Valeant Pharmaceuticals has plenty of room to raise its bid for Allergan. The acquisition machine, working with hedge fund manager William A. Ackman, thinks it can cut at least $2.7 billion of costs from the Botox maker. At Valeant’s single-digit tax rate, that’s worth nearly $25 billion. And the potential benefits go on from there. The $45.6 billion deal would still add up with a much bigger premium.
Valeant’s strategy of buying smaller pharmaceutical companies and cast-off assets has paid off for investors, with its stock up about 10-fold since the M.&A. binge began in 2008. The thinking is that many drug makers spend too much on overhead and research and development. Valeant slashes costs after buying assets and, with its low tax rate, can achieve higher net margins than most of its peers.
The tax rate or research and development expenses could eventually rise, of course, and the company isn’t immune to the occasional clunker of a deal. So far, however, it’s making a hefty profit, with analysts expecting net income to equal about one-third of revenue over the next year. That’s a margin almost 10 percentage points bigger than the number-crunchers are projecting for Allergan.
The cost cuts proposed for Allergan after the acquisition are enormous, about three-quarters of what the company projected to spend this year on R.&D. and sales and administrative costs. They are not, however, out of line with past Valeant deals. The $2.7 billion in estimated annual savings, combined with a single-digit tax rate, are worth perhaps $25 billion today.
Valeant, not surprisingly, says the estimated savings are on the low side and it doesn’t account for the benefits of applying its favorable tax rate to Allergan earnings or the additional sales the combined companies will produce.
Allergan’s market capitalization was about $38 billion on Feb. 24, the day before Ackman began buying stock, arguably a reasonable undisturbed price to choose. That means the buyers are offering a 23 percent premium, or about $10 billion, to Allergan owners.
That’s giving away less than half the present value of the potential savings from the deal. Indeed, Allergan’s shares are trading well above the value of the bid. Mr. Ackman’s Pershing Square Capital Management, with some funds from Valeant, has amassed a 9.7 percent effective stake in Allergan, which may discourage rival bids. Even so, no one should be surprised if Allergan holds out for a bigger price.
Robert Cyran is a columnist for Reuters Breakingviews. For more independent commentary and analysis, visit breakingviews.com.
