A Good Deal For Actavis, But Warner Chilcott Goes A Little Cheap

By Stephen D. Simpson, CFA | May 21, 2013 AAA

Confirming a pretty active recent rumor mill in the generic and specialty drug space, Actavis (NYSE:ACT) announced on Monday that it had reached an agreement to acquire Warner Chilcott (Nasdaq:WCRX) in an all-stock deal. This deal should bring real long-term value for Actavis, while giving the owners of long-struggling Warner Chilcott an honorable exit.

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The Deal To Be
Assuming that the deal gets the request approvals and a rival suitor doesn't break things up, Actavis will acquire Warner Chilcott in an $8.5 billion all-stock deal that values Warner Chilcott at $20.08 a share – a roughly 5% premium to Friday's close, but closer to a 50% premium relative to where the shares were trading before spiking on M&A rumors.

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This deal is a little more complicated than most, as a meaningful part of the deal value revolves around leveraging Warner Chilcott's Ireland domicile for better tax efficiency. In short, Actavis will acquire Warner Chilcott and reincorporate in Ireland, not unlike what happened when industrial conglomerate Eaton (NYSE:ETN) acquired Cooper and used the opportunity to reincorporate in Ireland (where corporate taxes are much lower). Given that Actavis had an effective tax rate that was pretty high within its peer group, this is not a trivial detail.

There is no debt involved in this deal, and it will not be a taxable event for Warner Chilcott shareholders. Because of the reincorporation angle, though, it will be taxable for Actavis shareholders. That is unfortunate, but at least partially outweighed by advantages like roughly 30% expected deal-related accretion in 2014.

Warner Brings A Lot To The Table
This is a solid strategic deal for Actavis. WCRX brings complimentary assets in urology and women's health, where the company has a history of innovation – including the first 24-day birth control pill and the first chewable birth control pill. The deal also brings new treatment areas like dermatology and gastroenterology into Actavis.

Warner's branded business is definitely a big part of this deal. Actavis has talked of wanting to build a $1 billion branded drug business by 2017. With this deal, Actavis will see its branded business jump from about 7% of revenue to 25% of revenue. With a larger branded business, and the complimentary generics businesses, Actavis can better leverage existing marketing and distribution infrastructure, and may also have opportunities to drive better long-term manufacturing efficiency.

Warner Chilcott is not a perfect asset, though. After all, there is a reason that Actavis is paying less than 9x trailing EV/EBITDA. Warner's performance has been up-and-down for years, as the company has struggled with rival generics (or fears of rival launches) and pipeline setbacks. To that end, there are some risks that generic Ascaol could hit the market in the next year or two, and pipeline compounds could fail to deliver.

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Will The Deal Happen?
As both the acquirer (Actavis) and the target (Warner Chilcott) have been involved in M&A rumors before, it's an open question as to whether peers and rivals will let this deal go through. Both Valeant (NYSE:VRX) and Mylan (NYSE:MYL) were interested in Actavis, and this deal can be seen as a means of guaranteeing Actavis's independence. On the target side, Warner Chilcott has been tied to many prospective buyers over the past 24 months, with Bayer AG probably the most commonly-discussed prospective bidder.

The implied valuation of this deal wouldn't appear to close off rival bids. It's not uncommon for deal multiples in generics and specialty pharma to go into the low teens, and an aggressive (or desperate) bidder could at least try to float a higher offer.

The Bottom Line
This deal makes sense for both parties. Actavis probably needs to get bigger to stay independent, and expanding the revenue base should lead to better margin leverage opportunities. Likewise, building up the branded business should add value over the coming years. For Warner Chilcott, shareholders may be disappointed in the valuation offered here, but at least it offers a deal value (and a tax-free deal no less) that is not insulting or embarrassing. Given the interest of other parties, though, it would seem that the M&A cycle in generics and specialty pharma could still have some room to go.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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