UK Edition
Questor: buy Shire – the market has punished its big acquisition too severely
Markets tend to have mixed feelings about acquisitions. Shares in the company being taken over normally rise, of course, but investors often steer clear of the buyer on the basis that so many of these transactions fail to deliver the benefits promised.
This has caused the share price of one acquisitive firm to be driven down too far, fund managers say.
Shire, the maker of drugs for rare diseases, which has a history of growing by acquisition, finds its shares in the bargain basement following its takeover of an American rival, Baxalta, last year.
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“The valuation has been driven down by this acquisition,” said David Pringle of Kames, which holds the shares in its UK Equity fund. “Instead of diversifying by making a few medium-sized purchases, Shire chose to do one big one. This resulted in more shares being issued and a feeling in the market that Baxalta had brought as much risk as opportunity.
“But we take the view that earnings forecasts already capture most of the risk. We also think the shares are good value even if the forecasts do turn out to be too optimistic.”
Mr Pringle pointed out that Shire was expected to produce sales growth in the mid to high single digits, and earnings growth in the mid teens, over the next few years. “We have a high degree of confidence in these figures being achieved,” he said.
This makes the current valuation of the shares, which trade at about 11.5 times earnings, seem too low. In fact, the last time the valuation was this low was during the financial crisis in 2008-09.
“The rating could easily improve to, say, 14.5 earnings over the next 12 months, Mr Pringle added. Coming on top of the predicted increase in profits, this would mean a big boost to the share price.
The firm is unlikely to be affected significantly by any attack on drug pricing by Donald Trump’s administration, he said, while the merger should lead to appreciable cost savings.
Shire is also relatively immune to competition from producers of low-cost “generic” medicines because these firms tend to concentrate on treatments for the more common conditions rather than the rare diseases that Shire specialises in.
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Alex Wright, the manager of the Fidelity Special Situations fund and Special Values investment trust, also has big holdings in the shares.
He told Questor: “I think there is significant potential for positive change at Shire over the medium term. Last year’s purchase of Baxalta diversifies its product range and reduces Shire’s reliance on Vyvanse, which loses patent protection in 2024.
“Although this reduces the company’s growth rate, it also reduces its risk, which I think in time could make the stock more attractive to other investors.”
He added: “The other key concern in the market is around increasing competitive pressure for haemophilia drugs. The market’s assumptions here may well prove to be too negative and doctors may be conservative and stick with the existing Shire product.”
Mr Wright said “the highly cash generative nature of the business” supported the extra debt it raised to help fund the Baxalta purchase. The board has also said it has no appetite for further acquisitions this year and will instead concentrate on reducing those debts.
Jeroen Huysinga, manager of the JP Morgan Global Growth & Income investment trust, also holds the shares.
He said: “We believe Shire is a company that can deliver strong growth over the longer term, driven by its leading position in treatments for rare diseases, with numerous promising late-stage programmes. We also continue to see potential for the Baxalta business, despite the market’s initial sharp reaction to uncertainty surrounding the deal.
“Shares in Shire appear very attractively valued on the basis of our own longer-term earnings forecasts.”
We rated the shares a buy in July last year at £48.55 and reiterate that advice now.
Questor says: buy
Ticker: SHP
Share price at close: £47.52
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