Monday, May 26, 2014

Astrazenca-Pfizer: Bird-in the Hand or Just the Bird?

Ordinarily we focus on buyer value destruction. The Astrazenca (AST) – Pfizer (PF) Drama illustrates sellers are also capable of snatching defeat from the jaws of victory. PF offered $120B - 45% in cash- representing a 45% premium to AST’s pre bid price. PF’s premium was based on cost synergies and tax savings from a planned Tax Inversion. AST claimed the bid undervalued the value of their drug development pipeline and the firm by at least 7% and rejected the offer. AST’s stock price dropped 11% upon the rejection while PF’s rose slightly. (This post will focus on the valuation issues of the bid and ignore the political issues of potential Job Cuts and U.S. taxes.)
AST’s sales and income have fallen from $33.5B and $12.7B in 2011 to $25.7B and $3.7B, respectively, in 2013. The large decline is due to the Patent Cliff faced by many firms in the big phrama industry. AST alleges –warning: hockey stick alert - its new drug pipeline will return sales to 2011 levels by 2017. Furthermore, 2023 sales will increase to $45B - a 75% increase over current levels.

This raises a classic valuation duel. Is a $120B bird in the hand now worth more than a bush containing the promise of something –TBD - larger in 10 years? All valuation questions involve three questions:

1)   How Much: what are the cash flows - not just revenues but the costs and investments associated with a 75% sales increase over 10 years?
2)   How Long: gets to the time value of money- more dollars are needed in 10 years to offset a current dollar.
3)   How Sure: how risky are the cash flows?

The market response to these questions for AST was reflected in the lower pre bid price. Clearly the market did not share AST’s optimistic view of its product pipeline. AST can respond by stating the market did not understand the pipeline - but whose fault is that - investors or AST for not explaining it well enough? More likely, investors are concerned with the high-risk nature of developing drugs as reflected in the continued decline in AST revenues since 2011. So what is going on here? My belief is management is trying to preserve its jobs by staying independent - the shareholders be damned.

Hopefully, shareholder outrage over management’s rejection of a valuable bird in the hand in exchange for receiving a management bird in the face will result in one of the following:

1)   Shareholder Action will force management to reconsider the bid
2)   Replace management and the board - bring in the lawyers
3)   Tie management’s compensation to the targets they believe justify the rejection. If management wants shareholders to roll the dice on the new drug pipeline, then management should join the shareholders and put its money where its mouth is and wager their future compensation - ante up boys.

OMG you can’t make this stuff up-


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