Allergan (NYSE:AGN) has been all over the news this week after pharmaceutical powerhouse Pfizer (NYSE:PFE) dropped its merger plans with the smaller, Ireland-based drugmaker. The $160 billion dollar deal would have gone down in history and formed the largest drug-developer on the planet, and it would have re-domiciled Pfizer to Ireland for tax purposes. But after the U.S. Treasury changed some regulations earlier this week and subsequently made the deal much less attractive to Pfizer, the celebrity marriage of the healthcare sector fell apart.
Allergan's stock price has fallen over 10% since the Treasury's announcement on Monday night, and $10 billion in market cap evaporated almost overnight. However, if you look back to November 2015, when the deal was first announced, Allergan's stock price was well over $300 per share. As of Monday, the share price stood at $277, implying that investors thought the merger would be damaging to Allergan. So how could it be that on Tuesday, just seven months later, an announcement that the deal is off sends shares tumbling even further to $236? Shouldn't investors be cheering?
Two things stand in the way of an escalation of Allergan's price
The first piece to this puzzle involves doubt that Allergan's planned sale of its generics unit to Teva Pharmaceutical (NYSE:TEVA) will go through. The deal is worth $40.5 billion to Allergan and would go a long way toward bolstering Allergan's balance sheet. As it stands, Allergan has $40 billion in long-term debt and just over $1 billion in cash on its balance sheet. Since the majority of the Teva proceeds would take the form of cash, Allergan would go from having a red-flag balance sheet to having a reasonable one ripe for further leverage.
Problem is, there's a hefty amount of skepticism that the FTC will allow this deal to go through. There has been a good deal of scrutiny surrounding generic drugs and their pricing in the U.S. lately, and it's not unreasonable to think that Teva might interfere with free-market competition by taking on Allergan's substantial generics unit. If the deal does not go through, then Allergan is fundamentally no worse for the wear -- but it will still have that glaring debt sitting on its balance sheet.
An unfair comparison?
The second thing investors need to understand in order to grasp Allergan's current share price is the general controversy in the United States surrounding drugmakers' profits -- particularly those that rely on acquisitions for growth. Allergan has quite the history of growing by acquisition. In fact, it's precisely this storied past that the Treasury depended on in the fine print of its rule change. (Although the Treasury claims that its rule adjustment was not aimed at any single transaction, the U.S. would of course rather not lose Pfizer as a U.S.-tax-paying corporation -- and the timing of the change does seems awfully coincidental.)
It seems that concerns about further government intervention are being blown out of proportion: Allergan has a very different business model from Valeant Pharmaceuticals (NYSE:BHC), which is the company on the receiving end of most of the pointed fingers. Valeant's entire entrepreneurial presence has been called into question. Is it ethical for a company to buy up other companies and raise the prices of their products, especially if said company is in the business of providing life-saving medications? Many people would answer no, and this has become the subject of heated debate -- particularly in this U.S. election year.
What many people don't realize is that Allergan and Valeant are not even in the same ballgame. Allergan, despite its history of acquisitions, spends substantially more on research and development than Valeant does, and its goal with acquisitions has never appeared to be simply raising the price of a drug that's already on the market. So while it's understandable that the entire healthcare sector has been somewhat deflated by concerns that a new U.S. president could change the regulatory and price-setting landscapes, it doesn't make much sense to have identical reservations about both Allergan and Valeant.
So is Allergan a buy?
Personally, I see a lot to like in Allergan right now, particularly after listening to CEO Brent Saunders defend himself and his company in multiple media outlets over the past few days. And yes, it's kind of a CEO's job to sound optimistic, but my gut reaction is to trust him. Plus, Pfizer saw a (desperately needed) growth opportunity in Allergan -- not just a chance to lower its tax rate -- and I think most investors looking at this stock should see the same.
The company is trading at a relatively cheap multiple (23 trailing P/E, 13 forward P/E), and analysts are calling for 15% EPS growth for the remainder of the decade. This is a company with several blockbuster drugs on the market, 70 mid- to late-stage drug candidates, and 14 more regulatory approvals expected just this year.
The only asterisk on my bullishness is the prospect that the Teva sale will not go through, which could potentially do even more damage to the stock -- at least in the short term, particularly if it affects Allergan's credit ratings. We should have definitive news on this sale by July of this year, and if the story then is the same as it is now, I'll consider picking up some shares.