Missed bargains


Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

AstraZeneca and GlaxoSmithKline, the two giants of the UK pharmaceutical sector, recently announced details of a proposed billion-dollar deal each.

Astra is looking to pay $1.2bn (£740m) for Ardea, which has a promising gout drug in phase 3 trials. That said, the business currently has little in the way of revenues and is forecast to make a loss of more than £80m this year. The earliest its drug can be on the market, always assuming it actually passes this final testing phase, would be 2015.

For its part, Glaxo is set to pay $2.3bn for Human Genome Sciences (HGS), whose latest drug has successfully passed its phase 3 trials; although initial sales have disappointed, the business continues to make losses and its share price has fallen 75%. Glaxo is already a 50/50 partner on this drug with HGS, however, and would appear to be exploiting short-term price weakness in the belief it has good long-term potential.

On the face of it, the Glaxo deal looks to carry less risk as HGS’s main product has already passed its trials – good news in itself for an industry that has been struggling for some time to find new drugs to bring to market – and Glaxo knows the product well as a result of the existing partnership. However, the price tags on both companies look exorbitant.

Once the adjustment is made for the fact Glaxo already receives half the profits through its existing agreement, the group is paying 40x sales for HGS while, in Astra’s case, sales are so negligible as to make any multiple completely meaningless. Furthermore, since neither acquisition target generates any profits, it is impossible to appraise either deal on any profit measure.

Since – at $7bn and $6bn respectively – Astra and Glaxo’s cash generation is so enormous, neither deal is likely to make or break anyone’s investment case for them. However, as a statement of intent, it is concerning for many pharma-heavy value investors, such as ourselves, and suggests the managements remain focused on sales growth rather than explicitly trying to achieve shareholder value.

This conclusion is all the more inescapable when you consider both Astra and Glaxo have the option to invest their cash in the shares of pharma companies that not only trade at just 2x and 2.5x sales respectively but also carry zero drug pipeline or execution risk. Where are these extraordinary deals to be found? As some of you may already have guessed, in the valuation of the pair’s own stocks.


Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

I joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Kevin Murphy and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Kevin and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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