We're lowering our credit rating on Shire (SHP) to A from A+ due to its recently announced Advanced BioHealing acquisition for $750 million, which will deplete most of its current cash reserves. At the end of March, Shire held $743 million in cash and $1.1 billion on its balance sheet. Due to its expected near-term free cash flow and the $1.2 billion in revolver availability, we still think Shire should be in a position to repay its $1.1 billion in convertible debt by that issue's May 2012 put date if necessary, but it will be tighter than we had expected. In general, the firm's progress on its net debt position has taken a significant step backward with this acquisition, and with rumours flying that Shire may be considering an even larger acquisition, the firm may need to take on significant additional leverage to meet its obligations and fund its M&A strategy. Depending on the terms of any future deals, we may consider a further downgrade.
With its narrow economic moat, we still like Shire’s business prospects. Shire is best known for Adderall, its wildly successful ADHD drug franchise. However, after the latest version of that product, Adderall XR, started facing generic competition in 2009, Shire has been successfully turning to new products to bolster results. Despite the contraction of the Adderall franchise, Shire still generated $373 million in free cash flow in 2009 and free cash flows rebounded substantially from that trough to $626 million in 2010. We expect continued growth before its debt comes due, as new ADHD drugs (Vyvanse and Intuniv) and a growing rare disease drug portfolio to help expand Shire’s reach. Vyvanse is the key product in Shire's portfolio, and the earliest we'd expect it to see generic competition is 2015. Also, we especially like Shire's opportunities with Elaprase in Hunter Syndrome and Replagal in Fabry disease.