Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

Abbott Laboratories may be worried it has another Valeant on its hands. And investors should be on the lookout for future look-a-likes.

The $58 billion medical-device company has raised "serious concerns" about the accuracy of financial information provided by Alere as part of their $8.4 billion merger agreement. That deal was announced just three months ago, but it's been a busy three months. Alere has since been subpoenaed by the Justice Department in connection with its sales practices in some foreign areas and has repeatedly pushed back the filing of its annual report. This came on top of an SEC investigation disclosed in November, before terms with Abbott were finalized.

A Rough Couple of Months
Alere has been hit by one piece of bad news after another
Source: Bloomberg

Even in a vacuum, that's enough to raise doubts. While the inquiries may not result in much more than fines, they could take years to complete and create years of uncertainty for Abbott. That kind of headache is even less appealing now that Abbott is also buying St. Jude Medical for more than $30 billion. It's a mega-deal that will require significant integration work and Abbott won't want to be distracted by Alere's accounting issues.

But this isn't a vacuum and Valeant's mountain of troubles is towering high in the background. Valeant and Alere are different, and their problems aren't necessarily of the same magnitude -- but there are some similarities. Valeant also had accounting issues (its problems were tied to a shady relationship with specialty pharmacy Philidor) and it, too, had to push back the filing of its annual report as its stock price plunged (it finally filed its 10-K on Friday but faces another default deadline with its first-quarter 10-Q). The experience has left many in the pharmaceutical business feeling a little wary. In that light, "serious concerns" may be a serious understatement.

So Abbott wanted out. And it was willing to pay Alere as much as $50 million to just forget the whole thing. That's not much of a consolation prize for Alere, though, which would lose the roughly $1.5 billion premium Abbott had offered. So it refused.

The company says it got an extension from its lenders on filing its annual report and plans to get the paperwork in "as soon as practicable'' -- whatever that means. Alere says Abbott has affirmed its commitment to abide by their agreement. Abbott says it's still waiting for the company to give it requested information about what's going on with this delay and the criminal grand jury subpoena. In announcing the purchase of St. Jude, CEO Miles White said his company had the financing capacity to complete both acquisitions, but in the past he has declined to answer questions about his commitment to the Alere deal.

For their part, investors are considering the deal dead. Alere's stock slumped as much as 11.2 percent on Friday, to about $39 a share, about where it was trading before the Abbott deal was announced. Bondholders don't seem confident, either. A group of bond investors filed a notice of default after apparently running out of patience on the continued delays in the filing of the annual report, according to people familiar with the matter.  

Whatever the ultimate fate of this purchase, Valeant and Alere won't be the last companies to surprise markets with potentially shoddy accounting. As the credit cycle turns, that's when analysts expect to see more instances of flawed accounting, possibly at companies once heralded for holding great promise.

Here's why: When investors are in a good mood, they're happy to extend credit to almost anyone. Companies can easily get away with fewer financial disclosures and employ less-rigorous accounting standards. This risk of eventual accounting questions is especially high for lower-rated companies, particularly those that rely heavily on debt. Banks "are able to off-load credit risk through credit-default swaps, loan sales, and loan securitizations, and thus to extend more credit to risky borrowers," according to a 2015 paper by University of Lethbridge's Yutao Li and Gerald Lobo of University of Houston's Bauer College of Business.

But all that changes when investors suddenly wake up to real, fundamental credit risk, and that's what's happening now.

There's a lot of money at stake. Investors raced into the U.S. junk-bond market in the years after the 2008 financial crisis as the Federal Reserve suppressed borrowing costs, causing such debt outstanding to almost double in less than a decade. Dollar-denominated high-yield debt has ballooned to $1.4 trillion, and it may be at greatest risk of a fast swoon as accounting standards turn more conservative.

Surging Junk Pile
The U.S. high-yield bond market has almost doubled since the end of 2008
Source: BofA Merrill Lynch index data

Valeant's bonds have lost more than $1.8 billion in market value since September. Stocks of SunEdison, the biggest U.S. solar energy company, fell more than 90 percent as it swiftly fell from golden star of hedge-fund portfolios to bankruptcy. Prices on Alere's bonds surged when the deal with Abbott was announced, but they have since given up most of those gains. 

Fading Hopes
Alere's bond prices surged after its acquisition by Abbott was announced, but they've since fallen
Source: Finra's Trace, Bloomberg

If Abbott does end up abandoning Alere, bond and stock investors will left holding the bag. And this won't be the last time they'll be put in that position.  

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net