Baxalta-Shire Spread Expected to Face Pressure

Baxter’s disposition of shares in Baxalta will likely widen the spread between the spinoff’s trading price and Shire’s offer, said four industry sources. A hedge fund source called the spread a buying opportunity.

“The spread will widen in this case because there’s a large seller, Baxter,” said the hedge fund investor. “It’s expected. Sometimes when spreads widen, it’s because investors worry that the deal won’t close. But Baxter has 132 million shares of Baxalta, and said it will dispose of them before the Shire acquisition closes. It’s a chance to buy Baxalta cheaper, not a negative indication about the Shire deal.”

Baxter, a maker of medical instruments in Deerfield, Illinois, spun off its biotech business Baxalta on July 1, 2015. Within days, Baxalta rebuffed a private offer from Shire, and the Ireland-based pharmaceutical company took its offer public a month later.

Two weeks ago, Shire announced that Baxalta agreed to a takeout at $45.57 per share.  Baxalta closed on Friday at $41.80, 7.6% lower than the value of Shire’s offer.

Baxalta’s spread is already wide, said an analyst. The spread is “appealing” to some investors, depending on their comfort with the Shire offer. But other investors are concerned that the deal will stumble over an uncertain tax situation stemming from Internal Revenue Service regulations regarding spinoffs. Since the IRS does not usually make decisions on a deal in play, uncertainty about whether the deal will incur taxes could last two to three years, speculated the analyst.

Baxter has received assurances from its advisors that the Shire-Baxalta transaction will not incur taxes, and noted that Baxter and Shire have obtained indemnities, said a Baxter spokesperson.

But in an amended S-1 filing on January 15, Baxalta acknowledged that the tax issue remains inconclusive. “If the spin-off ultimately is determined to be taxable, the spin-off could be treated as a taxable dividend to Baxter’s shareholders for U.S. federal income tax purposes, and Baxter’s shareholders could incur significant U.S. federal income tax liabilities… Baxalta is required to indemnify Baxter against any tax liabilities resulting from Baxalta’s action or inaction that causes the separation, the distribution, the debt-for-equity exchange, the tax-free dispositions or certain related transactions to be taxable. Baxalta is required to indemnify Baxter against any tax liabilities as a result of the acquisition of Baxalta’s stock or assets.”

Uncertainty about taxes aside, Baxter owns 20% of Baxalta shares and would incur taxes if it sold them for cash, said the analyst. It needs to use “mechanisms” that some investors may find more or less “comfortable.”  These “mechanisms” make it possible if not likely that Baxter will increase the Baxalta spread prior to the closure of its deal with Shire, the four sources said. Baxter has publicly expressed that it will use any of three options for disposing of Baxalta shares: debt-for-equity exchanges, equity-for-equity exchanges, and pension fund contributions.

Though Baxter cannot sell shares directly to the market, its financial counterparties and those who purchase Baxalta from its counterparties can and probably will, three of the sources said. According to a broker, the greatest risk of an effect on Baxalta’s spread is in the case of a debt-for-equity exchange, wherein Baxter must use an investment bank to transact the deal.

Baxalta stated in its amended S-1 filing that JPMorgan would underwrite a $1.45 billion debt-for-equity exchange for Baxter with lender Chase Lincoln. JPMorgan is likely going to approach hedge funds to buy Baxalta shares, said the hedge fund investor, who added that he would be eager to buy those shares to take advantage of buying the spread at a discount.

The hedge fund investor said Baxalta’s spread could widen using any of Baxter’s methods to dispose of its spinoff’s stock, even in a pension fund contribution. “There’s no guarantee a pension fund won’t sell its shares back to the market.” He expects Baxalta will use all methods in a number of tranches.

“We have to consider price, tax rate, and the actual cost of executing the trades,” said the Baxter spokesperson. “When we look at each of the three mechanisms, the marginal cost of execution as we increase the size of those transactions increases, to the point where if we were to go exclusively with one vehicle, the costs would start to increase.” Therefore the disposition would be “dynamic and dependent upon market conditions.”

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Sarah Cohen

Sarah Cohen

Sarah Cohen joined CTFN in August of 2015. Sarah is a New Jersey-based telecom and technology M&A reporter whose work has appeared in Forbes, TheStreet, FT.com, and many other publications including Mergermarket, where she worked for 10 years. Sarah has covered Yahoo, the data center space, new and incumbent telecoms, FCC matters, and CFIUS for CTFN. She has an MA in communications from Bowling Green State University and BA in English from the University of New Hampshire.

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