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What the Actavis Buyout of Forest Laboratories Means for You

By Sean Williams – Feb 18, 2014 at 6:30PM

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Actavis lays big money on the table to acquire Forest Labs -- is this a prudent move or a big reach for Actavis?

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Forest Laboratories (NYSE: FRX), a global producer of branded pharmaceutical products, rallied as much as 37% after a deal was reached by Actavis (AGN) to acquire the company for roughly $25 billion in a cash and stock deal.

So what: Under the terms of the agreement, Actavis will pay Forest Labs' shareholders $26.04 in cash per share and 0.3306 shares of Actavis common stock to acquire Forest Labs. Based on midday trading, that would value Forest Labs at roughly $94 per share, although volatility would be expected to continue in Forest shares with a good chunk of its buyout price tied to the valuation of Actavis. Actavis notes that it anticipates the deal will be immediately accretive to earnings, with double-digit accretion expected in 2015 and 2016. In addition to bringing Forest Labs' portfolio into the fold, Actavis foresees cost synergies of approximately $1 billion annually and expects free cash flow generation will top $4 billion. The deal is expected to close by mid-2014.

Now what: I am officially scratching my head here, and I believe shareholders may want to consider doing the same. Forest Labs has definitely had a number of key wins over the past year and change with antidepressant Fetzima being approved by the Food and Drug Administration, as well as irritable bowel therapy Linzess, which was co-developed with Ironwood Pharmaceuticals. However, Forest is facing the patent expiration of Alzheimer's disease drug Namenda in 2015. As of last quarter, Namenda accounted for $401.5 million of Forest's $846.8 million in total sales. In other words, Actavis just purchased a company that's set to lose half its current revenue stream next year for $25 billion!

As I've mentioned, there are positives here in that Forest is profitable and will deliver positive cash flow for Actavis, as well as long-term cost savings. Potential remains high as well for Daliresp, Tudorza, and Bystolic, which are a part of Forest's respiratory line of products. But, in the end, Actavis may have paid what I suspect could be more than eight times forward sales for a company on the edge of the patent cliff. There's plenty of opportunity for this deal to work in Actavis' favor over the long term, but I see plenty of inherent risks built into this hefty price tag.

Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool has no position in any companies mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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