There is more to good corporate governance and ethical capitalism than a buyer’s deep pocket. A Board must aim to have the most suitable shareholders to achieve the company’s goal. Following Pfizer-AstreZenca, we look at another US bid for a European Pharmaceutical company and the corporate governance lessons from the AbbVie-Shire bid.Shire, the major healthcare company listed in London, is in the news as the American pharmaceutical company AbbVie attempts to get Shire’s board to recommend its attempt to buy it. This comes hot on the heels of the failed attempt by AbbVie’s bigger US peer, Pfizer, to acquire Shire’s bigger UK peer, AstraZeneca. Since this seems to be part of a rush by cash rich US corporations to spend their offshore cash before the US Authorities take action to stop them, it seems appropriate to consider some of the implications these moves have for corporate governance.
AbbVie-Shire: Parallels and Differences with Pfizer-AstraZeneca
In our recent article we looked in some detail at the Pfizer bid for AstraZeneca, so let’s look at the similarities and differences in the AbbVie/Shire situation..
Parallels:
Shire was founded in the UK and, like AstraZeneca, is listed in the UK. Like AstraZeneca, it has a relatively new CEO, who is building growth rapidly and, like AstraZeneca, it can be categorised as a fast growing EU pharmaceutical company with strong growth from existing products plus a good pipeline of new products, being threatened with takeover by a bigger US predator.
Pfizer needs to take action to avoid a sharp drop in revenues as its patents approach expiry and AbbVie needs to reduce its dependence on a key drug, Humira, a very successful treatment for arthritis. Like Pfizer, it is a US company with a large pile of cash held offshore, deriving from its tax avoidance schemes and structures. Also, like Pfizer, it wants to use this cash and the device of tax inversion to spend the cash in an overseas acquisition to avoid repatriating the cash and paying a large amount of tax in the process. Also, like Pfizer, future tax is an issue and it calculates that moving its tax jurisdiction to the UK would reduce its corporation tax rate from 22% to 13%. Since early May, it has made three offers so far, culminating in an indicative bid of £27bn, compared with Pfizer’s £70bn for AstraZeneca. As with Pfizer’s bids, all AbbVie’s bids have been rejected as inadequate. Like Pfizer, it has downplayed the tax driver and made the supposed strategic argument that its bigger global scale will help a bigger distribution of Shire’s products.
Differences:
Shire is incorporated in Ireland and has been based there since 2008, though it is managed in Boston and its Research and Development is based in the US. Unlike AstraZeneca, which has a significant R & D presence in the UK, Shire has fewer than 500 people in working in the UK. This means that compared with AstraZeneca, there is likely to be comparatively little vociferous political and public support at this stage.
Shire’s best known product, a treatment for Attention Deficit Hyperactivity Disorder, has a number of years left under patent, and it is now building a reputation for specialising in rare diseases, with a target to double sales in the next 6 years. The specialised product areas mean that there are probably relatively few synergies in the sales area due to the niche market nature of its salesforce. Unlike the AstraZeneca defence, Shire’s CEO hasn’t ruled out the possibility of a sale at a high enough price.
What is driving this wave of M&A from US towards Europe?
According to recent research at Bank America Merrill Lynch, there is some $1.3trn of US cash held offshore, and their view appears to be that up to 61 major EU companies could be acquisition targets for the companies holding this cash. Among these companies, ARM, Amec, BAE Systems, Rolls Royce, BMW, SAP, and Nestlé could be targets. Their argument is that it is difficult to justify sitting on large cash piles with interest rates currently very low and likely to stay low for the foreseeable future. They suggest that use of this cash for acquisitions would now be looked on favourably by investors. All these large companies have more than 35% of their sales in exports and the cash they hold is equivalent to 10% of their market capitalisation.
The beginnings of what may become a significant trend to use tax inversion are seen in some recent deals and attempted deals. Last week Medtronic (medical technology) agreed to buy Ireland’s Covidien for $42.9bn, and other potential acquirers include: Stryker (medical devices) for Smith & Nephew (denied), Pfizer (pharmaceuticals) for AstraZeneca (foiled pro tem); Wyndham (hotel chain) trying to merge with UK’s Intercontinental Hotels Group (rejected)
Political and governance issues: what might change things?
Tax avoidance
Despite growing political objections to current tax avoidance policies by large corporations, it seems unlikely that any legislative action will be taken before the next US presidential election in 2016. Efforts to simplify and improve the US tax codes have made little progress in recent years.
In Brussels, the EU Commission has raised its concern about tax policies of certain states including low tax Netherlands and Luxembourg. It is considering a planned investigation into Apple’s tax arrangements with Ireland under state aid rules. Other large US corporations likely to be affected by such an investigation include eBay and Amazon.
The OECD has plans for a global framework of rules, aimed at making complex tax arrangements less feasible and less attractive. An example is Google’s use of what has been called the Double Irish with a Dutch sandwich, which involves companies in the UK, Ireland, Netherlands and Bermuda.
All these arrangements are aimed (successfully) at keeping profits and cash out of the hands of the US taxman, and they are clearly vulnerable to a change in the rules.
Competition regulation
Ultimately, at some point, the competition authorities in all the countries affected will demand to have a say. Arguably, this is the dog that hasn’t yet barked.
Industrial policy
At a macroeconomic policy level, there is a perceived failure of the EU to grow companies from mid-sized to global. This is unfavourably compared with the success of the US, which has easily the largest number of global businesses in the developed world. It is easy to see pressure for protectionist measures emerging.
Owner and manager incentive misalignments
Businesses requiring major investment to achieve their strategic goals demand a long-term perspective from owners as well as management. In privately owned companies this is much easier than in publicly quoted companies. Hence in an industry like pharmaceuticals, the needs of fund managers to show regular successful performance, coupled with the ability to exit their ownership with the pressing of a key on a computer keyboard, hardly provides the long term commitment required. Moreover, this leads naturally to the creation of incentives for the managers of these businesses to drive the share price and other important indicators of progress and value, and must make it much more difficult to keep focused on the long term success of the business.
It is also much easier for investors to take the cash now when an attractive bid comes along – jam today rather than jam tomorrow. Similarly, it must be easier for a CEO to hype up prospects to achieve an enhanced sale price now than to sweat through the years needed to achieve that forecast. Who can know today whether Shire’s CEO is right in promising a doubling of revenues over the next six years, or whether the promise of AbbVie’s CEO to increase revenues through their enhanced global distribution would be a more reliable way to grow the business significantly. Of course, it will never be known, even in hindsight, whether one course would have worked out better than the other.
How would we approach the Board’s decision regarding the bid approach?
We would, of course, apply our Five Golden Rules of good corporate governanceto guide the decision of the Shire board. The rules would consider the Ethics of the combined business, assess the existence and degree of support for a consistent Goal among the key stakeholders, judge the validity of the expressed Strategy to implement the new goal, look into whether the proposed new Organisation was suitably resourced and structured to deliver it, and check that it promised proper Accountability and transparency towards the stakeholders after the merger.
Considering these in turn:
Ethics:
The only small cloud on the reputational side is the issue raised over possible over-prescribing of Shire’s ADHD drug, but a possibly more significant threat could be a political reaction against what might become seen as the use of aggressive tax avoidance measures by AbbVie.
Goal:
Here we would consider the current goal for Shire as an independent company and whether the goal for the combined business proposed by AbbVie was a better prospect. Currently, general opinion would seem to be that AbbVie has not made a convincing strategic case for the clear superiority of its own vision for Shire’s future within a larger organisation.
Strategy:
Since the goal has not yet convinced, the strategy to achieve it would clearly be regarded as incomplete or flawed.
Organisation:
AbbVie might have the financial resources, but their sales and distribution side would not appear to be able to contribute much to the key dimension of enhancing Shire’s global reach or sales volume generally, and there would not appear to be much scope for administrative cost savings and efficiency improvements.
Accountability:
AbbVie has achieved excellent progress and a good reputation since its spin-off from Abbott Laboratories and there would seem to be no need for concerns in this regard.
Overall, then, we would not be recommending the sale to AbbVie on the basis of what we have heard so far. And note that, in our approach to a decision on a recommendation by the directors, the future of Shire as a company is much more important than the potential desire of some of the owners to sell their shares at a high price.
“This is a premium asset and if someone wants to shorten the life of this company they will have to pay a price that reflects that”
Flemming Ornskov, Shire CEO
What general lessons can be drawn for Corporate Governance?
An important lesson which we can draw from this flurry of interest by cash rich potential buyers is the need for a company to have shareholders who share the long-term goal of the business.
With a private company this should be a major objective of a conscientious board of directors. Once a company has gone public, the situation becomes much more difficult, particularly in view of the competing incentives for management and investors mentioned above. How far should, or can the directors go to prevent shareholders taking the cash against the long term interests of the company, while avoiding poison pills and allowing freedom to buy and sell?
The dilemma is well expressed by a quote from CEO of Shire: “This is a premium asset and if someone wants to shorten the life of this company they will have to pay a price that reflects that”
He speaks as the manager of a business which has grown by acquisition, so he clearly feels constrained from criticising a potential acquirer on principle. Are Shire shareholders willing to forego a big premium in return for longer term rewards?
For a private company, the trick is to select private owners with the promise of long term support, followed by bringing in a trade investor rather than going for an IPO where you lose control of your shareholders. For an existing public company, possibly the only practical way forward faced with a highly priced bid, might be to go for a sale to a suitable alternative trade buyer if such was available or contrive a sale to Private Equity, taking the company off the market.
