Why Even Valeant’s Sweetened Deal Is Bad for Allergan

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Last week, Valeant Pharmaceuticals (NYSE:VRX) raised its bid for rival drugmaker Allergan Inc. (NYSE:AGN), perhaps best known for being the maker of the injectable skin treatment Botox, in an unusual move that has disappointed most analysts on Wall Street.

Valeant raised its bid for Allergan from $58.30 per share to $72 per share, sweetening the offer by adding a portion of its own stock to the deal. The Wall Street Journal reports that according to Thursday’s closing price, the revised offer could be worth as much as $53 billion.

The news follows a previous meeting with shareholders in which Valeant CEO J. Michael Pearson said, “We’re not going to keep offering against ourselves.” Further, the move marks the second time in three days that Valeant has updated its offer for Allergan; the latter has yet to respond to either approach.

Pearson said Friday that the sweetened offer reflects the fact that Valeant is serious and means business. “We’re putting our money where our mouth is,” he said Friday in a statement, per The New York Times. “There’s no greater validation for this transaction than our willingness to give up $600 million to other shareholders for us to take 100 percent Valeant stock.”

The deal has been unique from the beginning, marking the first time an activist investor has partnered with a strategic buyer, according to The New York Times. Bill Ackman has provided extra star power to the ongoing drama between the two companies, which have been engaging in a veritable war of words since Valeant’s first offer.

But if a Valeant takeover succeeds, will it deliver any real benefit to Allergan? Valeant’s desperation seems to suggest otherwise.

Cat and mouse: Valeant’s pursuit of Allergan

Valeant has good reason for wanting to make an Allergan takeover happen. Should the deal go through, Valeant would effectively double in size, making it one of the largest specialty pharmaceutical companies in the world. The deal would also significantly beef up the company’s existing eye and skin care businesses, which Valeant has already invested in with a takeover of Bausch & Lomb in August.

Negotiations between Valeant and Allergan have been rife with criticism on both sides. On the one hand, Valeant claims that Allergan spends too freely on research and development interests and has promised that it would cut Allergan’s combined R&D spending by 69 percent should the company accept its takeover offer. On the other hand, Allergan’s pride and joy lies in its R&D team, and the company has a lot of faith in its current strategy.

In some ways, Allergan seems tailor-made for Valeant, with the company possessing strong core businesses in eye and skin care, two areas Valeant is currently focusing on. But it’s important to remember that Valeant’s business model is very different from Allergan’s, and therein lies the rub.

Valeant is thrifty when it comes to research and development, and it is able to pinch pennies on R&D pursuits in part because it prioritizes acquisitions over R&D, preferring to put that money toward buying other companies’ existing treatments, which Valeant then sells internationally, reports The New York Times.

Valeant CEO Pearson claims that his company’s business model is the only way Allergan could hope to be successful in the long term, saying, per The New York Times, “Industry R&D productivity has been very very low, so how all companies grow in this industry is through making really good acquisitions and growing those acquisitions after they make them.” Allergan doesn’t see it that way.

Allergan pushes back

Allergan has raised numerous concerns regarding Valeant’s business model, even filing an investor presentation with the Securities and Exchange Commission in which the company criticizes its suitor, emphasizing that Valeant’s debt-fueled acquisitions are unsustainable.

For the most part, analysts seem to agree with Allergan, believing Valeant’s approach to be unimpressive and at times counterproductive because of changing tactics and updated offers left and right. A number of analysts expressed disappointment following the release of Valeant’s revised offer on Friday, and Allergan, for its part, is still standing by its R&D efforts.

“We know that our success stems from innovation,” Allergan CEO David Pyott said in a conference call with investors to discuss Valeant’s proposal. “Our unparalleled R&D efforts and sophisticated sales and marketing infrastructure have been key to our continued growth.”

Regarding Valeant’s bid, most analysts agree that the revised offer is lackluster and desperate, echoing previous sentiments like the one made by David Amsellem, an analyst who covers both Valeant and Allergan for Piper Jaffrey. “I think Valeant really, really needs Allergan,” he said.

“We had hoped for something more imaginative, like substantially altering the share of cash and stock Valeant will use, or a more substantial increase in the value offer,” said Ronny Gal at Bernstein Research, in reference to Valeant’s revised offer, per Barron’s.

Overall, a common thread emerged from analysts regarding the deal, with most concluding that Allergan still has options and that Valeant’s offer still has yet to beat the company’s standalone play. “It is unclear whether this proposed transaction can match Allergan’s standalone options,” said David Buck of the Buckingham Research Group.

Conclusion

One thing seems certain: investors aren’t responding well to Valeant’s desperation, and analysts don’t seem at all impressed by the revised offer. As it stands, Valeant doesn’t seem to have much to offer Allergan and more importantly, its target’s business model doesn’t seem compatible with its own, acquisition-focused play. Barron’s notes that investors seem to have already picked up on analysts’ negative view of the deal: shares of both Allergan and Valeant on Monday fell 4.2 percent and 3.3 percent, respectively.

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