Valeant Pharmaceuticals International; Market Cap. (as of 3/10/2014): $42.9bn
Allergan Inc.; Market Cap. (as of 3/10/2014): $53.64bn
As low debt obligations alongside large cash holdings and patent expiration liabilities continue to foster a conducive environment for M&A activity in the pharmaceutical and biotech industry another multi-billion dollar struggle has emerged: Valeant’s hostile takeover of Allergan.

The Montreal, Canada-based company, Valeant has made a series of acquisitions since Mr. J. Michael Pearson took helm as CEO in 2008. In fact, it has been Mr. Pearson’s strategy to grow the company through a mixture of small and large acquisitions, with a focus on ophthalmological and dermatological companies, to drive growth. Since 2008, Valeant has made numerous small acquisitions, along with several “nine-figure” acquisitions. Since 2010, Valeant has a made roughly 30 acquisitions, according to Capital IQ, with a combined value of over $14.7bn.

In August 2012, Valeant successfully completed its first billion-dollar takeover, acquiring the skin-care company Medicis Pharmaceuticals for $2.6bn. Subsequently, in 2013, it made its largest acquisition, acquiring the eye-care specialist Bausch & Lomb for $8.7bn from the private equity firm, Warburg Pincus. The deal financing consisted of $4.5bn of cash and in new equity, with $1.5bn to $2bn debt secured from Goldman Sachs. However, the Bausch & Lomb shareholders only received cash compensation for their shares. Following the Bausch & Lomb takeover, Mr. Pearson said in a statement that acquisitions of such scale would remain an exception to the company’s strategy of tucking in smaller companies under its corporate umbrella.

However, Valeant is not new to failed acquisition attempts. In March 2011, Valeant launched an effort to acquire the specialized biopharmaceutical company, Cephalon, which has a patent portfolio of very niche drugs, such as narcolepsy miracle drug Modafinil. Cephalon rejected a $5.7bn takeover bid from Valeant, due to the price being too low. The Israeli generics giant, Teva Pharmaceutical Industries, subsequently managed to takeover Cephalon with a bid of $6.8bn in May 2011.

Allergan, most famous for its development of Botox, which has an array of application from neurological disorders to cosmetic applications, has been in Valeant’s sights. According to a presentation made by Allergan, not only will this transaction will be the largest in Valeant’s history, but also Allergan’s two most lucrative drugs, Botox and Restasis, alone out sell the top 30 drugs in Valeant’s portfolio ($2.9bn net for the two drugs vs. $2.5bn gross for Valeant’s portfolio of 30 drugs). After Allergan’s board of directors rejected Valeant’s formal advances to negotiate price for the company, Valeant resorted to hostility by issuing an unsolicited tender offer to Allergan shareholders of 0.83 Valeant shares in combination with $72 in cash in exchange for one Allergan share. Pershing Square, an activist hedge fund, has been in collaboration with Valeant by buying Allergan shares, accumulating a 9.9% share in the company, and exchanging them for 1.23 Valeant shares. With Valeant’s shares opening at $127.71 on October 3, the offer is currently valued around $177 dollars per share. However, Allergan’s Board of Directors has accused Valeant of “substantially undervaluing” Allergan.

Allergan’s Board of Directors has pointed specifically towards low organic sales growth, an unsustainable acquisition strategy and R&D cuts as the main arguments for rejecting Valeant’s offer. When generic drugs are considered, Valeant’s ex-ante revenues have been stagnant with no growth in 2013 and 1% growth in the first quarter of 2014 while pro-forma revenues are estimated to have decreased by 0.5% and 1.4% respectively. Allergan focuses on the acquisition of Bausch & Lomb in particular to highlight Valeant’s flawed acquisition strategy. While Bausch & Lomb’s overall business grew by 2% in 2013, sales eroded by 19% with pricing being the key driver of growth at an 11% increase. However, Allergan’s primary concern appears to be the balancing of long-term value creation with R&D reduction should Valeant’s takeover prove successful. Allergan’s SG&A ratio is projected to fall nearly fourfold from 39% to 10% alongside significant R&D cut of 15% to 2% of revenue, which Allergan suggest produce a $310m shortfall in R&D spending if cost saving synergies of $900m are to be achieved as claimed by Valeant. As a result, Allergan’s Board of Directors has considered various defensive strategies to thwart Valeant’s hostile take-over.

As one defensive barrier, Allergan is considering an all cash acquisition of Salix worth $10bn in an attempt to become too expensive and complex for Valeant’s strategic preferences. Valeant current cash and stock offer stands at $54bn, which would be insufficient following a Salix acquisition when considering Allergan’s $52.6bn market value in combination with the $10bn Salix valuation without premium. With Salix’s trailing P/E at 136x earnings, Allergan’s interest in Salix emphasises the board’s preference to avoid a Valeant takeover in favour of an enhanced and developing product portfolio.

However, William Ackman, CEO of Pershing Square, has threatened to sue Allergan should the deal materialize on grounds of pre-empting shareholder approval – all-cash acquisitions do not require backing from shareholders. These corporate governance concerns are shared with Jackson Square Partners, Rowe Price Group and Pentwater Capital Management LP, three dominant Allergan shareholders, who worry that the deal does not provide value for shareholders. With an Allergan shareholder vote on the board of directors scheduled on December 18, Ackman will be keen to postpone any major corporate developments before then. Until then, who knows what further surprises this story has to offer.

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