Merrill rates Shire a risky bet over Baxalta doubts, despite back-up plans

After the weekend revelation of Shire's plans for back-up acquisitions should its bid for US rival Baxalta fail, Bank of America Merrill Lynch said the drug company's reduced valuation had become attractive but near-term risks were a deterrent.

The FTSE 100 pharmaceutical group has reportedly hired investment banks to work on several potential deals, including possible takeovers of US-based Radius and Switzerland’s Actelion, in the event that its unsolicited $33bn move for Baxalta fails.

The Sunday Times wrote that sources close to the company said management needed its share price to increase before approaching Baxalta with an all-share offer again.

But Merrill pointed out that for investors, as Shire's shares had fallen 15% since the announcement of the proposed acquisition, its valuation as an equity investment appeared tempting at 15 times 2017 forecast earnings and 20% below the bank's 6,000p discounted cash flow target price.

However, it was held back from being more positive due not only to the potential next steps and price to be paid - if any - in the potential Baxalta acquisition, but also uncertainty over the US drug regulator's review of Shire's Lifitegrast dry eye disease drug on 25 October, with the litigation appeal hearing for patent infringement of Vyvanse not too much of a concern.

While there is "balanced risk reward" over the Lifitegrast decision, there remain "too many uncertainties" over Baxalta, Merrill said.

"The proposed deal raises many questions and is therefore likely an overhang for the stock in the near-term, in our view.

"Most critically the potential acquisition price and EPS accretion or dilution remains unknown as Shire’s initial offer was rebuffed by Baxalta and Shire’s currency (its own stock) has fallen 20% since."

Some media have reported that Baxalta's board were receptive to offers closer to $50 to open its books for due diligence, but Merrill analysts noted that even at the reduced Shire share price the deal would be 6% dilutive to 2016 earnings per share and only 5% accretive to net present value, versus 11% for the original deal at the higher share price.

Shire's rating was maintained as 'neutral' by BofAML.