AbbVie Inc., Market Cap (as of 19/09/2014): $94.63bn
Shire plc., Market Cap (as of 19/09/2014): £31.12bn

In its attempt to become one of the global leaders in the rare diseases market, AbbVie successfully got the approval from Shire’s board of directors for its $54bn acquisition. This approval came after two months and four previous offers by AbbVie deemed too low by Shire. It is no coincidence that this deal was pursued now, since it comes after a wave of transactions in the pharmaceutical sector. AbbVie Inc. is a research-based biopharmaceutical company, which was formed in 2013 after being spun-off from its parent company, Abbott Laboratories. The Company produces pharmaceutical drugs for specialty therapeutic areas such as immunology, chronic kidney disease, Hepatitis C, women’s health, oncology, and neuroscience. The Chicago based AbbVie plans to move its tax domicile to the UK, pending the success of the deal and regulators’ approval. Moreover, if the deal is completed AbbVie will become the largest US Company to move its legal address abroad as it seeks to lower its taxes and take advantage by accessing its global cash flows.

Shire is based in Dublin, and is incorporated in the UK dependency of Jersey. It sells the attention-deficit drugs Vyvanse and Adderall, and has plans to expand its portfolio of drugs for rare diseases. Although AbbVie plans to move its legal address abroad, it will keep its operations in the US. The offer comprises of $41.78 per share in cash and stock, whereby Shire’s shareholders will receive 0.8960 of AbbVie shares for each Shire share they hold. This means that Shire’s shareholders will own approximately 25 per cent of the new company. The deal values Shire at a 53% premium over its closing price on May 2 (a day before AbbVie’s first offer). The market reaction to the announcement was positive. Shire’s stock had surged 69 percent this year amid speculation that the company would be acquired, while AbbVie gained 2.6 percent to close at $54.91 in New York after the announcement.

This deal is the latest in the string of many multi-billion transactions that have been completed in the recent years, within the pharmaceuticals and biotech sector. Novartis and GlaxoSmithKline (GSK) have completed a complex transaction, whereby Novartis acquired GSK’s high-margin oncology unit for a $14.5bn, and GSK acquired the former’s vaccine unit for $5.4bn, reducing the number of major vaccine producers from five to four. The two have also teamed up for a joint-venture for the consumer divisions, essentially over-the-counter medications, creating a large pharmaceutical company with projected revenues of $11bn. Even though these transactions are quite large in size and scope, AbbVie acquisition of Shire far outsizes them, competing with Pfizer yet-unsuccessful bid for the British drug maker AstraZeneca, for the largest transaction in the sector in 2014. AbbVie-Shire acquisition price tag of $54bn is the second largest transaction completed in the sector in the past 5 years, after Pfizer’s acquisition of Wyeth Labs.

The industry forces behind this wave of transactions are quite clear. Most pharmaceutical giants have very low debt obligations, large stockpiles of cash and patent expiration liabilities, which refers to the forgone profits once their patents expire. As pharmaceutical patents expire, a flood of generic drugs substantially reduces sales for the patent holders. To counter this loss, major drug-makers use M&A transactions to broaden their portfolio or reach a greater scale to maintain their margins. For instance, GSK acquisition of Novartis’ vaccine unit, aims to consolidate the sub-sector and maintain healthy margins through scale. Further, industry consolidation often leads to lower overhead, and the combined R&D efforts could be lowered as a percentage of total sales.

The CEO of AbbVie, Richard Gonzalez said that the rationale behind the acquisition is much more than just getting the tax advantages that the media focuses on. Q2 results showed that Shire managed to grow 22% in product sales. By acquiring Shire, AbbVie will be able to diversify its portfolio thus making a more complex product mix. AbbVie has been highly reliant on its blockbuster arthritis drug Humira, which accounts for more than half of AbbVie’s revenue and is expected to lose its patent protection by the end of 2016. Moreover, the patent to its blockbuster triglyceride drug (Trilipix) expired in January of this year, resulting in sales plummeting 58%, from $1.1bn to a mere $235m. To counter these losses, Shire’s rare disease drugs generate about $2bn in annual sales. The combined company will produce 15 drugs in the last of three stages of testing.

AbbVie’s plan is to render the combined company a leader in the fields of immunology, rare diseases, neuroscience and metabolic diseases. In case the acquisition succeeds, Shire’s CEO, Flemming Ornskov, will lead the combined company’s rare-disease unit from Switzerland and help with the integration of the two companies. Even though AbbVie is confident in the completion of the deal, it had to establish a breakup fee, which it would pay to Shire in case the deal does not go through. The fee represents about 3 per cent of the transaction, around $1.6bn. Moreover, should AbbVie shareholders not give their vote for the deal, AbbVie will pay about $500mln to Shire.

Beyond the strategic reasons, there is another important reason for this acquisition, as it would potentially allow AbbVie to move its tax domicile to UK, thereby slashing its corporate effective tax rate from 22% to 13%. This type of transaction, labeled tax inversion, has been on the upsurge in the healthcare sector, with another transaction with similar size recently closed (June). Medtronic acquisition of the Dublin-based Covidien for $42.9bn was partially motivated by moving Medtronic’s domicile to Ireland. A similar move has been made by Burger King (see our article on Burger King – Tim Horton).

This tax inversion tactic has prompted a call to action from Washington lawmakers, who are scrambling to halt them as soon as possible. Should Washington pass legislation that would retroactively halt inversions, as the Treasury Secretary Jacob Lew suggested, AbbVie’s plan to move tax domiciles could be thwarted. Other lawmakers proposed different penalties to be imposed on companies that move abroad in an effort to avoid the higher taxation in the US. Bernie Sanders, the independent Senator from Vermont, has suggested the US government to withhold contracts from companies practicing tax inversion. On the other hand, business leaders and many Republican lawmakers point to the fact that this wave of tax inversion transactions is motivated by higher nominal tax rates and tax laws in the US, where companies can face double-taxation, should they decide to repatriate the profits made abroad. Under the current tax regime, companies would have to pay additional taxes on income brought into the US to finance their business or acquisitions.

Regardless of the merits of each side’s arguments, AbbVie has very little cashflow in the US, with the majority of its earnings trapped in offshore subsidiaries. According to an analyst at Barclays, AbbVie stands to gain close to $500m in tax savings, by accessing Shire’s US cashflows, even without moving headquarters. Further, AbbVie would stand save another $350m in tax obligations, should it succeed to move its tax base to Jersey. Independently from the outcome of the latter issue, it is projected that the acquisition will be accretive in the first year, and the earnings accretion would reach to $1.00 per share by year 2020.

JPMorgan Chase & Co. is advising AbbVie on the deal, while Citigroup Inc., Deutsche Bank AG, Evercore Partners Inc., Goldman Sachs Group Inc. and Morgan Stanley are advising Shire.

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