NEW YORK (TheStreet) -- AbbVie (ABBV) finally agreed to terms for a $54.8 billion buyout of Shire (SHP) Friday. In the process, AbbVie has become the largest U.S company to ever take over a foreign company in a bid to lower its tax rate, a move known as inversion. This was the fifth offer AbbVie had made to Shire before being accepted.
Irish companies have become a hot-bed of activity recently as U.S corporations use the much lower Irish tax rate to play accounting games and reduce their tax exposure. And TheStreet's John Mason analyzed the growing practice of inversion yesterday.
But is this move a good idea for the companies, aside from the tax rate?
The Shire buyout is expected to reduce AbbVie's tax rate from 22% to 13%, no small amount given the size of the combined company after the merger.
But according to AbbVie CEO Richard Gonzalez, "This is a transaction that we believe has excellent strategic fit, well beyond the tax impact. We wouldn't be doing it if it was just for the tax impact."
And there is merit in the AbbVie "strategic fit" argument.
AbbVie will benefit from Shire's revenue right away. Shire projects its revenue will double by 2020 to $10 billion. With $5 billion in revenue for the last year, Shire has posted 17% year-over-year quarterly revenue growth. Levered free cash flow is very strong for Shire, coming in at over $1 billion last year.
This added cash flow could be used by AbbVie to easily increase the dividend it pays, currently $1.68 per year -- a 3% yield. As of now, AbbVie pays out 53% of its annual earnings per share in dividends. With the deal expected to be positive for EPS, along with the extra free cash flow, a bonus to this merger could be an increase in the dividend.
This deal will also help AbbVie to reduce its reliance on its blockbuster arthritis drug Humira, which loses patent protection next year.
Shire brings to the table a portfolio of drugs in the rare disease market. Those drugs are attracting more attention in recent years. Shire is a leader in the ADHD market, with the leading drugs Adderal XR, Intuniv and Vyvanse. These drugs helped generate almost 40% of the company's revenue last year. The combined company will now have 15 drugs in Phase 3 trials.
"This deal validates the rare disease business model. Depending on how you do the math they could be the No. 2 or No. 3," stated Brian Corvino, head of global commercial consulting at pharmaceuticals specialist Decision Resources Group.
Abbvie also stated that the deal will increase its earnings per share in the first year.
The recent push in the sector to get bigger, such as last month's Medtronic (MDT) takeover of Covidien (COV) for $42 billion, is also pushing other pharmaceutical companies to join the merger parade lest they be left smaller and unable to compete.
AbbVie was only recently split off from Abbot Laboratories (ABT), gaining its independence last year. After this deal it will become the ninth-largest drug company in the world.
A boast to EPS in year one, a large portfolio of new drugs in rare diseases, and a large bump in free cash flow enabling an increase in its dividend payout all add up to make AbbVie's buyout of Shore a very good fit.
At the time of publication, the author held no positions in any of the stocks mentioned.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.
TheStreet Ratings team rates ABBVIE INC as a Hold with a ratings score of C. TheStreet Ratings Team has this to say about their recommendation:
"We rate ABBVIE INC (ABBV) a HOLD. The primary factors that have impacted our rating are mixed ? some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. The company's strengths can be seen in multiple areas, such as its notable return on equity, revenue growth and expanding profit margins. However, as a counter to these strengths, we also find weaknesses including weak operating cash flow and generally higher debt management risk."
Highlights from the analysis by TheStreet Ratings Team goes as follows:
- Compared to other companies in the Pharmaceuticals industry and the overall market, ABBVIE INC's return on equity significantly exceeds that of both the industry average and the S&P 500.
- The revenue growth came in higher than the industry average of 5.6%. Since the same quarter one year prior, revenues slightly increased by 5.4%. This growth in revenue appears to have trickled down to the company's bottom line, improving the earnings per share.
- The net income growth from the same quarter one year ago has exceeded that of the S&P 500, but is less than that of the Pharmaceuticals industry average. The net income increased by 1.2% when compared to the same quarter one year prior, going from $968.00 million to $980.00 million.
- The debt-to-equity ratio is very high at 3.07 and currently higher than the industry average, implying increased risk associated with the management of debt levels within the company. Regardless of the company's weak debt-to-equity ratio, ABBV has managed to keep a strong quick ratio of 2.20, which demonstrates the ability to cover short-term cash needs.
- Net operating cash flow has decreased to $624.00 million or 47.43% when compared to the same quarter last year. In addition, when comparing to the industry average, the firm's growth rate is much lower.
- You can view the full analysis from the report here: ABBV Ratings Report