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Valeant Bid for Cephalon Still Lowest With 15% Boost: Real M&A

Valeant Bid for Cephalon Still Lowest With 15% Boost
Cephalon Inc.'s Provigil, used to treat excessive sleepiness caused by narcolepsy, is arranged for photograph at a pharmacy in New York. Photographer: JB Reed/Bloomberg

Valeant Pharmaceuticals International Inc.’s hostile bid for Cephalon Inc. is so low that Valeant could raise the offer by 15 percent and still pay less than any drug takeover in history.

The $73 a share proposal, which lifted Cephalon’s stock 28 percent to $75.44 yesterday, values the Frazer, Pennsylvania-based maker of sleep and cancer drugs at 5.3 times earnings before interest, taxes, depreciation and amortization, the lowest for any acquisition over $1 billion in the drug industry, according to data compiled by Bloomberg. The deal would still be the cheapest even if Valeant raised it to $84, the data show.

While Valeant’s Chief Executive Officer J. Michael Pearson said he wouldn’t get into a bidding contest for Cephalon, traders who wager on mergers and acquisitions are betting on a higher offer that Gabelli & Co. projects will reach at least $80 a share. Pearson says the Mississauga, Ontario-based company can profit from Cephalon, which faces competition from generic drugs and declining earnings, by cutting costs and selling money-losing assets. It would be the sixth deal by Pearson since September, during which time Valeant has surged 90 percent.

“There’s a general awareness this is a steal,” said Jack Ablin, chief investment officer at Chicago-based Harris Private Bank, which oversees $55 billion. “The deal is as cheap as I’ve seen and public companies rarely trade anything close to that. There could be a higher bid, but it would seem like a reasonable deal at least for Valeant and what they’re looking to do.”

Relative Value

Pearson said on a conference call with investors and analysts yesterday that Valeant was “paying very fair value.”

Natalie de Vane, a spokeswoman at Cephalon, said in a telephone interview today that the company’s board of directors will meet “early next week to further the process of maximizing value for Cephalon shareholders.”

Cephalon’s shares climbed 0.9 percent to $76.08 on the Nasdaq Stock Market today. Valeant slipped 0.5 percent to $49.81 in New York Stock Exchange trading.

Valeant offered to buy Cephalon in a March 18 letter, which it disclosed in a statement on March 29. The $73 a share bid valued the transaction at $5.46 billion including net debt, data compiled by Bloomberg show. At that price, the deal is 5.3 times Cephalon’s trailing Ebitda of $1.04 billion last year, the data show. That’s 65 percent lower than the median 15.1 times for all drug takeovers over $1 billion.

The acquisition becomes more expensive based on future earnings as patent protection losses erode Cephalon’s sales. The deal is valued at 6.9 times analysts’ estimates for Ebitda next year and 8.1 times for 2013, the data show.

‘Significantly More’

Shares of Cephalon climbed 3.3 percent above Valeant’s bid yesterday, indicating that arbitragers are betting on a higher offer. The level above the bid was the second-highest of all U.S. deals over $1 billion announced this year, the data show.

Valeant could increase its offer by $11 a share, or 15 percent, to $84 apiece and still acquire Cephalon for less than the 6.1 times Ebitda that Little Chalfont, England-based Amersham Plc agreed to pay for Nycomed ASA in July 1997 -- currently the cheapest drug takeover on record, the data show.

While shares of Cephalon had the biggest advance since 1995 yesterday, Valeant’s U.S.-traded shares also jumped 13 percent, indicating the company has room to increase its offer without the risk of overpaying, according to Harry Rady, who oversees $270 million as chief executive officer of Rady Asset Management LLC, a hedge fund based in La Jolla, California.

“Valeant could raise their price by significantly more than 10 percent and the market would still like it,” he said.

Narcolepsy Drug

Valeant made its offer public after Cephalon lost 19 percent of its value in the prior 12 months.

Cephalon fell on concern its experimental medicines wouldn’t make up for the loss of revenue after its top-selling Provigil drug loses patent protection in 2012, Timothy Chiang, an analyst at CRT Capital Group LLC in Stamford, Connecticut, said in a phone interview yesterday.

Valeant, which in January forecast higher earnings this year than analysts estimated, expects to wring at least $300 million in cost savings from Cephalon, CEO Pearson said on a conference call yesterday.

The company will probably reduce research and development spending and cut jobs, while gaining Cephalon’s “significant” cash flow from its existing drugs, CRT’s Chiang said.

About 40 percent of Cephalon’s $2.81 billion in revenue last year came from Provigil, which is used to treat narcolepsy, a chronic disorder characterized by daytime sleep attacks. Cephalon’s cash flow from operations doubled in the past three years to $782 million in 2010, data compiled by Bloomberg show.

Barbados Tax Treatment

Valeant may also boost Cephalon’s after-tax profit because its operations in Barbados give it a lower tax rate. Valeant pays about 8 percent in taxes, while Cephalon pays closer to 30 percent, CRT’s Chiang said.

“They have a bunch of synergies they can bring to bear in terms of taxes and cost-cutting that will allow them to pay the highest price for this asset,” Eric Schmidt, an analyst at Cowen & Co. in New York, said in a telephone interview.

Valeant plans to fund the deal with debt and anticipates using cash generated by Provigil and the potential sale of Cephalon assets in western Europe to pay it down, Pearson said.

To complete the takeover, Valeant will need to raise $6.7 billion in debt, Pearson said. The company had $400.4 million in cash and equivalents versus $3.6 billion in total debt at the end of 2010, data compiled by Bloomberg show.

‘The Knock’

Valeant is rated B2H, one level below investment grade, according to Bloomberg’s Company Credit Ratings, which analyze borrowers based on indebtedness, profitability and other financial ratios. Adding $6.7 billion to Valeant’s long-term debt to account for the acquisition would lower its rating by three levels to B1H, the data show.

The company will also assume responsibility for Cephalon’s $1.04 billion of total debt, data compiled by Bloomberg show.

Valeant’s $1 billion of 6.875 percent, 8-year notes tumbled 1.69 cents, or 1.7 percent, to 100.25 cents on the dollar yesterday to yield 6.83 percent, according to Bloomberg prices. The drop was the largest since the debt was issued in November.

“The knock on Valeant is: can they continue to sustainably make these kinds of acquisitions, because this is how they’re going to grow,” said CRT’s Chiang. “Rather than do it via an R&D pipeline, you’re going to continue to buy companies.”

The valuation that Valeant is offering for Cephalon makes the acquisition worth the risk, according to Kevin Kedra, an analyst at Gabelli in Rye, New York.

“There’s room for Valeant to raise their bid and still have it be very attractive to them,” he said.

Overall, there have been 6,029 deals announced globally this year, totaling $583.8 billion, a 19 percent increase from the $488.9 billion in the same period in 2010, according to data compiled by Bloomberg.

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