Could You Profit From AbbVie Inc’s Failed Takeover Of Shire PLC?

shireThe world of pharmaceuticals is undergoing serious change, with corporate bosses the world over apparently looking to grow their empires. Medical devices manufacturer Medtronic will complete its acquisition of Covidien for an incredible $43bn in 2015 and Pfizer attempted to purchase AstraZeneca in what would’ve been a $70bn megamerger deal in May.

Everywhere you look people are touting companies as “buys” based on racy takeover rumours. Here at the Motley Fool, we invest for the long term, and I would never bet my hard-earned money on some boardroom takeover game.

But when the dust settles after failed M&As, the feverish takeover chasers leave and take their emotion with them, often leaving companies’ shares in freefall. These companies regularly find their way onto my radar, and I suggest you take a look at them too.

Global biopharmaceutical company AbbVie recently made a $54bn bid to acquire rare disease specialist Shire (LSE: SHP). Shares in the UK company rocketed to new heights, before a new US corporation tax law made the deal unfeasible. Shire now trades 25% lower than at the height of the merger madness, but the question is whether it’s a buy now?

So what does Shire do?

Shire specialises in rare diseases, such as Hunter Syndrome, which affects approximately 1 in 162,000 people. At first glance this tactic seems counterintuitive. You could be forgiven for asking, ‘why would a company incur R&D costs to target such a small market?’ The answer is that most wouldn’t. This is where Shire gains its competitive advantage.

When Shire creates a treatment for a previously ignored disease, it can typically gain market share dominance very quickly because there simply is no other treatment to compete, allowing them to draw more and more sales from patents with impunity, a fantastic position for any business to be in.

Furthermore, Shire is still expanding into overseas markets, allowing it to leverage more revenue from existing patents. This gives the company a route to growth other than research, which by nature is hit and miss.

However, I must admit that Shire has also been taking part in the pharmaceutical merger games, purchasing a number of businesses this year, but every one of these made strategic sense. The company also spends around 20% of earnings each year on R&D, and while this is a significant overhead, it is a necessary cost if the business is going to grow. Given the company’s fantastic track record of developing its pipeline thus far, I’m not too worried about the large spend.

Furthermore, Shire received a $1.6bn payment from AbbVie on the collapse of the merger talks, an amount that could cover R&D for a year and a half at current rates. A nice injection of cash by anyone’s standards!

Successful Strategy, but Is It Cheap Enough?

I’m a big fan of Shire as a business, and its strategy seems to be working. The company’s Q3 revenue grew 33%, and to give you some idea of how long management believe this growth can continue, CEO Flemming Ornskov recently said “Shire is well-positioned for future growth as we implement our plan to double product sales to $10 billion by 2020.”

I love ambitious management. After all, our task as investors is to find companies that can grow our capital better than we can. Further to this, Shire’s expansion has been composed and sensible, and the company currently boasts $540m net cash, which for me allays the fear that management could be overreaching.

But at the end of the day valuation drives returns. Trading at a PE of over 18 Shire seems to be an excellent company that is slightly overpriced. I need more of a margin of safety to invest. The shares could still be propped up by the ever-hopeful merger hunters, and I will personally wait until the last of them have cleared off, hopefully creating a buying opportunity.

One for the watch list then! But if you are looking for to make serious returns in the market I strongly urge you to check out The Motley Fool’s latest exclusive report.

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Zach Coffell has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.