Thanks to the now-public interest of Valeant (BHC 1.05%) in making Allergan (NYSE: AGN) its own, not to mention the vocal and financial support of Pershing Square and Bill Ackman, the status quo is gone for good at Allergan. Good first quarter results and improved guidance for the year were both nice to see, but Allergan is going to have to do a lot more to convince its shareholders that a plan for the future that excludes selling out to Valeant has their best interests at heart.
Good results help a little
I suppose Valeant would be able to crow a little louder about the need for sweeping cost cuts if Allergan had posted an expense-driven miss, but first quarter results were pretty good.
Revenue rose 13% as reported, good for a modest beat versus sell-side expectations. Allergan's outperformance was spread fairly evenly across the business, as pharmaceutical revenue rose 10% on 9% growth in eye care, 10% growth in Botox (slightly weak), and 10% growth in skin care. Devices were up 23%, with 11% growth in breast implants and 33% growth in facial aesthetics.
Allergan extended its outperformance down the income statement. Gross margin improved more than half a point from last year, beating expectations for flat performance. Operating income rose 31%, beating expectations by 6% as the company slightly underspent expectations as a percentage of sales.
And now what?
While Valeant has been trying to drum up shareholder support for its bid for Allergan, the target has been relatively quiet beyond its initial rejection and poison pill efforts. Rumors are flying all over the place that Allergan is beating the bushes, looking for either a target of its own or a "white knight" bidder that would acquire the company without the slash-and-burn cost cuts proposed by Valeant.
A key focus of these discussions has been Shire (NASDAQ: SHPG). Several sources, led I believe by Reuters, have reported that Allergan approached Shire earlier this year regarding a merger/acquisition.
Shire would hold some obvious appeal. Acquiring Shire would facilitate a tax inversion that would lower Allergan's income tax rate (a key benefit of the Valeant offer) and as both companies have sizable SG&A and R&D spends, there could be some real cost-cutting opportunities here (however ironic that may be). There are also good top-line reasons for a deal – Shire would complement Allergan's ophthalmology business and its rare disease drug business would generate the sort of above-average growth that Allergan needs to sell any alternative proposals to its shareholders.
Other acquisition targets for Allergan could include Teva or Alkermes, with Merck KGaA and UCB as even bigger longshots.
Will a white knight show up?
If Allergan cannot swallow another company and make itself indigestible to Valeant in the process, it may be possible to find an alternative bidder – one that would preserve more of the company, it's R&D, and its employees' jobs. Given the advantages that Valeant stands to reap, though, it's going to be hard to find a superior deal.
Perhaps Pfizer would be interested if it couldn't consummate its bid for AstraZeneca, as Allergan would offer some modest synergies in dermatology and Allergan's products could be leveraged through Pfizer's global sales force. I continue to believe, though, that Johnson & Johnson and AstraZeneca would be more probable alternative bidders, though I'd hardly describe either company's involvement as "likely".
The bottom line
Allergan's near-term financial performance is almost trivial in the context of its value today. The dominant question now is whether Allergan can find an acquisition of its own, an alternative bidder, or secure a higher price from Valeant. Much as Allergan may not like Valeant or its proposed changes to Allergan's business, management has an obligation to do right by shareholders (the owners of the company). Unless Allergan can court Shire on attractive terms, swallowing hard and extracting more from Valeant may be the best option left on the table.
