Astrazeneca wants Gilead; or does it?

Of all the deals investors have had to consider in 2020 this was surely the most bizarre yet. The bombshell from Bloomberg, that Astrazeneca had approached Gilead about a merger, dropped yesterday, causing widespread headscratching among analysts.

Indeed, subsequent reports, including from Bloomberg itself, have questioned why a company riding the crest of a stock market wave should fall prey to one with even better growth prospects. Still, viewed from certain angles a deal makes sense. Evaluate Vantage looks at the pros and cons.

Against: Gilead is up 18% year to date.

A company typically falls prey to a takeover when its shares no longer reflect the value within it. But Gilead is a 2020 stock market darling, riding the crest of a wave thanks to efforts to tackle Covid-19 and the fresh thinking brought by Daniel O’Day as chief executive. An interested Astra would have approached Gilead when its stock was truly out of favour in 2018-19.

For: Gilead is down 35% over the past five years.

It is only when you step back that you get the full picture. Gilead actually peaked in 2015, on the back of hepatitis C mania, but since then it has languished as the few efforts to build an oncology presence – think Zydelig and Kite Pharma – flopped, and a management fearful of risky M&A indulged in stock buybacks. This revealed a lack of imagination and exposed Gilead’s vulnerability.

Against: Gilead is a bet on unpromising approaches.

Astra boasts an impressively profitable, cash-generating business with one of the best oncology pipelines in the industry. Why should it want a stake in an underwhelming assets like Zydelig and Car-T therapies, the unproven promise of filgotinib, and a declining hepatitis C franchise?

For: Gilead is an underappreciated HIV powerhouse.

Though investors focused on Tigit, CD47 and other novel approaches might forget it, Gilead’s established HIV business is formidable. Gilead’s top three drugs by NPV are HIV antivirals, the biggest of which, Biktarvy, has 2026 sales forecasts of $11.7bn, and an NPV of $62.1bn, according to EvaluatePharma; it accounts for 65% of Gilead’s market cap. Combine remdesivir with Astra’s goal of leading in Covid-19, and the deal is a no-brainer.

Against: buying Gilead would constrain Astra’s sales growth.

The charts speak for themselves: Astra’s top line is forecast to grow 9% a year to 2026, while Gilead’s stutters at a pedestrian 1%. A combination of the two makes no sense because it would cut Astra’s CAGR to 6%.

For: buying Gilead would bring Astra significant new revenue.

But this is less about growth forecasts, and more about an absolute sales grab. A Gilead acquisition could be the biggest in biopharma history, and allow Astra instantly to show $45bn of prescription drug sales, its 2023 goal, which current sellside consensus says will not be met.

Against: The deal could be value-destroying.

Astra is strongly cash-generating, to the tune of $4.9bn in operating cash flow last year alone. It is a valid question whether its money could be put to better use than buying a pedestrian biopharma group, notwithstanding the vast profitability of Gilead’s established business, or any near-term share price reaction.

For: the deal could be earnings accretive.

Gilead has $24bn of cash on its balance sheet, and $24bn of debt. Analyst opinions on accretion/dilution are predicated on much of the deal being financed in equity. But Astra could instead raise significant cash through debt, at a time when interest rates are historically low. EPS accretion is not out of the question.

Against: the middle of a pandemic seems an odd time for a mega-merger.

Notwithstanding recent cash inflows into biotech equity raises, there is huge uncertainty over the effect of Covid-19. It is anyone’s guess when the economy might return to normal, and how deep the recession will be. Doing the biggest takeover in biopharma history now rather than later, when asset prices might have crashed, would take an amazing amount of certainty, not to mention nerves of steel.

For: uncertainty might create the ideal buying opportunity.

Throughout his time as Astra’s chief executive Pascal Soriot has shown himself to be an independent thinker, making big early bets on novel science – the group’s investment in Moderna is a case in point – and against the odds turning his company into a formidable oncology player. As Warren Buffett said, you pay a very high price for a cheery consensus; Mr Soriot is not wedded to conventional wisdom.

Of course, there is a broader dimension to any deal, and for one thing a Gilead takeover by a UK-domiciled company might be politically unacceptable while remdesivir remains the only antiviral available for treating Covid-19.

Also, it is not certain when Astra had made its purported approach, or whether this in fact concerned a full-on takeover or a joint-venture collaboration, say, or a minority equity stake. Nevertheless, the market now has something new to consider. – Evaluate Vantage