Takeda is cheap to comps on EBITDA and cheap to equity on an absolute basis. The stock trades at 8x FCF. We think the equity trades at 70% of fair value.
Takeda borrowed $30b at a 2.3% blended cost of debt to buy Shire. Shire is a growing, cash generative, non-cyclical business with excess assets that can be sold to de-lever. Synergies in pharma are real. It’s a public LBO and the math looks pretty compelling if you’re into IRR math. This is old-school 1980s style LBO – cheap, cash generative, excess assets, fat to cut.
We wish we had a bit more of a catalyst and admit that a cheap large cap “Japanese” company (to be discussed below) without a tight thesis makes this less than an A+ pitch. That being said, we do think 1) there are some weird technicals going on with the merger and multiple listings, 2) there is somewhat of an information void as the company hasn’t presented in detail since the deal closed, and 3) the leverage profile makes this off-limits for many natural Japanese holders. These 3 dynamics will sort themselves out over the next 18 months.
Takeda is a global pharmaceutical company, largely focused on the core therapeutic areas of oncology, gastrointestinal, neuroscience, rare diseases, and plasma therapies.
In May 2018, Takeda announced a deal to acquire Shire for $77b including assumed debt. The deal moves Takeda into the top 10 Pharma companies on revenue, EBITDA, and R&D. The deal is predicated on $1.4b in cost synergies, cheap debt, and up to $10b of asset sales to de-lever quickly. Following the deal, Takeda underperformed significantly. There was much written about the technicals of the arb spread and flows given multiple listings and investor positioning.
Sales reliance is 38% for top-five drugs vs 49% average for global top-10 comps, with only one major patent expiry over the next three years (Velcade). We think that Takeda’s pipeline and drug concentration are in-line to slightly-better-positioned than large cap global pharma peers. Like all global pharma companies, Takeda has well-defined patent cliffs and an amorphous prospective portfolio. This makes it easy to forecast declines in out-years and hard to predict where tomorrow’s growth will come from. That said, our conclusion on Takeda’s portfolio is more-or-less in-line with consensus: modest growth into the mid-2020s followed by modest decline thereafter. The lack of concentration and relatively long life of the portfolio should cash flow volatility, and we don’t see this being a major driver of performance over our investment horizon.
Financials and Valuation
Several analysts on the sellside have done detailed work on the topline on a product-by-product basis. We don’t claim to have a differentiated view on numbers.
As shown below, the thesis really comes down to hitting synergy targets. We think it’s still hard to lose money from here even if the synergies don’t come through, but the IRR will be uninspiring.
Not shown in these numbers is the effect of asset sales. The company plans to sell $10b, almost entirely in the “others” section above – products outside the core therapeutic areas. We think that there is significant potential for these asset sales to be accretive to EBITDA and FCF multiples – many of the asset are either early stage with limited cash flow or will trade at high multiples.
Pharma peers trade at 10.5x 2020 EBITDA and 12 – 13x EPS / FCF. Takeda’s M&A history has muddied the accounting a bit, so EPS is quite distorted. Nonetheless, we think Takeda fits squarely into the peer average, and suspect that as the situation normalizes and synergies come through, the stock should trade in-line with peers. Our base case is +60% (50% appreciation, 10% dividends) over a two-year holding period.
We’re a bit concerned about some of the softer risks here – it’s a Japanese large cap pharma company which sounds like a prime-time value trap. One might pushback and suggest that it’s a truly multi-national company with a strong CEO. We’re not sure he’s actually that strong – he’s shown a tendency to empire build and hasn’t created much shareholder value historically. Also, he’s a French CEO in Japan about to undergo a large cost-cutting initiative. Makes us a bit nervous about the politics with the Ghosn stuff ongoing. Additionally, the old CFO who was strong left in 2018 to go to WBA.