June 8, 2020 / 11:58 AM / a month ago

Breakingviews - AstraZeneca M&A puzzle sends shareholder warning

A man walks past a sign at an AstraZeneca site in Macclesfield, central England May 19, 2014.

LONDON (Reuters Breakingviews) - AstraZeneca’s approach to rival Gilead Sciences is a puzzle for shareholders, but also a warning. Chief Executive Pascal Soriot has done well for the $140 billion drugmaker’s investors. The risk is that the company’s debt load, or his bigger ambitions, threaten that record.

The Anglo-Swedish group’s decision to approach Gilead about a merger, as reported by Bloomberg on Sunday, is a strange reversal in corporate logic. Back in 2014, Soriot fended off a bid from Pfizer, arguing that the company would do better on its own. He was right: AstraZeneca’ share price is roughly 50% above Pfizer’s offer of 55 pounds a share.

Yet if a deal with Pfizer was unappealing, a combination with Gilead looks doubly so. The $96 billion U.S. group specialises in HIV drugs and Hepatitis C treatments, neither of which are AstraZeneca’s core areas. Gilead is building up its cancer business, and both companies have potential therapies for Covid-19. However, the lack of common interests would mean fewer cost savings and raise the risk of a botched integration.

A combination, worth $232 billion based on closing share prices on Friday, would therefore be a hard sell. Despite hopes that Gilead’s Remdesivir can help patients with Covid-19, the company’s stock trades at a mere 12 times expected earnings. Shareholders would probably demand a big takeover premium.

AstraZeneca investors, meanwhile, would question the logic of joining forces with a company whose sales are expected to grow by just 0.4% a year over the next five years, according to Morningstar.

Gilead’s clean balance sheet boosts its appeal. It churned out over $9 billion in operating cash flow last year and had barely any net debt as of March. By comparison, AstraZeneca’s roughly $12 billion debt pile in 2019 was nearly twice last year’s EBITDA, and operating cash flows won’t cover its dividend payments until next year, Moody’s reckons. An all-share merger would produce a less leveraged company. 

Another worry is that Soriot wants to do a deal. U.S. healthcare providers are joining forces and the pandemic will put greater pressure on governments to lower healthcare costs. With AstraZeneca shares near their all-time high, Soriot has a valuable acquisition currency. A merger with Gilead may be unlikely, but investors can’t ignore it entirely.

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