Abbott And Mylan: Winners and Winners?

Sometimes companies find that they have overlapping needs, and such was the case recently in the drug world. Abbott Labs (NYSE: ABT  ) was looking to reinvigorate its branded generic drug business, while Mylan (NASDAQ: MYL  ) wanted to join the parade of companies that have redomiciled in Europe to avoid taxes. The two companies came together on Monday in a $5 billion deal that will see Abbott sell its developed market drug business in a stock transaction that also gives Mylan the European tax base it wanted.

The deal
Under the terms of the deal announced Monday morning, Abbott will sell its Switzerland-based developed market pharmaceutical business (consisting largely of branded generics) to Mylan in a $5.3 billion deal. Abbott will be getting stock in the deal; specifically, 105 million shares of the new entity that will combine Mylan's current business with the new European drug assets into a new entity headquartered in Europe.

At around 10x to 11x EBITDA and 2.5x trailing revenue, Abbott is getting a reasonable price. While there have been several recent pharmaceutical deals at higher multiples, the developed market EPD business at Abbott has been struggling, with revenue down by the high single digits in 2013.

What Mylan gets
Rumors of an Abbott-Mylan transaction had been going around for some time, as well as the rumor that the deal would be structured as the first "spinversion" where a company sold a foreign-based subsidiary/business that qualified the buyer for a tax inversion (though I suppose technically Salix was first).

The key asset in this deal for Mylan is the lower tax rate. With U.S.-based Actavis and Perrigo headquartered outside the U.S., Mylan was one of the last major U.S. generic drug companies with a U.S.-based tax address. Mylan's 25% effective tax rate isn't bad, but I would estimate that every 100bp of lower taxes should mean $0.05 to $0.07 of higher EPS and most similar companies have seen sub-20% tax rates after the inversion.

Mylan should be able to handle Abbott's developed market assets a little better than Abbott has. Mylan's own European business had a tough stretch from 2010-2012, so management has some familiarity with the situation and I expect them to improve the results (though perhaps not dramatically). I'd also note that this deal involves no additional debt but adds $500 million or so to Mylan's EBITDA base – allowing the company to pursue further debt-funded M&A that it can leverage through that newly lowered tax rate.

What Abbott gets out of it
For Abbott, this deal immediately improves the top-line growth rate, though at the cost of $0.22/share in dilution. Abbott has made it very clear in the past that they consider dilution to be a significant issue, so I would expect to see the announcement of acquisitions and/or buybacks to soften the blow. Along those lines, Abbott management made it very clear that they are not long-term holders of Mylan shares once the deal closes and they're free to sell.

So what does Abbott do next? I've commented in the past that Abbott's cardiology business lacks scale, but I don't see a lot of obvious assets to buy. Being the third or fourth company in transcatheter valves wouldn't add a lot of value and there aren't a lot of obvious acquisition targets (though companies like CardioMEMS and Atritech were arguably not obvious targets when St. Jude Medical and Boston Scientific got involved).

In the peripheral vascular and diagnostics businesses, though, there are more targets. Abbott could perhaps look to acquire atherectomy assets to go with its peripheral stent business – a company like Cardiovascular Systems or Spectranetics comes to mind. On the diagnostics side, there's a larger number of targets in point of care, molecular diagnostics, personalized medicine, and disease-specific testing that could all make some sense within Abbott.

The bottom line
Both companies are going to walk away from this deal with more or less what they wanted. Abbott may not have gotten maximum value for its developed market pharmaceutical business, but that was going to be difficult given the challenged growth profile of the business. Mylan is taking on some dilution and will likely face some headwinds from the expected sale(s) of Abbott's stake, but it was a reasonable price to pay for the lower tax rate. Now it remains to be seen what Abbott and Mylan will do to leverage their respective proceeds and strategic advantages gained from the deal.

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