The world of generics and specialty pharmaceuticals includes many companies that fly below the radar of most investors, but Akorn (Nasdaq:AKRX) may be worth the time it takes to know it better. Not only is Akorn a leading player in generic ophthalmology drugs, but the company's acquisition of Hi-Tech Pharmacal (Nasdaq:HITK) looks like an all-too-rare case where both parties in the deal come out ahead.
Investors who took my advice regarding Hi-Tech a year ago are sitting on gains of nearly 50% (though the intervening 14 months was not smooth), but I'm not sure I'd rush to reinvest the proceeds into Akorn. Although I do like Akron and I believe this deal strengthens the company, the valuation there doesn't leave a lot of upside unless Akorn can drive even better synergies than its guidance suggests.
The Deal
Akorn is acquiring Hi-Tech for $43.50 per share, or $540 million in net cash. That represents a 24% premium to the prior day's close and a slight premium to the company's all-time high in December of 2011. At about 11 times trailing EBITDA, the price Akorn is paying seems fair. Likewise, a discounted cash flow analysis of Hi-Tech suggests that while Akorn is likely to generate a good internal rate of return from this deal, it's paying a premium to what the market should normally pay (as they can realize synergies and cost savings).
What Akorn Is Getting
M&A is commonplace in the generic drug space, as companies like Teva (Nasdaq:TEVA), Mylan (NYSE:MYL), and Actavis (NYSE:ACT) have all used acquisitions to add products and product/manufacturing capabilities, as well as marketing exposure and operational scale. In that respect, then, Akorn's deal for Hi-Tech is broadly consistent with what goes on in this industry.
Hi-Tech will add over $200 million in revenue to Akorn from day one (increasing the revenue base by two-thirds), and although Hi-Tech has posted lower gross and operating margins, Akorn believes they will wring meaningful synergies from the deal. On a 2013 full-year run rate, Akorn management believes the deal will be 40% accretive as the company can unwind overlapping SG&A costs and eventually pursue better manufacturing and logistical efficiencies.
Scale, And More
Were this deal just about operating leverage, it would be likely be worthwhile on its own merits. What makes the deal more interesting, though, is what Hi-Tech can add above and beyond its scale.
Hi-Tech has a meaningful OTC health care business focused around cold and cough medicines and treatments. While competing in OTC cold and cough means competing with companies like Johnson & Johnson (NYSE:JNJ) and Procter & Gamble (NYSE:PG), it's a large market with good margins.
Hi-Tech also has a strong history in liquid and semi-solid generic formulations, as well as difficult-to-manufacture generics with higher barriers to entry. While investors often seem to think that “all generics are the same”, that is very much not the case and there can be substantial differences in margins when selling difficult-to-manufacture drugs. Adding those capabilities should enhance Akorn's own possibilities and addressable markets. It's also worth noting that while Akorn has more than three times the number of pending Abbreviated New Drug Applications (ANDA) with the FDA (57 versus 18), the difference in branded sales is closer to 2x ($5.6 billion for Akron versus $2.6 billion for Hi-Tech), highlighting Hi-Tech's focus on high-barrier/high-opportunity generics.
The Bottom Line
Incorporating Hi-Tech into my Akorn model suggests an increase in fair value of about $1.50 to $3.50 depending on certain assumptions about long-run synergy and revenue growth. Normally that would be great, but with Akorn's stock already up nearly $2 on the news, it's not like the Street didn't notice those benefits. Even so, this deal does make Akron a stronger company and the shares may still be undervalued by 5% to 10%. That's not quite enough to coax me to buy today, but with Akorn now a stronger, more capable generics and OTC company, it's a name that is worthy of due diligence in the hopes of getting the shares cheaper somewhere down the line.
Disclosure – As of this writing, the author has no financial positions in any companies mentioned.

Related Articles
  1. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  2. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  3. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  4. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  7. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  8. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  9. Stock Analysis

    5 Reasons Thoratec Corp. Keeps Impressing Investors

    Learn about Thoratec Corporation and its position in its industry. Understand five key factors why the company has impressed investors.
  10. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Weighted Average Cost Of Capital ...

    A calculation of a firm's cost of capital in which each category ...
  3. Runoff Insurance

    An insurance policy provision that provides liability coverage ...
  4. Hunting Elephants

    The practice of targeting large companies or customers.
  5. Precedent Transaction Analysis

    A valuation method in which the prices paid for similar companies ...
  6. Poison Put

    A takeover defense strategy in which the target company issues ...
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. How long does it take to execute an M&A deal?

    Even the simplest merger and acquisition (M&A) deals are challenging. It takes a lot for two previously independent enterprises ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!