Activist investors, such as Carl Icahn and Bill Ackman, have been imposing their will on companies in a major way this year. Instead of digging up little known value plays to beat the market, these activists are targeting major corporations like Apple, Pepsi, among others, in hopes of creating higher valuations from inside.
While many shareholders have cheered activist intervention, acting board members have often revolted against their plans. Allergan, (NYSE: AGN), for instance, has fought the intervention of activist hedge funds like Paulson & Co.and Ackman's Pershing Square tooth and nail in recent months.
As a reminder, Ackman has been advocating for a merger between Valeant Pharmaceuticals (BHC -0.69%) and Allergan that would create one of the largest eye- and skin-care drug portfolios in the industry. The net result has been a bitter legal battle between Allergan's board and its activist investors.
Why is Allergan attracting activist investors?
When activists attack, the underlying presumption is that the business could be run more efficiently to ramp up value for shareholders. In Allergan's case, however, I think the activist investing thesis is aimed primarily at creating quick gains via a buyout.
To understand my point, I think some context is necessary. The healthcare sector has been rife with buyouts this year -- driven by the loss of top selling drugs due to the the patent cliff, so-called "tax inversions," or simply by the desire to diversify clinical pipelines to avoid future patent cliffs.
Allergan in particular has drawn interest from prospective buyers because of the double digit growth of its specialty pharmaceutical portfolio, highlighted by the blockbusters Botox and Restasis.
Source: Allergan
Besides Valeant, for example, Allergan has received an offer from specialty and generic drugmaker Actavis plc (AGN), showing the strong interest in the Botox-maker's product portfolio.
Knowing the desire of pharma companies to gain access to lucrative specialty products like Botox, my take is that these activist hedge funds were confident that they could shop Allergan to potential buyers willing to pay a huge premium. And indeed, Valeant's initial offer of $46 billion came at nearly a 50% premium compared to the closing price of Allergan's shares the day before the offer was announced.
Not surprisingly, Allergan's share price has skyrocketed by 61% year to date mainly because of this deal, shown by the chart below. And Pershing Square has been a huge beneficiary of this upswing in Allergan's share price, helping to make it one of the best performing hedge funds this year.
Why is a buyout not such a great idea for Allergan shareholders?
As Allergan's management has laid out in their argument against a buyout, the company's restructuring efforts and strong top-line growth are on track to propel diluted EPS higher by over 40% next year. Breaking this down a bit, I believe the company is worth at least $66 billion based on its growth prospects and factoring in a premium in a buyout scenario -- making Valeant's offer look low by comparison.
So, yes, Allergan shares have done well this year because of Valeant's tender offer, but this deal is short-changing shareholders on the order of perhaps 20%-25% over the long haul, in my opinion.
Nonetheless, Allergan's specialty pharma portfolio and the ongoing M&A frenzy in the healthcare sector have created an enticing mix for activist shareholders looking to create big gains in a hurry.
