Valeant Pharmaceuticals' New Offer for Allergan Falls Short

U.S. stocks were unable to add to yesterday's record high on Wednesday, but even as the benchmark S&P 500 broke a four-day winning streak, it fell just 0.1%. Meanwhile, the narrower Dow Jones Industrial Average (DJINDICES: ^DJI  ) and the technology-heavy Nasdaq Composite Index (NASDAQINDEX: ^IXIC  ) both fell 0.3%. In company-specific news, shares of Botox maker Allergan (NYSE: AGN  ) fell 5.4% today, even as its pursuer, Valeant Pharmaceuticals (NYSE: VRX  ) , announced an improved offer, including a $10 increase in the cash component.

Pfizer may have abandoned its ambitions with regard to AstraZeneca on Memorial day, but Valeant Pharmaceuticals shifted into higher gear in its pursuit of Allergan on Wednesday, with an improved cash-and-share offer worth $163.67, before one includes an exotic contingent value certificate based on the future success of Allergan's DARPin eye drug.

The following table sums up the proceedings to date:

Undisturbed Allergan closing share price on April 10, the day before activist investor Bill Ackman crossed the 5% ownership threshold

$116.63

Average Allergan closing share price over the 30-day period through April 10

$125.59

Initial Valeant offer, April 22

$149.11* per share

[0.83 Valeant share + $48.30 in cash]

Improved Valeant offer, May 28

$163.67 per share*

[0.83 Valeant share + $58.30 in cash componen]

+ Contingent Value Right in DARPin of up to $25 per share

Today's closing price

$156.12

Highest closing price since April 10

$169.91

*Based on Valeant's closing share price on May. 21
** Based on Valeant's closing share price on May. 28
Source: Author's calculations based on data from Yahoo! Finance and Valeant Pharmaceuticals

A higher offer was to be expected: Since Valeant announced its first offer on April 22, Allergan's stock has consistently traded at a premium to that offer. Indeed, based on Valeant's ultra-low effective tax rate and the $2.7 billion in cost savings it proposed to extract from the acquisition, Reuters BreakingViews calculated that the premium Valeant was offering Allergan shareholders initially was less than half of BreakingViews' $25 billion estimate of the value of the cost savings alone. As of today's close, Allergan's stock is trading at a 5% discount to Valeant's new offer, even excluding the contingent value rights, which is very tricky to value; indeed, the final details of the rights remain to be negotiated.

Valeant's offer to shareholders represents, at minimum, a 30% premium above the average price during the 30-day period through April 10, the day prior to activist crossing the 5% ownership threshold in Allergan shares. (Mr. Ackman teamed up with Valeant on its offer.)

Not a bad premium on the face of it, but I believe that long-term investors in Allergan ought to require a very healthy premium before they give up their shares. Allergan filed a presentation with the SEC today based on the research of two financial consulting and forensic accounting firms. The report suggests that Valeant Pharmaceutical's "roll-up" strategy, premised on frequent acquisitions, followed by R&D budget cuts (not to mention aggressive tax planning), is unsustainable. I'm inclined to agree with that assessment and, as such, I don't find the new offer compelling enough.

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