London-based pharmaceutical giant AstraZeneca plc (ADR) (NYSE:AZN) recently announced that it had agreed to purchase U.S.-based lung-drug manufacturer Pearl Therapeutics for at least $1.1 billion. The private firm is noted for its next-generation inhaler technology that could prove key in the fight to control chronic lung conditions like COPD as well as certain forms of childhood and adult asthma. Although the market’s reaction to the deal has generally been positive, many observers wonder whether AstraZeneca is doing enough to prepare for the knock-on effects of a weak development pipeline and looming patent expirations.
Since Pearl is a privately held company, investors cannot expect to receive an arbitrage premium from this deal. However, this does not mean that the merger lacks value. On the contrary, the successful integration of Pearl’s operations could put AstraZeneca plc (ADR) (NYSE:AZN) on the path to lung-drug dominance for years to come. Investors would do well to take a closer look.
AstraZeneca and the Competition
As a global pharmaceutical firm with a huge research and development apparatus, AstraZeneca competes with some of the biggest names in the business. For the purposes of this comparison, it would be wise to measure AstraZeneca plc (ADR) (NYSE:AZN) against fellow British drug-maker GlaxoSmithKline plc (ADR) (NYSE:GSK) and Merck & Co., Inc. (NYSE:MRK). All three of these companies engage in similar activities and have outsized influence on the global drug industry.
Relative to its peers, AstraZeneca seems rather inconsequential. The company’s $63 billion market capitalization is less than half the size of GSK’s valuation and nearly 60 percent smaller than that of Merck. However, the firm is a bit more profitable than the other two companies in this comparison. In 2012, AstraZeneca plc (ADR) (NYSE:AZN) took in about $5.7 billion on total revenues of $27 billion. This made for a profit margin of well over 20 percent. During the same period, Merck & Co., Inc. (NYSE:MRK) reported earnings of $6 billion on revenues of just over $46 billion. GSK earned $6.8 billion on a gross of $42 billion.
AstraZeneca plc (ADR) (NYSE:AZN) has a fairly stable balance sheet and a decent financial outlook. As of its most recent report, the company had about $8 billion in cash on hand and a little over $10 billion in long-term debt. Comparable figures for Merck came in at $16 billion and $21 billion. Meanwhile, GSK’s debt load of $31 billion dwarfs its $6.3 cash reserve. All three of these firms have adequate, proportional cash flow figures.
How the Deal Happened
The merger agreement between AstraZeneca and Pearl has a two-step structure that could provide the larger company with some protection against a potential flame-out. According to the text of the deal, AstraZeneca plc (ADR) (NYSE:AZN) will issue a guaranteed cash payment of about $560 million to Pearl’s private shareholders. If the newly subsumed company is able to create viable, marketable products that achieve pre-determined sales and revenue metrics, AstraZeneca will provide a second tranche of nearly $600 million to the company’s shareholders. Since AstraZeneca has not commented publicly on the substance of these metrics, it is difficult to determine whether they are realistic.
