No one will accuse Valeant (NYSE:BHC) CEO Mike Pearson of lacking boldness. He has laid out a strategy for turning Valeant into one of the largest pharmaceutical/med-tech companies in the world and has proven more than willing to turn to bold M&A moves to make it happen. Valeant's latest move is far and away the largest – a $47 billion bid (at the time of the offer) for Allergan (UNKNOWN:AGN.DL) – but the target's acceptance is hardly a sure thing and the company's views about the pharma industry may give investors reason for pause regarding the long-term strategy.
A large bid for a prime target
Allergan has been regarded as an appealing acquisition target for some time, and Valeant has stepped up with a $47 billion cash and stock offer. The initial offer is $48.30 in cash per Allergan share and 0.83 shares of Valeant, valuing Allergan at $158 at the time of the offer. Valeant is offering Allergan shareholders a degree of choice on the cash/stock mix, though the final weightings are subject to proration, and Valeant contemplates Allergan shareholders owning about 43% of the resulting company.
Making this bid a little more unusual, Valeant is teaming up with Bill Ackman's Pershing Square. Pershing Square has already acquired 9.7% of Allergan's shares and supports Valeant's bid, including a commitment to accept 100% stock in the bid.
While Allergan's shares had run up in anticipation of a bid, the 15% premium to the prior high is not as robust as might have been expected. With Allergan decidedly cool to Valeant's overtures (the company has reportedly been rebuffing Valeant for 18 months), it is not unsurprising to see speculation that Valeant will have to sweeten the bid to seal a deal.
Ample synergies on tap
Valeant believes that Allergan is ripe for cost cuts that will drive value for Valeant shareholders. Valeant management has laid out a case for strong (25%-plus) pro forma accretion, predicated on $2.7 billion in cost cuts and the significantly lower tax rate Valeant enjoys.
Valeant acknowledges that certain divestitures will be necessary to get approval, including parts of the Medicis aesthetics business. Even so, the company sees substantial synergies in the aesthetics, dermatology, and ophthalmology assets of Allergan. Botox is a major high-value, wide-moat asset for Allergan, but I would also observe that Allergan brings a fairly rich portfolio of glaucoma assets to a Valeant ophthalmology business that is very, very weak in that large space (roughly one-third of the ophthalmology drug market).
Potential flies in the ointment
There are at least a couple of issues that could get in the way of a successful deal here. First, Allergan is not exactly bursting with joy to see this offer from Valeant. The company has apparently rebuffed Valeant before and Allergan's board has adopted a one-year poison pill plan that effectively blocks an investor from acquiring more than 10% of the shares and/or taking an offer directly to Allergan's shareholders.
Second, and perhaps of more concern to long-term Valeant shareholders, is the company's attitude regarding R&D. Of the $2.7 billion in targeted synergies from the deal, about $900 million would come from R&D and Valeant basically proposes to gut Allergan's R&D efforts. Valeant's presentation went out of its way to show management's apparent disdain for pharmaceutical R&D, pointing out 35 clinical trial failures, declining R&D/pipeline investment returns, and so on.
I believe it is inarguable that pharmaceutical R&D has gotten more expensive and drug development has become more challenging. The alternative, though, is to simply become an M&A and sales operation, acquiring drugs and devices developed by other companies and running a bare-bones internal R&D effort. There's certainly room for differing opinions here; Forest Labs did pretty well with an in-licensing/acquisition philosophy, but I believe it will be quite a bit harder for a company of Valeant's contemplated size to be competitive with a weak internal R&D program.
Will Allergan look for help?
Allergan has options if it really does not want to become part of Valeant. Finding a "white knight" acquirer is certainly a possibility. Johnson & Johnson (NYSE:JNJ) has sizable eye care and skin care businesses, though it has not been as active in ophthalmology and dermatology and there would need to be divestitures in the breast implant business. Johnson & Johnson could also achieve meaningful SG&A leverage without gutting Allergan's R&D efforts. AstraZeneca could also be an option if the company wishes to avoid an offer from Pfizer, particularly as Allergan could leverage AstraZeneca's superior overseas sales leverage.
Allergan could also turn to offense. Acquiring either Shire or Teva would pave the way for a tax inversion transaction, and there would be some synergy with Shire's ophthalmology assets and Teva's global sales infrastructure.
The bottom line
I appreciate Valeant's bold vision of itself as a major up-and-comer in the pharma/med-tech space, but the company's attitude has given me reason for pause in the past, and its view of Allergan's R&D effort only intensifies those concerns. Maybe Valeant is right in its view that pharma R&D spending is increasingly wasteful, but it is my position that long-term success in this sector is predicated on a strong R&D effort.
For Allergan's part, it is hard to argue that Valeant isn't offering good value. Allergan's wish to see its business grow and thrive may well be an unresolvable conflict with Valeant's goals, but ultimately it is the board's responsibility to do right by its shareholders and maximize the value for them.