Valeant Works Its Mojo With Medicis

By Stephen D. Simpson, CFA | September 07, 2012 AAA

It seems pretty obvious that once a company figures out a winning formula, it ought to stick with it. Acquisitions have definitely done a lot to build and boost specialty pharmaceutical company Valeant (NYSE:VRX). Now the company is going to the well again to acquire Medicis (NYSE:MRX). While there's always a risk that Valeant will eventually bite off more than it can chew, this deal looks like a winner from the get-go.
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The Deal
Valeant and Medicis announced an agreement by which Valeant will acquire Medicis in a $2.6 billion cash deal. That works out to $44 per share for Medicis. At that price, Medicis shareholders are getting a 39% premium to the close on August 31, a nearly three-and-a-half times premium to trailing sales, and a greater than 13.5 times premium to trailing EBITDA.

SEE: Analyzing An Acquisition Announcement

What Valeant Is Getting
Valeant reportedly tried to buy Medicis a year or so ago, so this isn't a newfound interest. What's more, it's an acquisition that makes ample sense for the company.

I believe that Medicis currently has the largest dermatology franchise out there, and the acquisition will vault Valeant (currently the No.3 player) into the clear No.1 position well ahead of Galderma, and leaving Novartis (NYSE:NVS) and GlaxoSmithKline (NYSE:GSK) well behind to boot. Although Medicis has had challenges with its significant Solodyn franchise (which goes generic in 2018), the deal isn't about just adding Medicis products. Medicis has a strong sales organization and Valeant will clearly want to leverage those strong existing relationships with dermatologists.

Valeant is also buying a business that fits easily within its existing corporate structure. Consequently, management sees the opportunity to produce over $200 million in synergies relatively quickly. Along those same lines, I could see this deal boosting Medicis' operating income by 50% or more in 2014. As a result, I don't think the $85 million break-up fee matters all that much - simply put, I'm not sure there's another company that can (or would) out-bid Valeant for this property.

A Step too far?
Valeant is going to need to borrow money for this deal. Right now, that doesn't seem like a big deal - the company has the financing lined up, rates are low right now and the high degree of synergy with Medicis points to a good internal rate of return and payback timeline. Still, though, build-by-acquisition stories often end in tears as the buyer eventually chokes on the debt and/or eventually buys the wrong company.

SEE: 5 Must-Have Metrics For Value Investors

I don't think this is that sort of deal.

I do believe Allergan (NYSE:AGN) is a fierce competitor to Medicis and I do think that competing with the likes of Allergan and Johnson & Johnson (NYSE:JNJ) in the high-touch world of aesthetics could be a challenge for Valeant management. But this assumes that Valeant is adamant about holding onto that aesthetics business; management may well be willing to think about selling the business now or in the future if it seems to fall outside their skillset. All of that said, Valeant is going to exit this deal with a huge slug of debt on its balance sheet and investors can't afford to ignore that.

The Bottom Line
This is a relatively uncommon win-win deal for both sides. I think Medicis shareholders are not only getting pretty much full value for their shares, but without any of the risk tied to ongoing management execution. Valeant is certainly paying up for this asset, but it's an asset with uncommon synergy potential and one that Valeant should be able to lever into abnormal revenue, profit, and cash flow growth.

While I do like the potential at Valeant, the stock has moved significantly in the post-announcement afterglow. I'd be inclined to hang on if I already owned shares, but Valeant doesn't look like a tremendous bargain itself even with this accretive Medicis deal factored into valuation.

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

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