Shire (LSE: SHP) (NASDAQ: SHPG.US) is a valuable company, but its stock is incredibly expensive right now.
Value
One way to gauge the value of a business is to focus on its asset base. Shire reported total assets of $10.9bn as of 31 March 2014. Current assets totalled $2.6bn, or $4.48 per share on a fully diluted basis.
Long-term assets accounted for about $7.3bn, or $12.5 a share — 96% of which is represented by goodwill and intangibles. As such, according to this methodology, the total value of Shire stock is $17, for a 76% downside to its current market value.
Of course, this is not an ideal approach in the pharmaceutical industry. Other factors – such as R&D, SG&A and drugs pipeline — and calculations equally deserve attention to determine the fair value of a pharmaceutical company, but I don’t see why anybody should not be tempted to cash in at this level. Shire is at least 25% overvalued, based on most trading metrics.
The list of suitors for Shire is long, true. If an oft-rumoured takeover doesn’t take place, however, Shire shareholders will be left with a large paper loss.
Trading Multiples
Shire stock has recorded a +119% performance in the last 12 months. After a couple of dismal years, M&A rumours have greatly contributed to its surge in value.
With a market cap plus net debt of 20 times and 8 times adjusted operating cash flow and revenue, respectively, Shire offers upside to investors who believe that a blown-out offer in the region of £50 a share ($85) – some 10% above ABBVie’s latest proposal – will emerge.
Shire is attractive, as my Foolish colleague Rupert Hargreaves recently argued. Many players in the pharma industry could afford a bid, yet several signs point to downside risk, including M&A risk, because Shire, as a standalone entity, needs acquisitions to grow revenue and shore up earnings.
Return on invested capital could be strained if Shire remains independent.
Outlook
When Shire reported first-quarter figures last month, several analysts were pleased with the outcome following the integration of ViroPharma, but also voiced their concern about growth prospects.
Among others, analysts at Royal Bank of Canada noted that they remained “concerned about 2015 revenue growth with the pending Intuniv generic and the potential ADHD entrant, SHP465, only filling a niche role.”
“Combined R&D and SG&A are expected to grow by 4-6% vs. 6-8% previously,” they added. “The lower R&D expenditures can be partially attributed to the clinical hold of SPD602 as significant spending on the newly acquired Fibrotech assets will not occur until 2015.”
In the last few years, Shire has proved it can grow profits and reward shareholders. It is expected to maintain an operating profit above 35% in the next three years, while its earning per share are forecast to grow by roughly 60% over the period.
A conference call with investors was scheduled at 1pm BST on Monday. Management will need to deliver a very convincing pitch in the next few meetings to reassure investors that their holdings won’t plummet if rumours of a takeover fade away.
