What’s behind AstraZeneca’s US$39bn deal for Alexion Pharmaceuticals?

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AstraZeneca PLC’s (LON:AZN) planned US$39bn acquisition of US rare disease specialist Alexion Pharmaceuticals Inc (NASDAQ:ALXN) seemed to prompt some doubts from some investors and industry observers.

It comes six and a half years after the advances of Pfizer were rejected, nixing what would have been the biggest ever takeover of a UK company by a foreign rival and prompting several major investors into publicly criticising the Anglo-Swedish group’s boss Pascal Soriot and chairman Leif Johansson.

But having been vindicated by the performance of the shares, which earlier this year had risen three-quarters from the US giant’s offer price, the Frenchman and Swede have raised eyebrows again with today’s deal.

READ: AstraZeneca swoops with US$39bn bid for rare disease specialist Alexion

Soriot has spent the eight years since his appointment cultivating the FTSE 100 group’s role as a global leader in oncology, steering it through a choppy period of doubts about its drug pipeline.

Alexion’s approved drugs, meanwhile, focus predominantly on therapies for the treatment of diseases caused by an uncontrolled activation of what is called the complement system or ‘complement cascade’.

This is a part of the immune system that enhances the ability of antibodies and other immune cells to remove microbes and damaged cells and promote inflammation, and is associated with inflammatory and autoimmune diseases across areas such as haematology, nephrology, neurology, metabolic disorders, cardiology, ophthalmology and acute care.

Alexion’s lead drug Soliris, first launched in 2007, is approved in a number or rare indications and accounted for the vast majority of its 2019 revenues last year.

It’s second-generation orphan drug, Ultomiris, was launched three years ago and with many patients switched over from Soliris, while its drug pipeline has 11 molecules in clinical development across various indications.

What is the point of the combination?

Current consensus forecasts for Alexion point to the 21% growth last year moderate to a more modest compound growth average of 7% out to 2026, with Soliris expected to face biosimilar competition from 2025.

This means 65% of Alexion’s 2020 sales will face US biosimilars by 2025, although current management’s aim is to convert sales to Ultomiris.

From sooner though, maybe 2022, the complement biology market is getting more crowded, with competition and pricing pressure expected to emerge.

Based on the current Alexion consensus forecasts, the deal would seem to slightly depress AstraZeneca’s rate of growth.

But AstraZeneca said that its own capabilities in genomics, precision medicine and oligonucleotides can be “leveraged” to develop medicines targeting less-frequent diseases, to help target the several thousand known rare diseases that do not have marketable treatments.

The deal will be immediately earnings-enhancing, AZ added, while also expected to produce around US$500mln of savings within three years from completion, as well as strengthening cash-flow generation.

With limited overlap with Astra’s existing portfolio in terms of therapeutic focus, which could be looked at as a good thing or bad, it is the cash flow element that most analysts suggested was the main rationale.

The deal seems “strategic but somewhat opportunistic”, as analysts at broker Shore Capital put it, or as those from Jefferies said, the motivation of the deal seems to be “bulking-up…boosting cash flows” and so “perhaps viewed as a defensive move rather than the acquisition of a novel platform technology”.

UBS said that although AZ is a fast moving organisation with high levels of R&D productivity, there is “no reason” why it would be able to deliver better results on Alexion’s pipeline than the US company would on its own.

However, the Swiss bank’s analysts saw geographic rationale to the deal, as AZ makes around a fifth of its sales in China and could leverage its infrastructure there.

So while there is a portion on strategic rationale the UBS analysts said it “looks mostly like a financial deal to us”, as the FTSE 100 group “needs access to cash and cash flow and Alexion delivers that without diluting the top-line trajectory too much”.

“The result may well be more freedom to operate going forward though as cash conversion has been poor and the pro-forma numbers point to margin accretion and better cash generation.

Is the deal good value?

Furthermore, Alexion is being acquired for an undemanding valuation, many analysts agreed.

The NYSE-quoted shares are trading at a 40% forward p/e ratio discount to peers, the Shore Cap team noted, with rare and orphan disease “one of the more compelling growth segments of the market for growth-starved and cash-rich pharma”.

Furthermore, with Alexion estimated to generate around US$1.7bn of cash in 2021 and 2022 step this up to around US$2.2bn in 2023, this suggests the Anglo-Swedish company can afford the extra debt burden relatively comfortably, said UBS, and would de-lever the additional debt burden quickly.

Furthermore, the dividend would not be negatively affected and could be accretive, according to UBS’s estimates, with the dividend current not quite covered in 2021 and tight in 2022.

“The Alexion cash generation would hence allow for more dividend flexibility.”

Citigroup’s analysts said they like the deal “a lot”, with Alexion’s undisturbed market price seen to be 34% below its net present value and a discounted cash flow valuation pointing a fair price of £107 compared with £102 currently.

On the dividend, Alexion’s cash flow contribution “dilutes the risk” to AZ’s Tagrisso from looming competition and should offset the loss of US exclusivity on Farxiga and Brilinta.

Moreover, Citi said the high barriers to biosimilar entry for Soliris and Ultomiris “give AZN’s portfolio greater durability”.

What none of the analysts suggested, however, is that the deal might be a subtle swansong for 61-year-old Soriot, ticking some of the gaps for the company after a decade in charge.   

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