Despite Pharma giant Shire posting a decent set of Q3 results yesterday (revenues and profits beat consensus; healthy product sales growth; reiteration of full year guidance), the shares fell by 1.5%. Why? Because the company is being acquired by Japan’s Takeda for 4900p/share. In which case upside potential from better-than-expected results or an improved profits outlook is limited.

The implied offer for Shire shareholders currently sits at 4970p/share, a little higher than the actual bid. Because the offer has several moving parts. Firstly, the Takeda share price (priced in Yen; 53% of deal). Secondly, the £ vs Yen exchange rate determines the GBP value of those Takeda shares while the £ vs $ rate determines the GBP value of the deal’s $30 cash component (47% of deal).

Since early May, a weaker GBP (up to 5% vs USD and JPY) driven by Brexit concerns, has helped flatter the conversion value of both the share and cash components. However, this has been countered by Takeda’s share price being range bound (albeit a wide range) on concerns about the company loading up on debt to fund the deal. Looking at the extremes at which each of the moving parts has traded, the implied offer value has, nonetheless, remained around 4900-5000p/share.

With Shire yesterday saying it expects the marriage with Takeda to close in the first half of 2019, this means 8-months potential waiting for shareholders until they receive their shares in the newly combined entity, as well as their cash. And as we all know, a lot can happen in that many months. The world could be a very different place. One reason why the shares trade below the offer price.

While GBP weakness may have helped flatter the implied deal value over the last few months, the currency’s current rebound vs major peers, on hints about a Brexit deal/compromise, has served to temper Shire’s share price. Any meaningful progress on Brexit, and further GBP strengthening, could thus prove a real headwind for Shire shares over the next few months, given the negative translational impact on the implied offer value. The deal is therefore, very much exposed to politicians in Westminster and Brussels. Another reason why the shares trade below the offer price.

It would be a surprise if the Takeda-Shire deal fell through between now and mid-next year, with little regulatory or competition resistance of note since it was announced. However, anything is possible in the world of Mergers & Acquisitions (M&A). And the fact that the shares trade below the 4900p offer or 4970p implied offer is an indication of the 7% to 8.5% reward on offer in return for the risk of being exposed to the deal for another 8 months, having to wait patiently for one’s shares to be converted into some cash and some new Takeda shares.

With simple deals the price often jumps almost straight to the offer price. With more complicated, cross border transactions, however, which take time for approval, etc., the shares tend to hold back from the offer price to take into account the risk associated with something going wrong. In the City, trading the available upside is referred to as M&A arbitrage, profiting from the tendency for the share price of the company being acquired to trickle up towards the offer price over time, as the risk of something going wrong recedes, ending up around the offer price in the weeks and days before completion.

Which is what we are seeing with Shire, the shares drifting up from 4200p in July to trade around 4600p now, but still holding back from both the 4900p offer and 4970p implied offer to reflect the time and risk to completion. Having currencies and another share price involved have also played their part in Shire’s share price being, perhaps, even more volatile than your average takeover candidate, and holding back so much from the offer price.

If you are confident the Shire-Takeda deal will complete on-time next year, the shares could offer 7-8.5% upside… as things stand. And that is the point, the deal may well complete, but if GBP strengthens significantly vs USD (back to the levels when deal announced), it could take 100p off the deal’s implied value. A similar move by GBP vs JPY could deprive shareholders of another 50p. And if Takeda’s share price falls further, this would hurt even more, taking off another 200p.

It would appear that Shire shares are already pricing in a worse-case scenario. In which case, might there be upside on offer thanks to things turning out better than expected?

To stay up to date on the Shire-Takeda deal, other tradable Merger & Takeover situations as well as all the quality trade opportunities (e.g. ranges, momentum, breakouts, support) Accendo Markets sends out to its clients daily, get access to our award-winning research now.

Mike van Dulken, Head of Research, 2 Nov 2018