AstraZeneca – if the price is right surely Pfizer will win its battle

15th May 2014

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The Pfizer takeover bid for AstraZeneca is the biggest and most controversial takeover seen for a decade – it is far larger and more contentious than Kraft’s swallowing up of Cadbury writes investment journalist Tony Levene.

The US pharma giant’s current £50 a share offer tops the $100 billion mark – it looks more impressive in dollars but in whatever currency, a successful deal for the Americans could unleash a torrent of cash onto investment markets.

The bid has attracted far more media space – and political/commentariat scrutiny – than almost any other takeover. There’s national interest, patriotism, binding assurances – and just sometimes – getting a better price out of Pfizer. The suggestion is that £55 to £60 a share would put AZ into the Pfizer bag – even if the Daily Telegraph thinks it is worth £100 a share.

But individual investors who make the ultimate decision and face the prospect of how to use the proceeds from a successful bid, have three factors to consider. (And the so-called national interest does not figure in any). In my view, here are the three key questions.

Will the bid succeed?

Do mega mergers work? And is pharma a special case?

If Pfizer wins, what will happen to the money? And if it loses, what happens then?

Will the bid succeed?

History suggests it will. The majority of bids are successful although there is usually substantial horse trading. Everything has its price and Pfizer knows this. It will have factored in an opening amount to test the waters, a larger sum to see how major investors react and it will have a final amount that it will offer. It is aware that investors do not think like government ministers or the media. Investors only consider their own bottom line and, as the bid has sent the FTSE 100 index to 14 year highs, that can only be good for fund manager performance and indeed bonuses.

Bidders, like Pfizer, know that winning is all important. It does not want to lose face with its own investors. It will be prepared to pay a few dollars more a share to avoid the shame of defeat. Additionally, it is aware that AstraZeneca is in play. If it does not snap it up, then a rival in big pharma will try. Pfizer would rather overpay than see AZ end up with a competitor.

Neil Veitch, manager of the SVM World Equity fund believes the company requires a small increase in offer price, possibly with a small change to the cash element in the deal structure, before it will consider entering formal discussions.

“Formal discussions will likely result in an increased offer being tabled and, we think, accepted,” he said. “This means that a hostile takeover wouldn’t be necessary.”

Veteran fund manager Neil Woodford is high profile on AstraZeneca. Not only has he been a significant long term shareholder, he is currently launching his own Woodford Asset Management so there is a useful publicity synergy for him.

His view is that £50 “undervalues the company”. He says: “The company has now changed massively for the better. And this is beginning to be recognised by the market. Clearly Pfizer has recognised it too.”

Drugs companies have been among the most unloved areas of the stock market over the past decade. When Woodford, then at Invesco, bought into AstraZeneca five years ago he says it was under valued. “The market was worried that drug patents were about to expire and deprive the firms of much of their revenues — the so-called ‘patent cliff’. Investors ended up marking pharma shares down to ludicrously low levels.”

But Woodford, like all investors, is not sentimental and will have his price – with some speculation this is perhaps around £58 a share. Those rooting for the UK-based firm have an ally in Johan Unnerus, senior analyst at Swedbank.

He says Pfizer has a very poor M&A track record and that this deal has “no industrial logic.” He adds: “A mega deal is contrary to the recent trend where pharmas aim to secure scientific leadership in a few areas. ”

But investors should look most closely at what the market itself is saying rather than higher profile fund managers. The AZ share price is still below £50 – at £46.54 – suggesting shareholders in general are cautious, and have factored in a Pfizer defeat. The Pfizer share price is down 10% to $29 since the bid talk started so its own investors are not cheering the takeover to the rafters.

Do Mega Mergers work? Is pharma a special case?

The history of large mergers suggests they create profits for shareholders with the company receiving the bid but destroy value for investors in the bidder. However, it is not so clear in the special case of pharma firms.

According to recent research from consultants McKinsey, “conventional wisdom holds that large mergers have destroyed value in the pharmaceutical industry. Market commentators insist that these deals don’t work, that the challenges of large-scale integration unnecessarily disrupt the organisation and critical programs, and that research and development productivity suffers. These critiques have some merit but ignore larger points: mega-mergers have created significant value for shareholders, and some of these deals have been critical for the longer-term sustainability of acquirers. In short, we believe that the benefits often warrant the disruption that these deals entail”.

“Perhaps that explains their popularity. Megamergers have played a key role in shaping the global pharmaceutical landscape. Indeed, most of the pharmaceutical companies that stayed among the world’s 20 largest between 1995 and 2005 were involved in “megamergers.”.”

In what may be seen, effectively, as a riposte to AstraZeneca’s suggestion that its drug production could be disrupted, the consultants add: “Most importantly, collaboration can help reduce wasteful overlap. In a number of primary care diseases, including diabetes, hypertension, and hypercholesterolemia, many pharmaceutical companies have focused intensively on the same opportunities.”

The history of pharma over the past 20 to 30 years is a constant coming together. AZ has taken over companies. GlaxoSmithKline is an amalgam of many components.

If Pfizer wins, what will happen to the money? And if it loses, what happens then?

The final deal has yet to be tabled – Pfizer has until May 26 under takeover rules. Much depends on the mix of cash and shares. Will US investors want more shares in a UK listed Pfizer?

If Pfizer wins, it will be closely monitored for a time to see if and how it keeps any pledges it makes. The market does not like companies that are tied up so it will tend to look for, and applaud, the American firm for how it works around restrictions.

The cash element may well chase whatever the next mega merger is deemed to be. And it will enhance fund managers’ spending power – possibly pushing the Footsie finally over the 7,000 barrier.

If it loses, then AstraZeneca remains in play. Another pharma giant could table a bid. It could acquire itself. The AZ share price will, however probably fall in the short term.

Ultimately however, there are so many egos here – on both sides of the bid, the government, some fund managers, to name just a few, that a likely outcome needs to be found that leaves all with reason to think they have won. That probably means a higher bid than £50 when the formal paperwork is tabled. In investing just about everyone has their price.

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