Shire (LSE: SHP) (NASDAQOTH: SHPG.US) shareholders have seen the value of their stock rise by 60% this year, thanks mainly to a takeover bid from US firm AbbVie.
However, Shire’s management is currently playing hardball, by claiming that the bid “fundamentally undervalues the company and its prospects”.
If you’re a Shire shareholder, you may think that the correct approach is to sit tight and wait for AbbVie to make a higher offer — and they might. However, I’m not sure the figures support a higher bid.
1. Isn’t Shire worth more?
The main claim made by Shire’s board to justify a higher valuation is that Shire’s sales will double to $10bn by 2020.
Assuming the firm maintains its historic post-tax profit margin of around 17%, this means that net income could rise to around $1.7bn by 2020. If we generously round this up to $2.5bn to allow for acquisitions, then Shire’s current share price equates to a 2020 forecast P/E of almost 18!
I reckon that’s a very generous valuation indeed.
2. Are you a gambler?
AstraZeneca‘s (LSE: AZN) (NYSE: AZN.US) share price fell by 11% in one day after the Pfizer bid fell through.
The failure of the bid disappointed a lot of AstraZeneca investors, but as I wrote at the time, they really only had themselves to blame: if they wanted cash, they should have sold.
Waiting for a higher offer is a big gamble: one of the key principles of successful investing, in my view, is always to leave something on the table for the next person.
I mention all of this because I suspect that the same thing could happen with the current Shire bid — except here, the potential downside, post-bid, is much greater than it was with AstraZeneca:
| Valuation before bid | AstraZeneca | Shire |
| 2014 forecast P/E | 15.2 | 17.9 |
| Prospective yield | 4.5% | 0.5% |
| Peak valuation during bid | Â | Â |
| 2014 forecast P/E | 19.2 | 23.4 |
| Prospective yield | 3.5% | 0.4% |
Source: Reuters analysts’ consensus forecasts
Shire has been touted as a bid target for years — but now that a decent bid has appeared, shareholders might not be so patient in the future, if this bid is allowed to fall through.
Shire’s yield is virtually zero, so the only reason to hold the stock is for capital gains. In my view, Shire’s share price could fall dramatically if the firm’s board allows this bid to fall through.
3. You should sell
Shire’s share price is 4,579p as I write, only fractionally below the 4,611p value of AbbVie’s bid.
In my view, selling carries much less risk than continuing to hold, and is the only sensible decision for most shareholders.