If investors have learned anything from their experience with Valeant Pharmceuticals (NYSE:BHC) over the past six months, it is that it's important to consider what can go wrong at a company before investing in its shares. Now that Pfizer (NYSE:PFE) and Allergan plc (NYSE:AGN) have called off their proposed $160 billion merger and Allergan's shares have tumbled, let's play devil's advocate and highlight what other risks face the company that investors should be handicapping.
Risk No. 1: The FTC blocks its generics deal
Last summer, Allergan agreed to sell its generic drug business to Teva Pharmaceuticals (NYSE:TEVA) for $40.5 billion. However, that sale needs the blessing of U.S. regulators at the FTC before it can close.
Teva Pharmaceuticals has already gotten the OK from EU regulators, and Allergan's CEO is quick to point out that everything remains on track for this deal to close by the end of June, but if something unexpected causes the FTC to scuttle it, then it could put Allergan in a bit of a tight spot.
That's because the money Allergan is getting from Teva Pharmaceuticals will go a long way toward reducing the mountain of debt that piled up when Allergan was still known as Actavis. In the past two years, Actavis spent $28 billion buying Forest Labs and another $70.5 billion acquiring Allergan.
Those deals saddled Allergan with $2.4 billion in short-term debt and $41 billion in long-term debt, and given that Allergan's cash totals just $1.2 billion exiting December, the windfall from Teva Pharmaceuticals becomes pretty important.
Assuming Allergan's CEO is right and the sale closes soon, then Allergan will pocket $33.75 billion in cash and another $6.75 billion in Teva Pharmaceuticals stock. After taxes, Allergan estimates it will walk away with $36 billion in cash and equity.
That cash cushion will go a long way toward removing any lingering concerns about its debt. The company plans to pay down $8 billion of its borrowings right away and then save the remainder for future debt payments, acquisitions, or buybacks.
Overall, I think it's more likely that the FTC requires Teva Pharmaceuticals to sell off some assets, rather than abandon its acquisition; however, given recently soaring generic drug prices may have made regulators antsy about industry consolidation, we can't dismiss this risk altogether.
Risk No. 2: Ratings agencies force the company to ratchet down
Allergan is pledging to do whatever is necessary to maintain its investment grade rating, and if those agencies decide that Allergan needs to be far more aggressive in paying off its debt than it plans to be, then it could crimp the company's ability to fuel growth through acquisitions.
Allergan's management has said it wants to drive double-digit annual revenue growth and that growth will come both from new drugs developed internally and from drugs acquired from competitors. Buying growth from the outside doesn't come cheap and its pledge to maintain its top-tier credit rating therefore could result in a ratcheting down in deals and spending that could slow its expansion plans.
So far, agencies have been pretty mum on their opinion of Allergan following its breakup with Pfizer, but investors will want to watch and see if they make any statements about their outlook for the company over the coming days.
Risk No. 3: Pricing headwinds pick up
Pricing power has been propping up Allergan's revenue growth. However, the Turing Pharmaceuticals debacle has led to intense scrutiny of pricing decisions that could mean that price increases play a much smaller role in driving growth higher in the future than they have in the past.
In January, The Wall Street Journal reported the findings of a pricing analysis done by Deutsche Bank analysts indicates that Allergan increased prices on 40 of its drugs by an average 9.1% this year.
Since Allergan is forecasting sales to grow from $15 billion last year to $17 billion this year, or by 13%, it would seem that price increases could be a significant source of its growth. If the payer's price war leads to steeper-than-anticipated discounts, rebates, or slowing price increases in the future, then it could create a headwind that hampers Allergan's ability to deliver on its annual revenue growth targets.
Investors who have stuck with Allergan since 2012 have been rewarded with a 175% return that triples the return of the S&P 500, and given that performance, it is undeniably tempting to think that Allergan's recent share price drop makes this an unquestionable buy opportunity. That could be the case, but investors ought to weigh the potential for future returns in light of these risks before jumping in.
Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may have positions in the companies mentioned. The Motley Fool owns shares of and recommends Valeant Pharmaceuticals. The Motley Fool recommends Teva Pharmaceutical Industries. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.