Actavis Gaining More From Purchase Than Sale: Real M&A

Actavis Inc. stands to return 17 percent more to shareholders by acquiring birth-control drugmaker Warner Chilcott Plc than selling itself.

Shares of Actavis surged 12 percent last week to $119.86 after Bloomberg News reported that it’s in early-stage negotiations to acquire Warner Chilcott, which the companies later confirmed. The talks came after Actavis’s discussions to sell itself to Valeant Pharmaceuticals International Inc. stalled over price, people familiar with the matter said. Other people said that Actavis also rejected a $120-a-share takeover offer from Mylan Inc. Sanford C. Bernstein & Co. estimates that Actavis may climb as high as $140 by buying Warner Chilcott.

Acquiring Warner Chilcott would reduce costs by as much as $240 million and expand Actavis’s women’s health franchise, Royal Bank of Canada said. It also may provide Actavis, which is seeking to drive down its tax rate, with a $4-a-share tax benefit because Warner Chilcott is incorporated in Ireland, Leerink Swann LLC said. Adding to the $4.7 billion company’s appeal, Warner Chilcott has the second-lowest valuation relative to profit and free cash flow among its peers, according to data compiled by Bloomberg.

“The deal is good, the numbers work,” Ronny Gal, a New York-based analyst with Bernstein, said in a telephone interview. An acquirer of Actavis “would have to pay more than the price the market assigns the combination with Warner Chilcott.”

Merger Talks

Discussions between Valeant and Actavis regarding a merger had been going on for some time, Bloomberg News reported April 26, citing a person familiar with the matter who asked not to be identified because the negotiations were private. The talks reached an impasse because of a disagreement over price, people familiar with the matter said April 28.

Actavis, which makes generic drugs, also had rejected a cash-and-stock offer from rival Mylan this month valued at $120 a share, according to people familiar with the matter. In addition, Israeli generic drugmaker Teva Pharmaceutical Industries Ltd. has looked at Actavis, said one of the people. Teva is more keen on smaller acquisitions and isn’t likely to bid, one of the people said.

Bloomberg News reported May 10 that Actavis is in early-stage talks to acquire Warner Chilcott, prompting both companies to release statements confirming the discussions.

Actavis, which has a market value of $16 billion, is discussing a bid of more than $5 billion for Warner Chilcott, said another person. A deal could be completed in the next couple of weeks, that person said.

Upside Potential

Charlie Mayr, a spokesman at Parsippany, New Jersey-based Actavis, declined to comment beyond the company’s May 10 statement. Rochelle Fuhrmann, senior vice president of finance at Dublin-based Warner Chilcott, didn’t respond to a phone call or e-mail. Representatives at Montreal-based Valeant, Mylan in Canonsburg, Pennsylvania, and Teva declined to comment.

If Actavis buys Warner Chilcott, its shares may climb to $130 to $140 apiece, Bernstein’s Gal said. That’s at least a 29 percent increase to its stock price before any talks were reported last month and as much as 15 percent more than yesterday’s closing price of $121.68.

Alternatively, a $120-a-share bid for Actavis would value the drugmaker at 20 times its earnings before interest, taxes, depreciation and amortization. While that would rank as the second-highest valuation for a generic-drugmaker deal larger than $500 million, according to data compiled by Bloomberg, it’s still less than the possible gain for Actavis shares after a Warner Chilcott purchase.

Bolstering Brands

Today, Actavis shares climbed 1.8 percent to a new closing high of $123.88. Warner Chilcott climbed 1.9 percent to $19.28, the highest closing level in almost a year.

Actavis needs to do a deal so that its “long under-performing” branded medicines business can become a driver of growth, according to Elliot Wilbur, a New York-based analyst at Needham Group Inc.

Buying Warner Chilcott “would be a strong move toward fulfilling that objective,” Wilbur wrote in a May 13 report. The companies have complementary women’s health and urology products, and Warner Chilcott would give Actavis a presence in gastroenterology, he wrote, with a colitis drug that generated $793 million of sales in 2012, data compiled by Bloomberg show.

Cost Savings

The combined entity may also be able to cut $120 million to $240 million of operating expenses and reduce its tax rate from 28 percent to 23 percent, Shibani Malhotra, a New York-based analyst at RBC, wrote in a May 13 note to clients. Jason Gerberry, a Boston-based analyst at Leerink Swann, said he estimates about $200 million in cost savings and a combined share price of as much as $125 apiece, which includes a $4 boost from the lower levies in Ireland.

“If you think about it from Actavis’s perspective, buying Warner Chilcott gives it the ability to potentially improve its tax structure and expand its brand portfolio,” Gerberry said in a phone interview. “There are some cost synergies also that could be extracted because they have overlapping women’s health and urology businesses.”

Opting to buy Warner Chilcott now would allow Actavis to get the company while it’s cheap. Even after Warner Chilcott’s stock surged 26 percent in the last three trading days, it has a price-earnings ratio of 10, compared with the specialty pharmaceuticals industry’s median multiple of 28, according to data compiled by Bloomberg.

‘Big Potato’

Bernstein’s Gal cautions that it would still be a large deal for Actavis and the company shouldn’t be motivated by Warner Chilcott’s cheap valuation alone. When adding up the estimated value of each of its pieces, Irina Rivkind, a New York-based analyst at Cantor Fitzgerald LP, arrives at $23 a share. That implies a $9.2 billion transaction, including Warner Chilcott’s net debt, data compiled by Bloomberg show.

“This is a pretty big potato,” Gal said. But “the strength of the earnings and the cash flow of the combined company are so high that it more than offsets the concerns we have.”

Warner Chilcott, which tried to find a buyer last year, would probably command a better price now because of drug approvals the company has since received from the U.S. Food and Drug Administration, according to Cantor Fitzgerald’s Rivkind.

“We think that the company walked away from an offer last year since management thought it could do better later,” she said in an e-mail. “With these approvals under their belt, Warner Chilcott may now be able to command higher takeout valuations.”