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Was Astra Right to Walk Away?

 6 min read / 

So, Pfizer will not be buying Astra Zeneca, or not for the next 3 months at least. It was always a deal that I never wanted to see happen. I cannot refute that the deal made strong business sense for Pfizer. However, these benefits were based predominantly on tax inversion and aggressive cost cutting with severe negative consequences for a life sciences sector that I see as one of the few shining lights in the British economy. Put simply, I always felt the deal was good for Pfizer but bad for everyone else. In my opinion, this is not a justifiable premise for merger activity. However, I speak with a British bias and many of AstraZeneca’s largest shareholders would have accepted the offer and are urging management to re-open negotiations after the 3 month “cool-off” period mandated by British law. As a result, this article analyses Pfizer’s offer from a purely financial perspective in order to answer one very simple question: was Astra right to walk away?

Section 1: Comparable Transactions (Co.Trans.)

In order to give the best comparative indication of the value of AstraZeneca, I chose transactions that I felt best represented the transatlantic dynamics of the deal and the deal size while also reflecting current market conditions. As a result, I selected the five largest transactions for which accurate comparisons are publicly available, completed within the last 12 months. The details of these transactions are listed in the table, and illustrated in the diagram, of Figure 1 below.

The average EV/EBITDA multiple of the five comparable transactions selected is 14.6x. Interestingly however, I have also marked the EV implicit in Valeant’s tender offer for the common stock of Allergan, calculated as 23.7x EBITDA. As this proposal is an ongoing, and consists of a North American company attempting to acquire a UK corporate, I feel this is the perhaps the most comparable transaction available. By illustrating this multiple on the diagram, I do not mean to suggest that this is necessarily the multiple at which AstraZeneca should consider engagement with Pfizer. I do however feel it is useful to the extent that it indicates that the 14.6x multiple suggested by the comparable transaction result may be too low. This has strong implications for the valuation range set in section 4.

Section 2 – Comparable Companies (Co.Co.)

In order to further inform my valuation of AstraZeneca, I also included analysis of the EV/EBITDA multiples implicit in the trading prices of pharmaceutical companies I consider to be most similar to AstraZeneca. The results are displayed in Figure 2. The average EV suggested by this analysis is 12.9x EBITDA. Considering that mergers typically occur at a premium to the current EV implied by the market value of a company’s stock, it is not surprising that this is below the level suggested by the Co.Trans. analysis of Section 1. Nor, considering the lofty valuations resulting from current conditions of the market for mergers and the value of tax inversion for Pfizer, do I feel that AstraZeneca should sell to Pfizer at this level.

Section 3 – DCF Analysis

It is my opinion that the DCF analysis of this section provides perhaps the most interesting valuation technique used in the article. This is the case because AstraZeneca rejected Pfizer’s final offer, valuing the company’s equity at £69bn, on the belief that they could generate greater value for shareholder as an independent organisations. A discounted model of the company’s anticipated future cash flows should, in theory, tell us the extent to which this is the case. I have detailed this model step-by-step below. I will however, a summary of the main results and major assumptions here.

In the first part of the model, I calculate AstraZeneca’s weighted average cost of capital to be 9.28%. In the second part, I use the PRAT model (defined as the Retention Rate multiplied by the return on Invested capital) to calculate the near term growth rate of AstraZeneca to be 7.91%. I then use the Stage Model to calculate the long-term potential growth rate of AstraZeneca, which I take to be from 5 years time onwards, to be 3.74%. I then interpolate to find the growth rate for the second, third and fourth years of the model as 6.87%, 5.83% and 4.79% respectively. All these calculation are derived from basic accounting assumptions. However, these figures are roughly in line with the average 5.1% growth of the pharmaceutical industry between 2013 and 2020 predicted in a EvaluatePharma‘s World Preview 2014. I therefore consider these projected growth rates to be reflective of expectations based on current information. The final stage of this model uses these growth rates to calculate the Forecast Free Cash Flows and Terminal value for all years of the model. These figures are then discounted back at the 9.28% WACC to give a Enterprise value of £75.486bn. This equates to an EV of 19.51x 2013 EBITDA as calculated from AstraZeneca’s annual accounts.

Section 4 – Valuation Comparison

The results from the previous three sections are illustrated diagrammatically in Figure 3 (below), centered about the averages calculated with ranges based on the spread of the data to which they relate. As a result, Figure 3 provides a useful guide to the current value of AstraZeneca in relation to the proposed acquisition by Pfizer.

Based on the results of my analysis I judged that a fair valuation range for Astra Zeneca’s stock is between 17.2x and 19.2x 2013 EBITDA. Given that Pfizer’s offer, valuing AstraZeneca at 17.8x EBITDA, falls at the lower end of this range, I believe that this article finds support for AstraZeneca’s decision to decline Pfizer’s approach. This is especially the case considering the valuation being commanded by Allergan in the recent tender offer from Valeant, reflective of current, buoyant market conditions. Indeed, my analysis also suggests that Astra could generate higher returns by going it alone, even at the bottom range of my DCF calculation. I believe that this, considered in conjunction with the benefits of tax inversion, justifies AstraZeneca’s decision to walk away from negotiations on the basis that Pfizer’s offer understated the current worth of the firm.

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