Valeant Pharmaceuticals (TSX: VRX)(NYSE: VRX) recently made an unsolicited cash and share offer of around $46 billion to the shareholders of the pharmaceutical company Allergan (NYSE: AGN). At the time of the offer, this equated to $154 per Allergan share — a premium of over 20% compared to the previous trading price.
Pershing Square Capital Management under the leadership of Bill Ackman, has partnered with Valeant to pursue the acquisition. In the process, Pershing has already acquired 9.7% of the Allergan shares and is now the single largest shareholder in Allergen.
The positives for Valeant and Pershing
Valeant and Pershing are of the opinion that a merged and streamlined operation could create substantial shareholder value. The combined entity would, in the first instance create a strong portfolio of leading products in ophthalmology, dermatology, and aesthetics. According to their estimates, the transaction would enhance cash profits of the combined entity by 15-20% over the medium term.
This will be achieved by reducing the combined entity’s general and research and development costs by 30% or $2.7 billion. Included in this amount is the rationalisation of headquarters, elimination of non-essential global functions and staff, and a $900 million reduction in the annual research expense, which would equate to a 69% saving on the pro forma joint expense. There will also be additional benefits through a lower effective tax rate for the combined entity as well as revenue synergies from the combined product offering.
Valeant faces an uphill battle to make this work
The Allergan board did not react kindly to what they called a hostile and unsolicited offer and rejected it out of hand without engaging in formal discussions with Valeant. They offered a number of reasons for the rejection including an observation that the offer undervalued Allergen and that it created risks and uncertainties for Allergan shareholders. They also pointed to their company’s track record of producing consistent growth and solid results over time and outlined a 20% per annum profit growth target through 2019.
The reaction of the Allergan board was probably to be expected when the following factors are taken into account:
- The acquisition would be very valuable from a synergistic perspective for Valeant. Valeant could increase the offer considerably before it becomes unattractive.
- Allergan shareholders would be expected to accept Valeant shares as part compensation. The Valeant share price increased dramatically over the past five years and has become an expensive currency to accept as payment.
- Valeant has performed well under the current CEO, Mr Michael Pearson. However, a large part of the success could be ascribed to a very active acquisition strategy which yielded more than 100 acquisitions, costing $19 billion since 2008. The Allergan board described this business model as unsustainable.
- Valeant carries a high level of debt on the balance sheet, which may double when it pays out the cash component to Allergen shareholders. On the other hand, Allergen currently has a net positive cash position that can facilitate share buybacks and increased dividends.
- Valeant is still in the process of digesting the $8.6 billion Bausch and Lomb acquisition plus a multitude of recent smaller acquisitions. Allergan will be a much larger acquisition and may distract management from operational execution.
The Valeant board has indicated that it would improve the offer and make an announcement during a scheduled webcast on May 28 when it will discuss details of its plans for the Allergan merger.
The conclusion of this saga has some way to go but eventually it will be up to the Allergan board and shareholders to decide whether they find the Valeant proposal acceptable. In my view they may prefer to work internally to achieve some of the cost savings highlighted by the Valeant proposal rather than going through the disruption of a major merger exercise.