Teva And Cephalon Solve Each Other's Problems

By Stephen D. Simpson, CFA | May 04, 2011 AAA

Whenever companies announce a deal, managements try to paint it as a great move for each shareholder group. Experience says that is rarely the case, but Teva Pharmaceuticals' (Nasdaq:TEVA) acquisition of Cephalon (Nasdaq:CEPH) really could be a case where that is true. This deal solves significant, but different, problems for each company.

Tutorial: Mergers And Acquisitions 101

The Terms Of The Deal
Unlike Valeant's (NYSE:VRX) attempt at a hostile bid (or its thus far unsuccessful attempt to find a friendly agreement with Cephalon's board), Teva pursued a friendly offer and both boards agreed to it unanimously. Teva will acquire Cephalon in an all-cash deal that pays Cephalon shareholders $81.50 - 12% more than what Valeant had offered. The deal amounts to about $6.8 billion for Teva, which will have to raise debt for the bid.

Not Great, But Better
Cephalon shareholders may still grumble at the terms of the deal. After all, less than six times trailing EBITDA and about two times trailing revenue is not an exciting premium. What's more, in recent memory Pfizer (NYSE:PFE) paid for more for King and Abbott (NYSE:ABT) paid for Kos.

Still, Cephalon shareholders should realize that this was about as good a deal as they could have hoped for in a buyout. The company has some promise with Nuvigil, Fentora, and Treanda, but there just is not enough in the pipeline to really make for a lot of excitement or a rich valuation. Frustrating as it may be, this deal basically maximizes the value Cephalon had as a going concern with none of the ongoing execution risk. (For more, see Mergers And Acquisitions: Understanding Takeovers.)

A Smart Move for Teva
With recent news from Biogen Idec (Nasdaq:BIIB) casting doubt on Teva's long-term prospects in the multiple sclerosis franchise, and a dearth of major patent expirations after 2013, Teva needed to do something to change up its business. The acquisition of Cephalon will give Teva more than 20 branded drugs, less risk on the MS front (since that will be a smaller part of the business) and an interesting generics business within Cephalon (Mepha, acquired by Cephalon about a year ago). What's more, it should be accretive more or less immediately.

A New Teva?
It will be interesting to see where Teva goes in the next few years. Major pharmaceutical companies like Novartis (NYSE:NVS) and Sanofi-Aventis (NYSE:SNY) have expanded into generics as a way of adding a little more predictability to the business models and better leveraging the sales infrastructure.

Will Teva now try to bulk up its branded business even further, to take advantage of the growth and margins present there, and/or find a value-accreting use of cash? It is a risky move, but the fact remains that reimbursement for branded drugs is still very strong, and there are rich rewards to developing successful compounds.

The real question may be how much more Teva will pay for its expansion plans. Teva trades at a premium to many pharmaceutical companies, and that could make its shares useful as a currency. That said, recent deals have been cash-and-carry, so Teva may find its options more limited on that basis. (For more, see Pharmaceutical Phenoms: America's Best Selling Medicines.)

The Bottom Line
Teva is a borderline buy candidate. There is definitely value here, and this Cephalon deal improves the company's prospects. There are other, cheaper, ideas out there for investors to consider, but Teva is definitely worthy of consideration. (For more, see Teva's Rocky Road.)

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