Investors were greeted with an intriguing rumor early Tuesday morning, as the Wall Street Journal and other financial news sources were reporting that Actavis (NYSE:AGN) and Forest Labs (UNKNOWN:FRX.DL) were closing in on a deal. It didn't take long for this to play out, as Actavis announced the deal before the market opened.
This is a bold move for Actavis, as Forest Labs substantially expands its therapeutic end-markets, its addressable health care markets, and its balance sheet. There are definitely rich opportunities for operational and financial synergy here, but successful execution on this premium deal is an absolute must.
Actavis confirmed that it had reached an agreement to acquire Forest Labs for approximately $25 billion or $89.48 per Forest Labs share. This cash+equity deal gives Forest Labs shareholders a 25% premium to Friday's pre-holiday close, and shareholders will be getting $26.04 per share in cash and 0.3306 shares of Actavis for each Forest Labs share.
This is the latest, and certainly the greatest, of the many deals that built Actavis into what it is today – dwarfing the $9.2 billion acquisition of Warner-Chilcott and the $5.9 billion acquisition of Actavis (the company now known as Actavis used to be Watson Pharmaceuticals).
This deal will vault Actavis's revenue to more than $15 billion in 2015 (assuming no divestitures), while growing the branded drug business to about one-half of the total. Forest Labs will significantly augment Actavis's already-strong position in gastrointestinal medicine, adding Linzess, Canasa, and Carafate to the business. Forest Labs will also bring meaningful scale in CNS (Saphris, Fetzima, Viibryd, and Namenda XR) and some scale in respiratory, cardiovascular, and hospital medicine.
Why do the deal?
Drug companies like Actavis and Valeant (NYSE:BHC) have shown voracious deal appetite of late, stimulated in part by the synergy benefits of running a larger enterprise, but also cheap debt, advantageous taxation, and an increasing premium on scale when negotiating with payers and health care organizations.
Both Valeant and Actavis have taken extensive advantage of their particular tax structures. Legally domiciled outside of the U.S., these companies book their revenue in tax jurisdictions like Ireland where corporate tax rates are much lower, effectively giving them a 10% to 20% advantage on their tax rates compared to U.S.-based drug companies of similar size.
"Re-domiciling" was a significant part of the Forest Labs bull thesis, and I would estimate about $10 to $12 per share in value to Forest Labs just from having that option. That covers almost half of the premium that Actavis will be paying if this deal goes through as currently contemplated.
There are other potential advantages for Actavis in this deal. As companies like Actavis and Valeant have grown larger, so too has their bargaining power with health care systems in Europe and payers in the U.S. As both public and private health care systems are trying to hold the line on costs, that is no trivial detail. Larger companies generally have an easier time getting included in formularies, and that can be critical to sales.
There is also a relatively routine synergy play here, though perhaps not as much as the bulls will be expecting. Combined, the two companies will be able to pare away superfluous overhead and operating costs. On the marketing side, Forest Labs' sales force is nearly five times the size of that of Actavis, but I'm not sure how much Actavis can (or should) trim that. Forest Labs has significant primary care exposure, and that is a market that requires an above-average level of detailing and personnel to maintain share.
Probably safer to take the "over"
All things considered, it seems likely that there will be more deals across the pharmaceutical space. Valeant management has already made it clear that they see the company as a Big Pharma in the making, and companies like Endo Health are also looking to get better by getting bigger. With that, a host of companies including Salix, Mallinckrodt, and Ironwood could find themselves visited by a larger company.
The bottom line
There is a valid argument as to whether it is better to invest billions developing drugs through internal R&D programs or to acquire already-approved drugs through M&A. Forest definitely has a relatively young roster of drugs to market, and Actavis is an experienced hand at integrating deals. All of that said, this is not a cheap deal, so Actavis must execute to preserve (let alone build) shareholder value.
For Forest Labs shareholders, I'd be in no rush to sell just yet. This company has been bandied around as a target for some time now and it wouldn't be a complete surprise to see another company (perhaps Teva or Valeant) make a competing bid.