We took the precaution of reducing our holding in AstraZeneca in April at a share price of between £47 and £48 in order to hedge the transactional risk. We have, however, been able to build this position up again in the £41 to £43 range following the board’s rejection of the proposals. AstraZeneca’s management mounted a creditable defence to Pfizer’s proposed offer, but they now face the challenge of justifying the rationale behind their rejection.
We shouldn’t lose sight of the fact that slightly over half of the proposed £55/share on offer from Pfizer was payable in its shares, the value of which would vary, but £55 will nevertheless represent a fairly firm watermark which AstraZeneca’s management will come under pressure to achieve.
We believe shares in the company are certainly capable of justifying a price tag of £55 or more, but we are fairly agnostic as to whether this is achieved via a bid or under the company’s own steam.
In response to the bid, AstraZeneca has so far announced a revenue target of $45bn by 2023 from $25.7bn last year, a CAGR [compound annual growth rate] of just over 6 per cent, and it has stated – unsurprisingly – that the rate of earnings growth should be greater due to operational leverage.
Performance of stock and index over 5yrs
Source: FE Analytics
If – as was reported recently – AstraZeneca’s search for strategies to release shareholder value has gone so far as to consider the effective securitisation of some of its patents, this raises a red flag for us and we think the same would be true for some of the company’s largest investors.
Such a deal would be seen as a takeover defence against the likes of Pfizer, who would be reluctant to buy a company that had sold the (rights to the) ‘crown jewels’.
Given that Pfizer has to wait up to six months if it wishes to revive its offer, investors in AstraZeneca may be willing to allow its management team to articulate its strategy for growth and justify its assertion that Pfizer’s offer “undervalues the company and its attractive prospects”, but we think there would be resistance to a plan that makes the company less attractive to suitors.
A 2011 amendment to the UK Takeover Code allowed negotiations to be revived again before the six month cooling-off period has ended if they are instigated by the target company but “such consent will not normally be given within three months”.
A scenario where investor pressure persuades AstraZeneca’s board to reconsider Pfizer’s overtures within this three-to-six month timeframe should therefore not be discounted, and its likelihood increases if off-the-wall defence strategies come under consideration.
The potential for a Pfizer/Astra combination is motivated by more than just balance sheet efficiencies, as we view AstraZeneca’s pipeline potential as providing Pfizer with a credible growth strategy and, importantly, it would satisfy Pfizer’s ambitions in the field of immuno-oncology.
To recap, we think there is the potential for a substantial rerating of the pharmaceuticals sector as pipeline potential translates into profit growth potential. Following something of a ‘lost decade’, the sector is finding growing political patronage which is encouraging companies to shed consumer-facing businesses and return to being the innovative growth businesses of the past.
More efficient research processes and various regulatory changes (fast track processes and breakthrough therapy status) certainly provide further encouragement to “big pharma”.
Many companies have now negotiated the so-called ‘patent cliff’ and we hope that pipeline success will provide the necessary earnings stimulus required to justify investors’ faith and belief in sector.
The global healthcare theme accounts for 18 per cent and 17.5 per cent of the Liontrust Macro Equity Income fund and Liontrust Macro UK Growth fund respectively, with positions in AstraZeneca of 4 per cent and 3.5 per cent.
AstraZeneca is a top-10 holding for both of Bailey’s funds, which he has run with Jan Luthman since 2003 and 2002, respectively. Both are FE Alpha Managers.
Astra is a top-10 holding for almost 200 funds in the IMA universe, including Mark Barnett’s Invesco Perpetual High Income fund, Neil Woodford’s SJP UK High Income fund and Leigh Harrison’s Threadneedle UK Equity Income fund.
