Why Did This Generics Maker Just Divest its Chinese and European Operations?

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Actavis (AGN), one of the largest manufacturers of generic drugs in the world, recently surprised investors with two major moves -- exiting the Chinese market and selling a large portion of its European operations to Indian generics maker Aurobindo.

Were these two divestments wise or foolish moves for Actavis, which primarily competes against Teva Pharmaceutical (TEVA 5.21%), Mylan (MYL), Valeant Pharmaceuticals (BHC 1.86%), and Novartis' (NVS -1.28%) Sandoz in the rapidly growing market for generic drugs?

Let's take a look at three key facts you need to know.

Why is Actavis leaving China?
Actavis decided to divest itself of its assets in China on January 16, which include Actavis (Foshan) Pharmaceutical, the company's joint venture with Foshan Chanbende Development, a manufacturer of antibiotics, digestive drugs, and cardiovascular drugs. Specific financial details of the deal have not been disclosed yet.

Although the divestment leaves behind 1.3 billion potential customers, Actavis CEO Paul Bisaro stated that China wasn't a "business friendly environment" and was "too risky" for continued expansion. Bisaro was likely referring to the ongoing investigation of GlaxoSmithKline (NYSE: GSK) and several major drugmakers regarding bribery allegations.

Actavis has not been accused of any wrongdoing. Yet Actavis' footprint in China is tiny, and the company previously stated that it considers Japan, not China, to be its fastest growing Asian market.

While it's unclear who will buy Actavis' Chinese assets, Pfizer (NYSE: PFE) would be a strong choice, since its generics division, which reported a 4% year-over-year decline in sales last quarter, has been struggling to find new sources of growth.

What did Actavis sell in Europe?
Actavis also sold its generic drug operations in seven western European countries -- France, Italy, Spain, Portugal, Belgium, Germany, and the Netherlands -- to Aurobindo for approximately 30 million euros ($41 million) in cash on January 18.

Of these markets, France and Germany are the most important, respectively accounting for 8% and 3% of its fiscal 2012 sales. Aurobindo believes that it can turn around Actavis' European generics operations by combining them with its Indian generics business.

Actavis believes that exiting China and part of the European market can help it concentrate its efforts on expanding into higher growth markets in Southeast Asia, Central Europe, and Eastern Europe.

Most of Actavis' revenue still comes from the United States, which accounted for 62% of its 2012 sales.

How is Actavis faring against its chief competitors?
Actavis has notably outperformed Teva, Mylan, and Novartis, and matched Valeant's triple-digit rally over the past 12 months.

Source: Ycharts.

Actavis and Valeant share a similar strategy of inorganic growth.

Actavis, formerly known as Watson Pharmaceuticals, took on its current form after acquiring Actavis in October 2012 for 4.25 billion euros ($5.8 billion). That acquisition created the third largest pharmaceutical company in the world. Actavis' acquisition of Warner Chilcott for $8.5 billion in May 2013 added women's health care and dermatological drugs to its portfolio, and allowed the company to relocate to Ireland for a lower corporate tax rate.

Valeant has followed the same path, acquiring Medicis Pharmaceutical for $2.6 billion in September 2012 for its cosmetics and body aesthetics portfolio and Bausch & Lomb for $8.7 billion for its eye care portfolio.

Yet the differences between Actavis, Valeant, and their industry peers become clearer with a side-by-side comparison:

Source: Company quarterly/annual reports, Yahoo Finance as of Jan. 21. Note: Actavis/Valeant's earnings growth excludes acquisition costs on a non-GAAP adjusted basis.

After Actavis and Valeant's earnings growth are adjusted for one-time acquisition costs, Actavis clearly becomes the strongest choice for investing in generics, followed closely by Valeant. Actavis' robust revenue growth and low 5-year PEG ratio suggest strong long-term profitability ahead.

The Foolish takeaway
Divesting from China and Europe could be smart moves for Actavis if it helps boost its position in higher growth markets. Those divestments could be the next phase of growth for the company, and will help streamline its operations following its previous phase of massive inorganic growth.

More importantly, Actavis remains the best fundamental bet in the rapidly growing market for generic pharmaceuticals, and is well poised to outperform its industry peers in 2014.