Love-hate Triangle: Why Perrigo Rejected Mylan’s Bids

Perrigo executives plan to go it alone based on potential growth in the non-prescription market, acquiring competitors, organic growth and an MS drug. Teva and Israeli investors in Perrigo, will influence Perrigo’s future course.

Bloomberg

A love-hate triangle that has riveted the pharmaceutical industry in recent months will probably reach a decisive stage in July or August. The three protagonists are Israel-based Teva Pharmaceutical Industries, Perrigo, which is traded on the New York Stock Exchange and the Tel Aviv exchange, and Mylan, which is based in Pennsylvania and traded on the Nasdaq exchange.

Mylan is expected to issue a $29 billion offer for all the shares of Perrigo and push to have Perrigo shareholders vote on the proposal. On the assumption that at least half of Mylan’s shareholders approve the offer, Perrigo is expected to convene a shareholder meeting in the middle of October.

Mylan chairman Robert Coury is pursuing the purchase of Perrigo primarily to fend off a bid by Teva for his own company at $82 per share. The Teva offer is based on a market value for Mylan of $40 billion.

Mylan’s offer for Perrigo requires the approval of the holders of at least 80% of Perrigo shares. It appears that the Israeli shareholders of Perrigo, who hold 9.6% of the 146 million shares of the company, will have an important role in the approval or rejection of Mylan’s bid. Approval would bring an end to Teva’s efforts at a hostile takeover of Mylan, while a rejection of the Mylan offer for Perrigo would make Mylan’s management, which has refused to entertain Teva’s offer, that much more vulnerable.

Up to now, Perrigo has rebuffed three offers to be taken over because, at $205 per share (when Perrigo shares were trading at $164), they were considered an opening shot, undervaluing its economic value and growth potential. Perrigo management also expressed the sense that the most recent purportedly improved offer was less than the original price, which did not include a breakdown in payment through shares and in cash.

The main ammunition of Perrigo and its President and CEO Joe Papa and CFO Judy Brown in explaining why Mylan’s bid should be rejected are the company’s outstanding past record and the assessment that the future will be equally rosy. Between 2007 and the day before Mylan’s offer, April 7, Perrigo had provided 971% growth for its investors. Since then, Perrigo shares have jumped by about 20%.

Direct contact with end users

Between 2011 and 2014, Perrigo experienced annual organic growth of 7% and management is forecasting that the period of 2014 to 2017 will see organic growth (including the purchase of Belgium’s Omega Pharma in March) at 5% to 10%. Perrigo has declined to provide earnings-per-share targets because that is barred under Irish law, where the company is incorporated. It appears, however, that management intends to boost earnings per share more rapidly than the pace of sales growth, as has been the case up to now.

In a presentation to investors on the company website, Perrigo noted that organic growth of 5% to 10% is based on its three main product lines: First is non-prescription drugs and products, both through private-label brands it has been producing for the U.S. market and brand medications produced for Europe since the acquisition of Omega for 3.6 billion euros ($3.9 billion). Second is generic prescription drugs, and third are revenues from Biogen Idec for sales of the multiple sclerosis drug Tysabri.

Perrigo management notes that it is the market leader with respect to two of its major product lines. It has a 70% market share in the U.S. of the non-prescription drugstore and supermarket private label market, which in turn is 35% of that country’s non-prescription market. As a result, it commands more than 24% of the total American non-prescription market.

These operations, unlike the generic prescription market, provide the company with direct consumer customer contact with respect to 76% of Perrigo’s sales. This interface, the company says, enhances customer loyalty for products in a way that solidifies company profits and cash flow, and offsets the need to constantly add to its product mix, a process that generic companies cannot avoid.

Perrigo is also one of the world’s leading companies in the generic skin medication sector, which includes ointments, creams, nasal sprays and gels. It’s a niche that involves products some of which are difficult to produce, with little competition and relatively low price erosion. Such a market allows Perrigo to rack up high gross profits in the generic sector, and its strong product pipeline is expected to help it grow and show major profits in the future.

The forecast relies on Perrigo’s global base and does not take into consideration future acquisitions and products under development, which are expected to generate a billion dollars in sales over the next three years. Between the lines, it can be understood that Perrigo sets its growth targets based on internal, organic growth because it believes that earnings targets per share based on acquisitions, as Mylan issues (at $6 per share in 2018, compared to the current level of just over $3), gives management an incentive to acquire companies.

Perrigo’s growth forecast doesn’t include the three components that could substantially boost its organic growth beyond the 5% to 10% that it has committed to. The first component, which has a high probability of coming to fruition, involves a shift from prescription drugs, sales of which are $32 billion, to non-prescription products where Perrigo, as noted, has a 70% share of the private label U.S. market at stores such as Wal-Mart and CVS.

The market for allergy nasal sprays, which have sales of $4.4 billion, is transitioning to non-prescription availability, Perrigo notes, while other market segments that may undergo a similar shift include cholesterol-lowering statin drugs, sales of which are $7.3 billion, migraine medications ($4.3 billion) and medications for an enlarged prostate ($6 billion). With its acquisition of Omega, Perrigo has marketing capabilities in 35 countries and therefore has the potential of penetrating these markets with new products. Following the acquisition of Omega, it can be assumed that other European purchases may follow.

Another factor not included in Perrigo’s growth projection is mergers and acquisitions, even though they were responsible for 50% of its sales growth – from $1.7 billion in 2008 to $4.1 billion in fiscal year 2014. Mergers and acquisitions were also responsible for an improvement in the company’s adjusted operating profits, from 14% of turnover in 2008 to 25% in 2014.

An additional source of accelerated growth beyond the target to which Perrigo has committed may come from new medical indications for Tysabri, which is currently prescribed for multiple sclerosis. Biogen Idec, which bought the drug from Elan of Ireland – which in turn was purchased by Perrigo in 2013 – is expected to publish decisive clinical trial results from patients with more advanced stages of the disease and a study in which the drug was prescribed for the treatment of strokes. Perrigo receives 18% royalties on the sale of Tysabri up to $2 billion, and 25% over that sales level. As a result, if the indications for the use of the drug are expanded, it could substantially boost royalty revenues.

It can be assumed that Perrigo’s cool response to Mylan’s takeover offer and the assessment that it is better off as an independent company are partially due to Mylan’s analysis of the potential synergies if the companies’ operations were combined. Mylan has told its investors that the combination would result in annual savings of $800 million within four years of the completion of the merger.

Perrigo’s management, however, apparently believes that such a figure is unrealistic in light of the absence of overlap between the two companies’ operations and the fact that Perrigo is considered a lean, efficient company. Perrigo’s combined costs for distribution, sales and marketing, research and development, and general administration are about $830 million a year, or about 20% of its revenue prior to the purchase of Omega. As a result, Mylan’s savings projection does indeed appear to be overly ambitious.