This is definitely a season of deals in the health care space, with Forest Labs (NYSE: FRX) choosing to add another asset to its GI business ahead of its anticipated merger with Actavis (NYSE:AGN). Forest Labs is offering a significant premium for Furiex Pharmaceuticals (NASDAQ: FURX) and there are still FDA-related risks in play, but it seems like a reasonable offer for what could prove to be a highly synergistic asset.

The deal to be
Assuming all of the relevant i's are dotted and t's crossed, Forest Labs will acquire Furiex for $95 per share in cash, or $1.1 billion. Forest will offset the cost of the deal through an agreement to sell Furiex's royalty streams on alogliptin and Priligy to Royalty Pharma for $315 million after tax.

Forest Labs is also offering very important contingent value rights (or CVR) to Furiex shareholders. Depending upon if and/or how the FDA treats Furiex's lead drug eluxadoline as a controlled substance, shareholders could receive an additional $30 per share in cash (no scheduling), $20 (Schedule 5), or $10 (Schedule 4).

Why do the deal?
This deal makes a tremendous amount of sense for Forest Labs. Furiex is basically a drug development specialist with a single high-profile asset – eluxadoline for the treatment of diarrhea-predominant irritable bowel syndrome (or IBS-D). Furiex reported solid topline phase 3 data back in February, announcing that eluxadoline led to significantly better response rates (stool consistency and pain) in comparison to placebo; in study 3002, response rates were in the very high 20%'s over weeks one to 12 and the low 30%'s from weeks one to 26 versus placebo response rates of 16% and 20%, respectively.

There is a risk that the FDA will schedule eluxadoline as a controlled substance (it is an agonist of the mu and delta opioid receptors). Being placed on Schedule Four or Five would create some limitations regarding prescriptions and would impose some additional burdens on prescribing physicians and pharmacists, the net effect of which would likely be to reduce the number of patients taking the drug and its overall revenue potential.

Even so, exluxadoline looks like a highly complementary drug for Forest Labs. The company already markets Linzess through its partnership with Ironwood Pharmaceuticals. Linzess is approved for constipation-predominant IBS (IBS-C) and it will likely take only the most minimal incremental efforts to add eluxadoline to this sales effort. As the same doctors generally treat both types of IBS, it should make the sales calls of Forest reps incrementally more productive and profitable.

Based on my reading of Furiex's 10-K, Forest/Furiex will owe milestone payments to Johnson & Johnson if and when the drug is approved in the U.S. and if the drug hits certain milestones. Forest/Furiex will also owe a royalty up into the high single digits on exluxadoline sales.

A reasonable deal
Furiex has not yet filed for FDA approval, but expects to do so in the third quarter of 2014. The FDA has given a hard time to other IBS drugs in the past, including Salix Pharmaceuticals' Xifaxan, but the phase 3 results that Furiex announced in February should de-risk the approval process pretty significantly.

Assuming a best case scenario (no scheduling), Forest will be paying close to $1.5 billion for Furiex, or about $1.2 billion net of the royalty sales. Given estimates of the IBS-D market being worth $400 million to $600 million a year, that seems like a very attractive price for Forest. Forest Labs could perhaps see a competitive counter-bid, but rival bidders would need a pre-exisitng GI sales force to really make the numbers work and there are only a limited number of plausible bidders. It's also worth noting that this bid really isn't dependent upon the Actavis transaction going through; the arguments for acquiring Furiex and eluxadoline would hold up even if the Actavis deal fell through.

The bottom line

It's a little surprising that Forest was able to get this asset for such a seemingly reasonable price, though the risk of exluadoline being declared a Schedule Four drug is a significant one in terms of potential sales ramifications. While Furiex shareholders may hope a better offer comes through (and should probably hold their shares for a little while to see if a bid materializes), competing bids aren't all that common in the drug space.