FROM $2.5 BILLION TO $25 BILLION

Biovail sale oddly leaves its owners in control

By Robert Cyran

It’s a neat trick to sell a company at a premium and keep a controlling interest. But Biovail is pulling it off. Specialty U.S. drug group Valeant is effectively paying 15 percent over the market price for Canadian rival Biovail – yet the latter’s shareholders are ending up with 50.5 percent of the merged group. There is a rationale, but the danger is it’s too complex.

There is strategic logic. Valeant, whose chief executive Michael Pearson will head the combined company, thinks $175 million of annual cost cuts are there for the taking. If so, these savings could be worth more than $1 billion today – against the combined market capitalization of the two firms of $5.8 billion.

Yet tax problems could have killed the deal. Biovail’s operating subsidiary is based in Barbados. To preserve its low tax rate, that company needed to be the entity doing the acquiring. Meanwhile, also for tax reasons Valeant needed to end up owning less than half the combined entity. As the bigger company by market capitalization before the deal, that meant making a cash payout for its own shareholders part of the deal.

The result is a curiosity. In return for giving up their collective control, Valeant shareholders end up with cash and shares in Biovail worth $42.77 for each Valeant share – about $3 less than their value before the deal – plus a promise of another $1 in the form of a dividend before the end of the year. For Biovail shareholders, the merger values their shares at a premium.

Valeant shareholders may figure that their share of the mooted synergies should be worth slightly more than the premium they are ceding to Biovail’s owners. Furthermore, Valeant gets to appoint the tie-breaking director on the combined board – subject to Biovail approval.

Even so, Biovail’s checkered past justifies a certain skepticism. A few years back the firm accused hedge fund SAC Capital and others of conspiring against it – but ended up facing Securities and Exchange Commission charges, which it settled. That may all be in Biovail’s past now. And on one interpretation, Valeant’s clever structuring has allowed the business benefits to trump pesky tax problems. But it would be a shame if it turns out strategic discretion was neglected in that valiant effort.

Published on June 21, 2010

Hasty hostility costs Valeant its Cephalon quarry

By Robert Cyran

Hasty hostility has cost Valeant Pharmaceuticals its quarry. The drugmaker hoped to snaffle rival Cephalon in weeks with a proxy fight it launched late in March. But Valeant made it clear it wouldn’t get in a bidding war. That left plenty of room for white knight Teva Pharmaceutical to swoop in for Cephalon with a higher, $6.8 billion offer.

Hostile deals are difficult to seal. Instead of quiet backroom conversations, everything is played out in public. Valeant’s effort to dismiss the managers of Cephalon was a recipe for rancor. There was also an element of opportunism about the $73 a share offer it took directly to Cephalon’s shareholders. Valeant said if it didn’t get enough support by mid-May, it would walk away. At best, the would-be acquirer indicated it would increase its offer only slightly if Cephalon opened its books.

The result was merely to flush the quarry into the open, where it has now been bagged by Teva. The white knight is stumping up $81.50 a share, a 12 percent premium to Valeant’s price, partly based on the belief that its target’s pipeline has value – something Valeant didn’t recognize. A softer approach by Valeant might have made Cephalon less reflexively hostile.

Alternatively, a higher initial bid might have scared off rivals. But Valeant missed that trick, too. Sure, it offered a 24 percent premium to Cephalon’s market price, but health companies often attract twice as much. And figures from its past mergers suggest Valeant low-balled the annual cost savings that the combination would have created. The fact that investors marked down Valeant’s stock by 7 percent when it said it was abandoning its bid implies value may have been left on the table.

Even though it misplayed its hand along the way, Valeant is right to fold now. Engaging in a bidding war, or overpaying, would have set a bad precedent for future transactions. The company thinks buying up rivals, cutting costs and selling their undeveloped drugs is a recipe for value creation. There are still plenty of targets, such as Forest Laboratories and Endo Pharmaceuticals, which fit the bill. Next time, expect Valeant to play its cards more patiently.

Published on May 2, 2011

Sometimes extra-rich pay packages actually do work

By Robert Cyran

In just about three years, Michael Pearson has received about $200 million in stock as chief executive of Valeant Pharmaceuticals. Sound outrageous? Not to shareholders of the drugs group which last week walked away from a bid battle for rival Cephalon. Indeed, the incentives may very well explain that sensible decision.

Consider the way Valeant pays Pearson. At its most basic, Pearson is motivated in the way a private equity firm might be. To begin with, Pearson had to put some of his own money at risk. When he took the job in 2008, he was required to personally buy $3 million of the company’s stock. He bought $5 million.

Then he was rewarded a form of restricted equity that would pay him as much as $4 for every $100 of value created on his watch. But there was a hitch. The stock only vested if shareholders were treated to a 15 percent return annually. That’s like the hurdle ratios common in private equity – though they are usually much lower than 15 percent.

Moreover, if the return for shareholders hit 30 percent per annum, his rewards doubled, and they tripled if returns were more than 45 percent per annum. That meant more shares for outperformance, which mathematically keeps his share of all value created for shareholders at about 4 percent.

The incentives seem to have worked brilliantly. A dollar invested when Pearson came aboard Valeant’s predecessor company in 2008 would be worth about four times as much. Valeant stock is up more than 80 percent this year alone. As a result, Pearson is now sitting on securities worth some $200 million.

This, more than anything else, may explain why Valeant last week walked away from its attempt to acquire Cephalon for $5.7 billion. As originally, and hostilely, pitched, the deal made sense for Valeant, which would have reduced Cephalon’s heavy spending on R&D and prioritized selling the company’s existing drugs.

But when Teva Pharmaceuticals waltzed in with a 12 percent higher bid, Valeant didn’t get distracted. Rather than engage in a capital-destructive bidding war, it walked. Investors liked the discipline – the shares are almost 15 percent higher than where they were before the company made its initial bid. That’s reward enough for Pearson.

Published on May 10, 2011

(Image: REUTERS/Christinne Muschi)

Valeant shows how some M&A favors the brave

By Robert Cyran

Valeant Pharmaceuticals shows how some M&A favors the brave. Buying $8.7 billion Bausch & Lomb is the biggest deal yet for the acquisitive company, but it comes with huge cost savings that investors glorified. Chief executives elsewhere should take note.

A big part of Valeant’s success has been its ability to find drugs in the marketplace instead of the lab. It shares have gained 10-fold over the past five years compared to just 50 percent for the sector at large.

The industry spends huge sums on research and development because the prospect of developing a blockbuster is so alluring. Unfortunately, lab productivity has lagged, broady delivering a poor return on overall investment. The internal rate of return for the top 12 pharmaceutical companies last year was only 7 percent, according to a study by Deloitte and Thomson Reuters.

Instead, Valeant buys up smaller firms and deeply slashes costs. Whatever expertise it may lack with test tubes it more than makes up for with the accounting ledgers. Valeant’s tax rate is only about 5 percent. The combination has been potent, especially when new purchases are thrown into the mix.

Valeant estimates it can cut $800 million of costs by uniting with Bausch & Lomb. It’s an impressive sum – amounting to about half its target’s R&D and administrative costs – considering the eye-care company was already owned by notoriously stingy private equity. Applying a standard corporate tax rate of 30 percent would make the savings worth about $5.6 billion today, or about the same amount added to the company’s market value following the deal’s announcement. If Valeant can keep its tax rate down, the value created will be greater.

Chief Executive Michael Pearson sees room for more takeovers, particularly in ophthalmology and dermatology. He even alluded to the idea that Valeant isn’t yet as large or diversified as $250 billion Johnson & Johnson. That’s plenty of ambition for a company almost a tenth the size. So long as Pearson adheres to the same financial logic, investors will stay on side. And with M&A activity broadly stagnant, CEOs elsewhere might consider the lesson from Valeant.

Published on May 28, 2013