Earlier this week, Valeant Pharmaceutical (NYSE:BHC) made a public offer to buy rival Allergan (UNKNOWN:AGN.DL). Let's review the major questions this huge potential deal raises, to see whether it's a smart move – and whether or not it'll actually happen.
What is Allergan?
Allergan sells specialty pharmaceuticals and medical devices, with businesses spanning eye care, dermatology and aesthetics. It's best-known for its Botox franchise, but its largest business segment is eye health, with treatments for dry eyes, glaucoma, inflammation, allergies, and retinal diseases.
In 2013, Allergan's sales grew 11%; the company generated 31% operating margins ; 38% of sales came from outside the United States; and it spent $1 billion (more than 15% of sales ) on research and development.
Why does Valeant want to buy it?
Valeant and Allergan are focused on similar therapeutic areas: eye care and dermatology. Together, the combined companies would be the second-largest global player in eye health, with a cheaper, more effective combined sales force to boot.
According to Valeant's estimates, Allergan gets 60% of its revenue from durable products – those that don't rely on patent protections to generate sales – and 65% from products with limited reimbursement risk from government-run health-care programs. Obviously, these types of products are attractive because they'll generate sales over a long period. Governments spend a lot on health care, but they aren't the best customers. They have a tendency to demand huge discounts, pay late, and introduce numerous bureaucratic hassles.
Furthermore, Valeant believes that it can trim a lot of fat from Allergan's cost structure, achieving $2.7 billion in cost synergies by cutting $1.8 billion in overhead costs and $900 million in research and development costs from the combined companies.
How much did Valeant offer?
Valeant is offering $48.30 in cash and 0.83 shares of Valeant for each outstanding share of Allergan. Based on Allergan's diluted share count of 307 million , the deal is worth approximately $49 billion. To finance the cash portion of the deal, Valeant has secured $15.5 billion in debt financing, which is expected to have an interest rate of 5.5%.
Is it a good deal for Valeant shareholders?
On paper, this looks like a great deal. If the combined company achieves its targeted synergies, shareholders will benefit as the company's per-share cash earning power rises between 25% and 30%. In other words, the benefit of folding Allergan's business into Valeant will more than offset any dilution for current shareholders. The deal will also shore up Valeant's balance sheet and reduce leverage.
Valeant CEO J. Michael Pearson has an outstanding track record of making smart purchases and delivering target synergies. But Valeant has never done a deal of this size ever before. Inevitably, there will be hiccups, and only time will tell whether Pearson's making a wise move here.
Will the deal go through?
Prior to making this offer, Valeant hired two law firms for advice -- Skadden, Arps, Slate, Meagher & Flom LLP, and Osler, Hoskin & Harcourt LLP . If these lawyers aren't the best in the world, they're at least among the most prestigious and expensive. Since both firms concluded that there shouldn't be any antitrust concerns, I suspect regulators will approve the deal.
Will shareholders also say yes? I think they likely will. Allergan insiders, who have the greatest incentive to reject the deal, only own 0.18% of shares. By contrast, Allergan's largest shareholder, the Bill Ackman-led Pershing Square, vocally favors the deal. Ackman is so enthused by the deal (and Valeant) that he has agreed to accept 100% stock for his ownership stake.
Of course, I do expect some saber-rattling by Allergan's board of directors. They'll hire an investment bank to look for competing offers, but I don't think any better ones will come. Allergan's board could make a perfunctory effort to haggle with Valeant for a better price, but in the end, I think this deal will get done at or near Valeant's initial offer price.
Foolish bottom line
The price Valeant would pay looks reasonable in light of potential synergies, and shareholders should benefit. But integrating the two companies could prove challenging over the next several years, and investors in either company should keep a careful eye out for any signs of trouble.