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Why shareholders had a severe adverse reaction to AstraZeneca’s Alexion deal

December 14, 2020, 12:12 PM UTC

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AstraZeneca’s purchase of Alexion in a $39 billion cash-and-stock deal has not impressed AZ’s investors. They sent the company’s shares tumbling sharply in Monday morning trading.

At one stage, AZ’s shares on the London Stock Exchange were down more than 7%, before rebounding slightly.

Investors are worried that AstraZeneca is overpaying for Alexion, offering a 45% premium to the Boston-based company’s current share price, valuing the company at more than 40 times its trailing 12-month earnings.

While some have pointed out that this kind of valuation is not expensive by biotech standards, AZ’s shareholders are suffering from the stock market equivalent of the curse of the empty restaurant—that queasy sensation based on the notion that “if this place is so good, why isn’t anyone else eating here?” Alexion has been actively shopping for a buyer since at least May, when activist hedge fund Elliott Management began publicly agitating for a sale. And AstraZeneca has said that although it took months of wrangling to close the deal, as far as it knows, it was the only bidder in the hunt.

It has not been a great few weeks for AZ’s shares. Unease over the deal comes just weeks after investors pummeled AstraZeneca’s stock because the company’s COVID-19 vaccine results disappointed. While the pharma company, based in Cambridge, England, had jumped to an early lead in the race for a coronavirus vaccine in the spring—a position that sent its shares skyrocketing to all-time highs and made it briefly the most valuable company in London’s benchmark FTSE 100—a series of missteps in how it and its partners at the University of Oxford handled aspects of the clinical trial have resulted in a muddied picture of the vaccine’s effectiveness compared with those produced by rivals Moderna and Pfizer. While the vaccine is still likely to receive approval in the U.K., doubts are now growing over whether the U.S. Food and Drug Administration will approve it—at least not without much more clinical trial data.

But, in many ways, the COVID-19 vaccine sweepstakes was always a bit of a distraction. The company, which had little track record in vaccines prior to COVID-19, had promised to take no profit on its inoculation until the pandemic was over. And the chance of the product becoming a blockbuster was always iffy.

The Alexion deal, however, matters far more to the company’s future. And here, the picture is decidedly mixed, which may be why a number of investors bailed out on Monday morning.

In some ways, AstraZeneca CEO Pascal Soriot looks smart: The run-up in the company’s shares have handed him a powerful currency with which to make an acquisition; he would look foolish if he wasted the opportunity. Back in 2014, when he fended off a takeover attempt by Pfizer, Soriot had promised AZ’s shareholders that he would double the company’s revenues to about $40 billion by 2023, a target the company was unlikely to meet through organic growth alone. (Its 2019 revenues were just $20 billion.) The Alexion purchase puts AstraZeneca $6 billion closer at least.

In addition, Soriot had invested heavily to reinvigorate the company’s research and development pipeline and expand its footprint in China. Those were good moves strategically. AstraZeneca now has the strongest earnings growth prospects of any of its large competitors. But they were not cheap decisions, and Soriot has had the additional burden of maintaining the company’s rich dividend, a choice he portrays as important for rewarding AZ’s shareholders for sticking with the company throughout his long turnaround of the business (others more cynically point out that dividend growth is one of the metrics to which Soriot’s own pay package is tied). As a result, the company has been perennially cash-poor and has had to sell legacy assets and borrow heavily to fund these moves.

Some analysts think that AstraZeneca is buying Alexion because it basically had to buy someone (anyone!) to shore up its cash flow and avoid missing aggressive earnings growth targets. That’s the view of Naresh Chouhan, an analyst at Intron Health, a boutique health care research firm in London. “We believe there is no strategic rationale other than to buy near-term earnings and cash flow,” Chouhan wrote in a report to his clients on Monday. That helps explain why some investors, unnerved by the whiff of desperation surrounding the deal, reached for the ejection handle on Monday.

Alexion instantly helps shore up the company’s cash position: It threw off $2 billion in free cash flow in 2019, and is on track to produce more this year, and AstraZeneca has said the deal will also immediately boost earnings. Even Chouhan, a skeptic on AstraZeneca, allows that the deal is likely to supercharge earnings growth in the next few years.  

The deal also buys AstraZeneca suite of drugs that are potentially complementary to its existing portfolio. While AstraZeneca is especially strong in oncology medicines, Alexion has a focus on rare diseases, particularly those caused by the uncontrolled activation of part of the body’s immune response called the complement system. It has one blockbuster drug in Soliris, which generated almost $4 billion in sales last year. The deal may also prove that some of Alexion’s R&D around the complement system will dovetail with AstraZeneca’s heavy investment into a class of immunotherapy cancer treatments known as PARP inhibitors.

But Chouhan points out that there were probably other ways to gain this expertise than paying a $13 billion premium to Alexion’s stockholders. He also points out that while the deal will likely boost AstraZeneca’s earnings over the next four years, it actually increases the company’s vulnerability to patent expirations from 2024 onwards when three of its own blockbuster drugs—Farxiga, Brilinta, and Lynparza—will lose patent protections. Plus, Soliris will also begin facing competition from generic alternatives.

Of course, by 2024, Soriot, who is 61, may have cashed out and retired. It looks like a lot of investors aren’t sticking around to find out.

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