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Morningstar | Solid Quarters at Takeda and Shire; Both Firms Remain Slightly Undervalued

Following separate quarterly earnings announcements from Takeda and Shire, where management reiterated their outlooks for the full fiscal year, we maintain our JPY 5,100 per share fair value estimate for Takeda, where we still assume that the firm acquires Shire toward the end of its fiscal 2018 (early calendar 2019). Given recent share price appreciation for Takeda, we're increasing our fair value estimate for Shire to GBX 4,990 (from GBX 4,890); we assume a 100% probability of the acquisition going through, and since part of the offer price is in the form of Takeda shares, our Shire valuation fluctuates with Takeda's share price. We're also lowering our fair value estimate for Shire's ADS to $196 (from $205), based largely on foreign exchange fluctuations. While we currently assign Takeda a stable, no-moat rating, we may consider a positive moat trend or even a narrow moat rating if returns on invested capital begin to exceed the cost of capital; our estimates are preliminary, but we assume the combined firm could see ROICs exceeding its cost of capital by 2022.

Takeda will likely see top-line pressure as another generic version of oncology drug Velcade launches this year, but several newer products are gaining momentum, and vaccine readouts could add upside. Takeda saw relatively flat revenue growth in its fiscal first quarter, but expects a roughly 2-percentage-point top-line headwind for the full fiscal year. There is only one Velcade generic on the market (Fresenius), but a new nonequivalent generic is expected to launch in the U.S. in September 2018 with both IV and subcutaneous formulations. That said, GI drug Entyvio, neurology drug Trintellix, and oncology drug Adcetris continue to grow strongly outside of Japan and have near-term potential for growth in Japan as well. In the pipeline, Takeda has data from two vaccine programs--Dengue fever and norovirus--reading out later this year, and each could see significant sales at peak if approved.

For Shire, we expect continued plasma strength and a turnaround in hereditary angioedema to offset accelerating headwinds in hematology. Shire saw 4% constant-currency product sales growth in the quarter despite continued pressure from Lialda generics. The firm's immunology portfolio (12% growth) was driven by a 19% increase in immunoglobulin sales, and the recent approval of a new fractionation facility secures Shire's ability to process immunoglobulin; however, we're keeping an eye on Shire's ability to expand plasma supply, as competitor Grifols recently acquired Haema and has an option to fully acquire Interstate Blood Bank in 2019, giving it access to mature collection centers and reducing supply to Shire. Also in immunology, Shire saw a 9% increase in HAE sales (partly restocking) despite competition from CSL's Haegarda. With lanadelumab's U.S. approval expected in August, we think HAE market share could begin to swing in Shire's favor, although generic Firazyr could also affect the firm in 2019. We expect hematology to become more of a headwind for the firm in the second half of calendar 2018, as Roche's Hemlibra is already weighing on Feiba and should have U.S. approval in the broader noninhibitor market (where it can compete with Advate and Adynovate) by October.

The Shire acquisition is fairly neutral to our valuation of Takeda, as we previously valued Shire at a similar level to Takeda's accepted offer price. Shire shares still trade at a 13% discount to our fair value estimate, likely owing to the long timeline until the deal closes, as well as some uncertainty around ultimate shareholder votes and regulatory approvals. The U.S. FTC has already approved the deal, but Takeda will need regulatory approval from Europe, Japan, China, and other countries before moving forward. Takeda is doing what it can to make the debt required to finance the Shire acquisition less burdensome by selling noncore businesses, following on the heels of the sale of its chemicals unit and older, nonbranded products, Takeda has also sold its stake in smaller businesses in China and Brazil. While cost and revenue synergies are likely to significantly outweigh the one-time acquisition-related costs, we expect Takeda could opt to divest Shire's ophthalmology business (including dry-eye drug Xiidra and a pipeline of other eye disease treatments), given the lack of overlap with Takeda's portfolio. Xiidra had $100 million in sales in the second quarter, which reflected strong growth as Shire has been able to pull back in launch-related discounting, but generic Restasis (likely later this year) and a delayed European launch (likely 2020) could slow growth in the future.

We've slightly boosted our estimates for Takeda's next-generation oncology drug Ninlaro to account for recent positive data in the maintenance setting; however, a lack of overall survival benefit at interim analysis from two prior studies (first-line and relapsed disease) and the competitive landscape prevent us from significantly modifying our peak sales estimate, which remains well below management's $3 billion target. As we discussed in our recent Healthcare Observer, “Steady Flow of Blood Cancer Pipeline Creates Opportunity but Builds on Existing Moats,” global rights to Ninlaro and potential for longer duration of therapy (given oral administration and fewer side effects) are countered by our expectations for significant competition in the first-line setting (from Velcade) and maintenance setting (from Revlimid and potentially Darzalex).