FROM $25 BILLION TO $90 BILLION

Dawn raid makes comeback via activist drone strike

By Robert Cyran and Richard Beales

Remember the dawn raid, when a would-be acquirer built up a stake before the target realized it was under attack? Activist investor Bill Ackman has come up with a kind of drone strike version. His Pershing Square Capital Management hedge fund and Valeant Pharmaceuticals have teamed up to grab a potential 9.7 percent stake in Allergan, with a hostile takeover by Valeant ready for deployment.

The acquisitive Valeant has reasons to be receptive to such an arrangement. For one thing, it’s essentially the creation of an activist hedge fund, ValueAct Capital, which set it on the path of serial dealmaking. Slashing research and development costs and applying its low tax rate to acquired businesses has served investors well. Its stock is up more than tenfold since it started buying rivals in 2008. The prospect of another deal kicked its shares 10 percent higher after regular market hours on Monday, taking its market capitalization up to $46 billion.

Moreover Valeant, which contributed $76 million to Pershing Square’s Allergan war chest, knew that nearly 10 percent of shareholder votes were in deal-friendly hands before it had to announce its intentions. Ackman has also committed to buy $400 million of Valeant stock at a discount and to hold considerably more for at least a year if the company does manage to buy Allergan.

For his part, Ackman gets to skip the step in which, after buying a stake in a company he thinks is ripe for a shake-up, he then tries to make something happen. Instead he has a ready-made buyer. The result so far is a gain of at least $1 billion on paper -and he hasn’t even yet had to turn cost-effective call options, through which Pershing Square has acquired the bulk of its economic interest, into shares.

A successful outcome isn’t assured for a hostile Valeant offer for Allergan. The two companies compete in the plastic surgery area, so antitrust regulators may ask questions. And after Allergan’s shares popped 20 percent on Monday, it’s now larger than its suitor with a market value north of $50 billion.

There are rules that would have forced a Valeant disclosure much sooner had it started accumulating stock in Allergan for itself. Of course, Ackman is putting up most of the capital and there’s no suggestion anything should have been revealed sooner. Even so, another set of watchdogs may wonder whether this novel battlefield tactic is too stealthy for comfort.

Published on April 22, 2014

(Image: REUTERS/Brendan McDermid)

Valeant’s M&A machine may soon overheat

By Robert Cyran

Valeant’s M&A machine may soon overheat. Some of the brain trust behind its hyper-acquisition strategy is leaving the board just as the pharmaceutical company embarks on its biggest deal. Buying Allergan would swell Valeant to about $75 billion in market value with a gargantuan debt load. Finding meaningful targets will be much harder.

Fred Hassan, the former Schering-Plough boss and current private equity honcho, and Mason Morfit, of activist hedge fund ValueAct Capital, are leaving the board along with Lloyd Segal from Persistence Capital. Valeant says its size and scope now creates conflicts with their day jobs. Morfit, in particular, was instrumental in picking Michael Pearson to be chief executive and setting the company on its takeover trail.

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Note: Thomson Reuters values include net debt of the target company.

Valeant’s growth presents other, perhaps bigger, problems. In 2008, its market capitalization was about $1 billion. That meant buying a firm like Dow Pharmaceutical Sciences for $285 million – many of similar size still exist in the sector – was a big deal back then. Today, it would barely register.

Bill Ackman, Valeant’s hedge fund partner in the Allergan transaction, points out that there are 58 drug or device companies worth more than $10 billion apiece, for a sum of $3.2 trillion. Most of them would make poor targets, though.

The strategy at Valeant is to slash research and development. That works at places where drugs are difficult to make, sales are too small to interest rivals or there’s brand loyalty. Most of the companies on Ackman’s list – and all the ones worth over $50 billion – invest heavily in R&D or eventually face shriveling sales.

At Valeant, sales of existing products increased just 2 percent last year. It reckons there’s growth for Allergan in emerging markets, but that may be harder in practice than in theory. And if revenue starts to decline, Valeant could find the expected $30 billion of net debt post-Allergan to be rather imposing.

Together, the two companies reported less than $4 billion of EBITDA last year. Even after the promised $2.7 billion of savings from the merger, it would leave the combined company with debt of eight times EBITDA. That’s on the extreme end for leverage at a pharmaceutical group. For Allergan shareholders being offered Valeant stock, it’s a good reason to inspect the deal apparatus closely.

Published on April 24, 2014

Valeant’s slashing could trigger FDA lashing

By Robert Cyran

Valeant Pharmaceuticals’ promised slashing of Allergan’s costs could trigger a Food and Drug Administration lashing. If the Canadian takeover machine succeeds in its $47 billion hostile acquisition of Allergan – in cahoots with activist hedge fund manager Bill Ackman – Valeant expects to cut its target’s research and development spending by 80 percent. How it could do so without eating into required regulatory spending is a puzzle.

The two companies have totally different models. Valeant thinks R&D is often wasted: Cut it, and the profits will flow. There’s something to this idea. The return on investment in a typical biopharmaceutical portfolio often fails to cover its cost of capital, according to McKinsey – the old employer of Valeant Chief Executive Michael Pearson.

Allergan, more old-school, is committed to finding new drugs. Alongside some failures, it has had big successes such as expanding the medical uses of blockbuster Botox. Over half the wrinkle remover’s sales now come from treating migraine headaches, overactive bladders and the like.

Wall Street seems to favor Valeant’s method. Its stock is up more than tenfold since 2008. Allergan’s share price has merely tripled. But Valeant needs more and bigger deals to keep growing. That can’t go on forever, perhaps a reason why Pearson told big investors Valeant would consider a break-up if it became too large, according to Reuters.

Going after Allergan so aggressively -including promising an improved offer on May 28 – could indicate that the Valeant CEO is feeling the pressure to deliver growth. Perhaps haste and incomplete information explain why, according to news reports, he told analysts Allergan had a golf course that Valeant could get rid of to save money. There’s no such golf course.

A shortage of data also might help explain why Valeant thinks a $200 million R&D budget is sustainable, let alone sufficient to expand the uses of Allergan’s existing products and develop some late-stage drugs. Allergan spent $550 million last year on trials for these purposes, and an additional $200 million on studies of drugs already on the market.

Even with outsourcing and contributions from Valeant’s laboratories, it’s hard to see much scope to fund expansion or research and testing of new drugs. There’s even a risk of underfunding mandated studies of already-approved drugs. Skipping those allows the FDA to pull them off the market. That really could throw a wrench into Valeant’s financial machine.

 Published on May 20, 2014

ValueAct’s Valeant return hints at value trap

By Robert Cyran

ValueAct’s valiant return to Valeant Pharmaceuticals hints at a value trap. The departure of the activist fund led by Jeff Ubben from the drug company’s board in May set off a slide in Valeant stock, the currency so critical to its M&A-driven strategy. ValueAct is rejoining the board, and may buy more shares. Some good investments, it seems, are harder to leave than they are to make.

The San Francisco activist hedge fund is in large part responsible for Valeant’s success. It helped appoint Chief Executive Michael Pearson and drew up the lucrative compensation scheme that encouraged him to go on a massive shopping spree, which Valeant then capitalized on by slashing R&D and other spending at its targets. Wall Street loved the story, sending the stock up about 10-fold.

While Ubben’s fund has done extraordinarily well, cashing out may be proving problematic. Valeant is now a $43 billion company and saddled with lots of debt – to bag the big game it needs to grow, it needs to use its stock as currency. About 60 percent of its proposed $50-billion-plus takeover of Allergan comes in the form of equity. If Valeant’s stock weakens, so does the appeal of the deal.

Ubben says his fund never sold any stock. He has consistently defended Valeant’s business model. The perception that the smart money was considering cashing in, however, encouraged a self-reinforcing spiral downward – helped by criticism of Valeant’s business model by short sellers such as Jim Chanos, and Allergan’s bruising defense.

ValueAct’s return, and its promise to buy more stock, will dampen these attacks. Valeant’s stock rose 3 percent on the news. Yet Valeant’s business still needs big acquisitions to grow -and that requires a strong stock. Leaving may be just as difficult – maybe even more so – when ValueAct does actually decide it’s time to move on.

Published on Sept. 20, 2014

Valeant’s activist deal too clever by half

By Richard Beales and Robert Cyran

Valeant has tried a seven-month M&A experiment that boss Michael Pearson – and other corporate chiefs – should think twice about repeating. The $45 billion drug company’s failed tilt at Allergan alongside Bill Ackman’s Pershing Square landed a $400 million windfall. But with Actavis snatching the quarry, Ackman and Allergan’s owners have made out best. Valeant lost time and risked legally questionable tactics.

There’s nothing new or problematic about an investor buying a stake in a company, as Pershing Square did with a 9.7 percent stake in Allergan, and then agitating for a sale. Activism has been a money-spinner in recent years, delivering among the best returns of all hedge-fund strategies in 2012, 2013 and so far in 2014, according to indexes maintained by Hedge Fund Research. Ackman’s fund was up a very strong 31 percent this year through the end of October, Reuters reported earlier this month.

What was novel was Ackman’s agreement ahead of time with Valeant, a potential buyer of Allergan, to work together. Valeant must have known the move would put Allergan in play, but with Pershing Square’s votes and market clout Pearson would have hoped to have the edge.

That’s not how it turned out. Instead, Valeant and Allergan exchanged potentially damaging critiques in a long conflict. That has cost Valeant the chance to pursue other targets, in line with its strategy of growth through acquisitions. Pearson has a consolation prize, largely thanks to a 15 percent share of Pershing Square’s profit on its Allergan shares. But that may not be enough to make the scars worth bearing.

The legality of the deal Valeant made with Ackman is also uncertain. A judge ruling on whether Pershing Square could vote its Allergan shares found earlier this month that the plaintiffs in the lawsuit had raised “serious questions” about whether the arrangement violated U.S. securities rules on insider trading. That may never be settled for this case, but a successful bidder indulging in similar tactics could find itself in a legal morass, at best.

Sure, Allergan might never have contemplated an approach from Valeant alone. But an activist hedge fund doesn’t share the same goals as a corporation, even a serial acquirer. Ackman’s $2 billion or so of profit may encourage him to look for other similar opportunities. Companies would be better off acknowledging the tactic as too clever by half.

Published on Nov. 17, 2014

(Image: REUTERS/Brendan McDermid)

Deal junkie Valeant shoots up on $10 bln fix

By Robert Cyran

 Deal junkie Valeant Pharmaceuticals has shot up on a $10 billion fix. The drugmaker’s pledge last year to focus on organic growth and debt reduction didn’t last long. Cost cuts and tax savings from buying Salix Pharmaceuticals proved irresistible. What Valeant’s injecting isn’t clear, though. Salix’s numbers are fuzzy after it admitted pumping clients full of inventory.

Valeant reckons it can quickly cut at least $500 million in costs. Moreover, the combined company’s tax rate should be around 5 percent. The present value of these savings, when capitalized on a multiple of 10 – assuming its low tax rate is sustainable – surpasses $4 billion.

That’s partly why Valeant’s market value rocketed up almost $8 billion to $66 billion. It helped that the company’s fourth-quarter results, also announced on Monday, were better than expected. Revenue grew 11 percent compared to the same period last year and executives’ comments about the growth of existing drugs this year may also have excited investors. There’s also relief among Valeant’s backers that the company is back to signing deals, after its long chase of Allergan left it empty handed. Rival Actavis won with a $66 billion bid.

Valeant’s problems from its deal binges have not gone away. After whittling down its debt by about $2 billion over the past year, the new deal will nearly double its load to close to $30 billion. Questions about the company’s sustainability have not been answered either.

This deal may intensify them. Salix has been growing fast, and Valeant says this will continue after the deal closes. Yet the cost cuts Valeant is proposing equate to two-thirds of what its target spent on sales, administrative costs and R&D over the past 12 months.

Moreover, frenzied deal-making in pharma over the past few years means there are fewer high-quality assets available at reasonable prices. Salix’s reputation and market value took a hit after executives admitted in November that its stellar growth had been partially fudged as a result of overstocking clients with its drugs.

The sale values the company at slightly less than its market worth prior to the accounting scandal. Valeant is confident it understands the problem. What observers can say with more certainty is this deal junkie is going to keep on looking for more fixes.

 Published on Feb. 23, 2015

Valeant pops risky $1 bln libido pill

By Robert Cyran

Valeant Pharmaceuticals is popping a risky $1 billion libido pill. The acquisitive drug firm is buying Sprout Pharmaceuticals, the maker of Addyi, the so-called “female Viagra” that received U.S. Food and Drug Administration approval for treating low sexual desire in premenopausal women just two days ago. Valeant will have gotten a bargain if the pink pill hits its sales hopes. Snag is, the drug isn’t very effective, has bad side effects and regulatory restrictions may crimp sales.

Valeant Chief Executive Mike Pearson told CNBC that annual sales will be “in the hundreds of millions, but hopefully it’s in the billions.” There may well be a lot of demand for such a pill, but such blockbuster sales would be an accomplishment. Pfizer, for example, only sold $2 billion of Viagra at its peak.

Addyi would not need to be that successful for Valeant to pat itself on the back. A rule of thumb in biotech is that companies sell for five times revenue. Even if it takes Valeant a few years to crank $300 million in yearly revenue out of its newest acquisition, the company’s deal will look smart.

The drug has several drawbacks, though. First, its efficacy is mediocre. The drug only helped about 10 percent more patients than a placebo in clinical trials -and increased the number of times they had sex by just 0.5 to one time per month. Such figures suggest that many patients will try the pill, but not renew their prescription.

It also carries significant adverse effects. The FDA slapped a black box, its strictest warning, on Addyi because it can cause severe low blood pressure and fainting. The regulator also requires that both doctors and pharmacists be trained and certified before they administer it. That’s to ensure patients know to avoid alcohol and certain medicines like birth-control tablets that raise the risk of side effects.

Finally, during the FDA’s approval process, Sprout promised not to advertise the drug for 18 months on television or radio. All these limits may leave Valeant with a bitter pill.

Published on Aug. 20, 2015

(Image: REUTERS/Alexandra Beier)