Two decades of mergers and acquisitions turned Teva Pharmaceutical Industries into the world’s largest generic drug maker. But the company’s crown might now be in jeopardy for the first time, at least in terms of market share, and it’s uncertain whether the current management is as concerned with retaining first place as much as its previous management had been.
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In the past two months Actavis − formerly Watson Pharmaceutical, the world’s third largest generic drug company now trading at a $16.4 billion stock market valuation − has emerged as a takeover target for two North American drug makers: Canada-based Valeant Pharmaceuticals International, which enjoys a market capitalization of $22.8 billion; and Mylan, headquartered in Pennsylvania, the world’s fourth-largest generics company that trades at a $12.1 billion value.
Valeant expanded by running amok with mergers and acquisitions and leveraging itself to the hilt in the process. It offered to buy out Actavis at a company value of $13 billion through a share swap, but the talks broke down last month following a dispute over the purchase price. Mylan, which learned about Actavis might be up for sale from media reports on the negotiations with Valeant, offered $15 billion for the company on May 7. Actavis rejected Mylan’s offer outright three days later.
The acquisition of Actavis by Mylan would have made the combined company the world’s largest generic drug manufacturer with a 20% market share in the United States and consolidated generic turnover of $13 billion, eclipsing Teva’s forecasted revenues for this year of between $10.3 billion to $10.7 billion. It would relegate the Israeli company’s market share to second place. Mylan estimated that the merger would produce $1 billion in annual savings.
But this past Monday those plans, for now at least, appeared to be dead in the water. Actavis the hunted was hunting itself, it seems, and said it had reached an agreement to take over Warner Chilcott, a specialty pharmaceuticals company, for $5 billion in stock.
Protection from hostile takeover
If the takeover goes through, the combined companies will be trading at about $21 billion market capitalization, based on their current share prices. A price tag like that should protect Actavis from a hostile takeover, at least temporarily, particularly by Mylan with its $7.7 billion debt burden. Valeant too, shouldering a $10 billion debt load, could find the purchase of a company with equivalent value to its own financially too onerous.
Moreover, becoming a takeover target has lifted the price of Actavis shares 35% since the beginning of April, boosting its market cap by $4.2 billion. In other words, the merger talks themselves have earned Actavis most of the cost for purchasing Warner Chilcott while distancing its two more aggressive suitors.
Ronny Gal, a senior research analyst covering the specialty pharmaceutical industry at Sanford C. Bernstein, told The Financial Times this week, that a rival bid from Mylan for Warner Chilcott was possible, but the current deal was likely to close. “As [Actavis] transitions from a small ‘smart generic’ to a mid-cap diversified pharma company, investors will need to be convinced the company is still worth betting on,” he told the newspaper.
If Actavis stays in play, other candidates for acquiring it are Pfizer and Sanofi. Novartis, which owns Sandoz, the world’s second-largest generics company, has already said it isn’t interested in acquiring Actavis. Although Associated Press cited unnamed people as saying Teva has also been looking at Actavis, the Israeli company is hamstrung by its $12.7 billion debt. Teva has also said that it would only pursue expansion through the purchase of niche companies as opposed to the blockbuster deal strategy that been pursued before Jeremy Levin’s was appointed CEO a year ago.
Actavis is headed by Paul Bisaro, former chief operating officer at Barr Pharmaceuticals, which was later bought by Teva.
Besides keeping suitors at bay, the takeover of Warner Chilcott by should also prove advantageous in other ways. The plans are for the combined company to be registered in Ireland, the home base of Warner Chilcott, which will entitle it to a lower tax liability than it has in the United States.
The move will also help further entrench Actavis’ position in the market for women’s health drugs where it competes head-to-head with Teva. Sales by Warner Chilcott in this segment amounted to $1.4 billion over the past 12 months, compared with forecast revenues of $460 million to $500 million for Teva this year.
But sales by the Irish company include $553 million from contraceptives and an equivalent amount from treatments for osteoporosis, the latter sales having shrunk 20% in the last quarter and 27% in 2012. And with a deficit showing on its balance sheet, it’s clear why Warner Chilcott has been on the shelf for the past few years.
The generic drug industry telenovela reflects, on the one hand, the influence of cheap money and a worryingly dimmer outlook for the U.S. generics market due to the dwindling reserve of proprietary drug patents due to go off patent. Last year, some 40 brand-name drugs valued at $35 billion in annual sales lost their patent protection, according to an analysis by Credit Agricole Securities. This year, the value of drugs scheduled to lose their patents is expected to decline by more than half, to about $17 billion.
For generic drug makers, that means there will be fewer drugs that can mimic when their patents expire and fewer opportunities to reap huge profits that the first-to-the market generic maker enjoys during a period of legally permitted exclusivity. Companies are hunting M&A deals as a way to cut costs amid growing price pressure in developed markets such as North America and Western Europe. Bigger companies are better-positioned to move into emerging markets like Russia and China.
On the other hand, the industry is in the midst of increasingly intense merger and acquisition activity while the market valuations of the players are rising.
Teva itself put out two new bond series in December 2012, one maturing in 2020 and the other in 2022, at fixed interest of 2.25% to 2.95%. The 2.95% rate would mean that purchasing a generics companies using cheap financing would raise earnings per share as long as the purchase goes through at a price-earnings ratio not exceeding 34 − the break-even point at which the bond interest financing the deal offsets the contribution to Teva’s earnings from the purchased company.