Takeda‘s (NYSE:TAK) acquisition of Shire, one of the largest deals in the history of the pharmaceutical space, has shadowed the company ever since the start of the process in late March of 2018, with the shares underperforming the sector by about 40% since then. While there were legitimate objections and concerns to the deal, the cost synergy performance since the deal close has been better than expected, and Takeda has made steady progress on billions of dollars’ worth of non-core asset sales. On top of that, Shire’s plasma therapy business is producing strong growth in an attractive market.
I’m not particularly enthusiastic about Takeda’s pipeline, but that’s not a new development, and the company does have some credible oncology, neuro, and rare disease drugs in the pipeline, as well as a dengue fever vaccine that could generate over $1b in revenue. Between discounted cash flow and an earnings-based approach, I believe it could be significantly undervalued today, with double-digit annualized total return potential.
Good Progress On Asset Sales
Takeda management sold the Shire deal to shareholders in part on the basis of pledging significant non-core asset sales ($10 billion) to reduce the debt taken on to fund the acquisition. So far, the company has made good progress on that goal, with $8.8 billion raised to date from sales ($10.8B including earn-outs).
The sale of Shire’s Xiidra to Novartis (NVS) for up to $5.3 billion, including earn-outs, kickstarted the process in May of 2019, but just this year, Takeda has sold its Latin American assets to Hypera (OTCPK:HYPMY) for $825M, a portfolio of European and Canadian assets to Cheplapharm for $562M, and its Japanese OTC business to Blackstone (NYSE:BX) for about $2.3 billion. Takeda also outlicensed a collection of early-stage neuro/CNS drugs to Neurocrine (NASDAQ:NBIX) for $120M upfront and potential follow-on milestones and profit participation.
I don’t believe that Takeda is hocking the crown jewels through this process. Xiidra is a good drug, but doesn’t really fit with any of Takeda’s areas of focus. Of the assets that Takeda sold, the LatAm assets were maybe the most painful to see go (with a profit margin firmly in the 30%’s), but this too was not a core business.
Are Plasma Therapies An Underrated Driver?
There has been legitimate criticism that Takeda paid a substantial sum for a business (Shire) whose lead drugs have, at best, a mixed outlook. Advate is a shrinking business pressured by rival compounds like Roche‘s (OTCQX:RHHBY) Hemlibra and at further risk from newer approaches in the clinic (including RNAi and gene therapy), and the rare disease portfolio outside of angioedema is likely a minimal growth driver over the next five years.
On the other hand, the plasma therapy business could be an underrated growth driver. This business grew 17% in the last quarter, with 25% growth in the Ig business, and I believe growth over the next five years could remain close to 10%. With expanding on-label and off-label usage, plasma-derived therapies have seen growth accelerate from a historical rate around 6% to 8% to over 10% since 2017, and at this point, growth seems more constrained by supply limitations than demand. With that growth, I believe this business could be close to 20% of Takeda’s revenue in FY’25, with above-average margins.
A Pipeline With Some Assets Worth Watching
Takeda has been revamping and restructuring its R&D efforts over the last few years, looking to improve productivity in its core focus areas of oncology, rare diseases, neuro/CNS, GI, and vaccines.
Within the oncology portfolio, pevonedistat (an NAE inhibitor) has a Breakthrough Therapy Designation for high-risk myelodysplastic syndromes, and this could be a multibillion-dollar drug at peak. Mobocertinib (an EGFR inhibitor) is also worth watching as a potential multi-billion-dollar contributor in lung cancer.
Outside of oncology, the company’s new dengue fever vaccine is likely to be the biggest near-term contributor, with strong efficacy (at least compared to available alternatives) in Type 1 and Type 2. The company’s narcolepsy program, focused on orexin 2 receptor (or OX2R) agonists, is also a promising one, but probably five years or so from commercialization, and that’s only if the clinical trials work out.
While I’m bullish on the plasma-derived therapy business, as well as the hereditary angioedema portfolio, Entyvio, and some current oncology drugs (Ninlaro and Adcetris), I’m only expecting low single-digit revenue growth over the next five and 10 years, as losses to generics (Velcade most notably) and new products (Advate) take their toll. The need to work down debt should limit Takeda’s M&A ambitions for a while, but I wouldn’t be surprised to see the company try to find some licensing/partnership opportunities.
On the profit side, management has increased its three-year Shire cost synergy target from $1.4 billion to $2.3 billion only about a year and a half into the process, and I believe good execution on costs will continue. With that, I expect FCF margins to move toward the mid-20%’s over time, driving high single-digit annualized FCF growth. I also expect Takeda to generate high single-digit core EPS growth over the next five years.
The Bottom Line
Takeda looks undervalued on the basis of both free cash flow and EPS growth, and that’s including a higher discount rate to account for the added risk of a debt-heavy balance sheet. On the EPS side, Takeda could generate only half the EPS growth I expect over the next five years and still be undervalued by more than a third on the basis of what the Street typically pays for given levels of pharma EPS growth.
There are certainly issues with Takeda, and I’m not sold on the idea that the company has really turned the corner on pipeline/R&D productivity, but the market seems to be taking an excessively bearish view of the business, and I think this is a name to consider at these prices.
Disclosure: I am/we are long NBIX, RHHBY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.