Billionaire activist investor William Ackman joined with Valeant Pharmaceuticals International (NYSE: VRX) in a bid to buy Allergan (NYSE: AGN) for $47 billion. It is a cash and stock deal where owners of Allergan receive $48.30 per share and 0.83 shares of VRX which currently trades at $160 per share. The deal is another in the mold of the Heinz transaction Warren Buffet completed last year where he partnered with 3G Capital to buy the ketchup maker for over $23 billion. This deal was a bit different in that Ackman’s Pershing Square Capital Management played a more central role than 3G did in the Heinz transaction. It could be the first of many that use this approach.
More Transactions Could Utilize this Approach
The structure of this deal and Ackman’s timing was different than his activist approach in the past. Ackman’s hedge fund first purchased the shares of Allergan, while he already had a potential acquirer in mind in Valeant. Instead of pushing for changes at Allergan or even for it to open itself to sale, he bought the stock and had the acquirer already in pocket. The stock price increased by 15% and already resulted in gains for Ackman through his 9.7% stake of Allergan.
Investors historically have closely watch the actions of investors like William Ackman, David Einhorn and Warren Buffett. The speed and methodology Ackman took here will have investors more closely scrutinizing these investment managers along with other hedge funds looking to replicate the deal. While this was not the first like this, it was much larger than previous deals done this waythat typically ranged from $1- $3 billion.
Valeant previously tried to purchase Allergan, the maker of Botox, over the past year but was unable to bring the two companies together. Both companies businesses focus around skin-care and eye-care. Ackman partnered with Valeant CEO Michael Pearson this past February and decided to make a joint bid since Valeant could not get one done on its own.
Ackman, through a special purpose vehicle created by both Valeant and Ackman, started to acquire shares and options in Allergan. Ackman agreed that he would hold the shares in Valeant for a period of time after a deal would close. This does indicate that Ackman is not in the deal for just the quick pop in the share price of Allergan but will need the deal to create value for shareholders of Valeant.
Estimates are that the Deal is more Accretive than Previously Thought
Valeant management stated that it expects accretion of around $2.40 per share. If this estimates proves accurate, it represents upside of over 20% to FY16 EPS estimates for Valeant. In that case, the valuation of the current share price would look attractive at about 10x earnings.
Management did also note that it would substantially cut costs at Allergan to drive this level of accretion. However, it believes the combined firm can have high-single digit sales growth over at least the next few years. There is some concern on the Street that the level of cost cutting will hinder sales growth at Allergan.
Some additional information was also provided by management about the deal. It expects R&D over a bit over $300 million versus the current run rate at Valeant of $200 million for the year. The combined tax range will fall in the high-single digits and Valeant will also start to pay a dividend of $0.20 per share after the deal closes. This is in line with the current dividend at Allergen. Also, the debt will have a 5.5% interest rate and when combined with its current debt, result in a blended rate of 5.3%. Valeant expected net debt of $28 billion after the deal closes.
Valeant will have to sell a few product lines to close the transaction due to competitive issues. Dysport and Restylane, respectively competitors to Botox and Juvederm, will be sold. Management is already in talks to sell these lines, and the price is estimated in the $200-$300 million range.
The deal is interesting for two reasons, first the structure and two the potential synergies. The structure of this deal should further magnify moves activist funds, like Ackman’s Pershing Square, make. Investors already watch the holdings and filings closely of these funds for ideas. However, it is important to understand why these firms are buying these stocks versus merely replicating their holdings. Since filings are on a time lag, buying these after the fund announces their position puts investors at a significant disadvantage.
In terms of the actual deal, the shares of Valeant are attractive if management can execute on its cost cutting plans and achieves the expected synergies. This is tricky and tough to predict but the potential accretion in this deal is large enough that a small miss will still create value. Investors should not look for a white knight to buy Allergan. It will be hard for another firm to generate enough return on a deal since the synergies would not be as great.
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