at Shire a far less than the AbbVie margins. Shire will represent about 20% of combined revenue and has the potential to decrease AbbVie's own margins depending on the product mix. In other words, I wouldn’t expect margin expansion as a result of the acquisition and earnings growth may not accelerate.
Shire does bring a small pipeline of products. Most promising was a treatment for dry eye. This is a pervasive condition that can damage the cornea. Allergan has the best treatment Restasis selling $940 million in 2013 at 15% of revenue. Dry eye can be big business. Unfortunately Shire’s product failed to meet all endpoints in its Phase 3 trial and it may be an almost useless part of the acquisition for AbbVie instead of a potential blockbuster.
The blue whale in the room
The price tag for Shire was insane. It’s not a bad company, but it has few blockbusters and a pipeline that has some indications for small patient populations. There is no Humira here, but a lot of little things that will patch the leaks. The $54 billion it’s going to cost is frankly nuts. The debt load will be huge and the dilution undesirable. There will be some tax advantages and it will be something to track after the merger to see if it was worth the price, the debt and the dilution.
If the deal goes through, Shire shareholders would end up owning around 25% of the new combined company—above the 20% threshold needed to pursue an "inversion," where a company changes its tax residence through an acquisition. AbbVie stressed that the purchase wasn’t solely based on tax considerations. I suspect this was largely PR because there is some blowback on the pharma segment’s recent fascination with acquisition of foreign companies. They insist the acquisition will diversify AbbVie but as we saw above, there’s not much difference in Humira as 57% of revenue or 45% of revenue—both are still big percentages difficult to fill on patent expiration.
AbbVie said the combined company would be a leader in the fields of immunology, rare diseases, neuroscience and metabolic diseases. But the two companies have little overlap in their respective businesses, limiting likely cost synergies. AbbVie declined to provide specifics about potential cost savings.
Debt is a definite dealbreaker
The cost is 32 billion pounds or $54.7 billion. The initial debt will be a bridge loan of 13.5 billion pounds ($23.03 billion). The bridge loan comprises a loan of up to 9.1 billion pounds with a 364-day maturity, a 3.2 billion pound loan with a 364-day maturity, and a 1.2 billion pound facility with a maturity of 60 days. The financing pays an interest margin of 62.5 basis points (bps) to 150bps over Libor, depending on rating of the merged company after the acquisition.
JP Morgan is the sole arranger and underwriter of the bridge loan, expected to be refinanced with up to 15.5 billion pounds of senior unsecured bonds that AbbVie is planning to issue to cover the cash element of the acquisition. In dollars that works out to $26.5 billion and brings AbbVie’s total debt to around $41 billion (dollars). If debt reaches that level in dollars, debt/capital rockets to an uncomfortable 81%. They are going to need to refinance fast as there are interest penalties for delaying. There is a duration fee of 50bps, payable 90 days after closing. It rises to 75bps 180 days after closing and to 100bps 270 days after closing.
AbbVie is paying 26.2x EBITDA for Shire that seems to be a popular price range these days for pharma mergers. Valeant is offering about that for Allergan. It’s undeniably high since a “good” value is considered to be in the 8x-11x range. The dilution is 33% with shares issued to Shire shareholders. The combined cash flow from operations in 2013 came in at $7.8 billion and free cash flow was $6.9 billion. We are a long way from realizing maturities on the debt, but with this level of free cash flow, paying principal will be challenging. Large future acquisitions are out of the question so AbbVie is going to have to make it on the pipeline that isn't bad.
That’s about all the interest I have in AbbVie until the final numbers are out.