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.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

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.

SEE: Analyzing An Acquisition Announcement

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.

SEE: 5 Must-Have Metrics For Value Investors

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.

Related Articles
  1. Investing Basics

    Start Investing With Only $1,000

    Find out what fees and restrictions need to be considered before investing $1,000.
  2. Investing Basics

    Long-Term Investing: Hot Or Not?

    Forget the latest craze - you're more likely to succeed with a buy-and-hold strategy.
  3. Options & Futures

    Socially Responsible Investing Vs. Sin Stocks

    Can your principles make you richer or poorer? Find out if it pays pick your portfolio based on ethics.
  4. Fundamental Analysis

    5 Must-Have Metrics For Value Investors

    Focusing on certain fundamental metrics is the best way for value investors to cash in gains. Here are the most important metrics to know.
  5. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  6. Investing

    What Investors Need to Know About Returns in 2016

    Last year wasn’t a great one for investors seeking solid returns, so here are three things we believe all investors need to know about returns in 2016.
  7. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  8. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  9. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  10. Stock Analysis

    The Top 5 Micro Cap Alternative Energy Stocks for 2016 (AMSC, SLTD)

    Follow a cautious approach when purchasing micro-cap stocks in the alternative energy sector. Learn about five alternative energy micro-caps worth considering.
RELATED FAQS
  1. What is Fibonacci retracement, and where do the ratios that are used come from?

    Fibonacci retracement is a very popular tool among technical traders and is based on the key numbers identified by mathematician ... Read Full Answer >>
  2. What is the formula for calculating EBITDA?

    When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements ... Read Full Answer >>
  3. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
  4. How do you calculate return on equity (ROE)?

    Return on equity (ROE) is a ratio that provides investors insight into how efficiently a company (or more specifically, its ... Read Full Answer >>
  5. How do you calculate working capital?

    Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining ... Read Full Answer >>
  6. What is the formula for calculating the current ratio?

    The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center