Actavis announced last week that it would pay an EV of $25bn to take control of Forest Labs, the equity component of which represents a 25% premium to Forest’s closing price the previous Friday. The deal will be 70% stock, 30% cash, with the result that Forest’s former shareholders will own roughly a third of Actavis. Closure of the deal is expected to be in mid-year, assuming approval by both sets of shareholders and by the relevant competition authorities.
Forest Labs is a US-centred specialty pharma company that focuses on in-licensing products at a relatively late stage of their development, getting them approved and then marketing them aggressively. Its key therapeutic area is CNS, where it has a strong portfolio of both on-market brands and pipeline products. Just over half of Forest’s total sales come from a single CNS product, Namenda (memantine, licensed from Merz of Germany). Namenda loses patent protection in 2015, but Forest is replacing it with an extended-release form of the drug that should extend its protection until 2016/17, assuming a ‘hard switch’ and little flow-back to generics. Forest also operates in the cardiovascular and GI areas and has smaller franchises in cystic fibrosis and respiratory disorders. The company has some 2,800 reps in the US, detailing mainly to GPs but also to specialists, plus smaller sales forces in Canada and Europe. Manufacturing is done in only four plants (two in the US and two in Ireland), which has to be a big plus point for Actavis, which is already struggling with the supply chain logistics arising from the multiple production sites that it has inherited from its previous acquisitions.
According to press reports, the deal was sparked off by a meeting between the CEOs of the two companies at the JP Morgan conference early in January and was agreed in a mere five weeks. This strongly suggests that the project was driven more by do-ability than by any deep analysis of the fit between the Actavis and Forest. Of course, Forest has long looked vulnerable to a take-over, having seen its earnings hit hard by the loss of patent protection on Lundbeck’s antidepressant Lexapro (which it sells in the US) and being under fire from the veteran activist shareholder, Carl Icahn, who has made repeated attempts to get his own nominees on the board. As a result of this pressure, the company had already brought in a new CEO, commenced a cost-cutting programme and announced the acquisition of Aptalis, with the aim of returning to growth as quickly as possible. Even so, it clearly felt unable to resist Actavis’s approach.
In our view, the deal does make some sense, even if it was a bit spur of the moment. While there is no real overlap between the two companies, Forest will take Actavis much more deeply into branded territory and into innovative R&D which, provided that management can cope with the risks that this introduces into its business model, should create a much more sustainable product flow than generics. Of course, Namenda is a concern, because payers may well attempt to push patients towards the twice-daily product once generics appear, even if Forest has taken its own immediate release formulation off the market. This could result in sales dropping off sharply in 2015 (late 2015 if Forest is able to get a paediatric extension, which would shift patent expiry from April to October), rather than holding up until 2017. Should this happen, the financials of the deal will look a bit shaky, particularly since Actavis is already paying an EV/EBITDA multiple of close to 40x, based on Forest’s expected results to March 2014 (but closer to 17x on the March 2015 numbers, thanks to Aptalis and some of Forest’s newer products). What matters to Actavis is EPS accretion (always a fairly easy target thanks to US accounting) and cash flow, but both of these would be hit hard if Namenda is wiped out by generics in 2016.
Paul Bisaro, the Chairman and CEO of Actavis, described the deal as creating a ‘new model’ of specialty pharmaceutical company, one with ‘generic DNA’. What he means by this seems to be a company that is very disciplined in its expenditure and doesn’t waste money, but that is easier said than done when you are spending $1bn a year on R&D, mainly on products that could easily fail in the clinic. Actavis will also be a specialty pharma company that isn’t actually very specialised, as it will operate in broad range of therapeutic areas (Actavis already had women’s health and urology to add to the Forest list noted above, not to mention its biosimilar pipeline) and mostly address family doctors rather than hospital specialists. This model of business will also have only around half of its sales coming from spec pharma products, with the rest being generics, but mixing generics and brands is hardly new and in any case, Actavis was already trying to focus its generic operations in less competitive areas, such as patches and injectables.
One thing that can definitely be said about the combined company is that it will be much more US-centred than Actavis alone. Once the deal closes, a mere 15% of turnover will come from outside North America and since most of the pipeline is also focused here, this percentage is more likely to go down than up, absent further M&A activity. Several analysts asked about the potential to expand the sale of Forest’s products worldwide, but the reality is that most of the company’s licences are for North (and sometimes South) America only, since Forest had no sales capability in Europe or anywhere else. The Aptalis pipeline is more promising, since the company generally still has global rights for its products, but a sales infrastructure would be required – Aptalis itself was mostly focused on out-licensing in Europe. And on the call, Siggi Olafsson was dubious about the prospects for Europe, citing difficulties on getting good prices for innovative products. All of which makes us wonder whether even the 15% of overseas turnover will be worth holding on to, or whether it might not make more sense to divest Actavis’s non-US assets altogether. After all, their contribution to profits is probably rather less than their contribution to sales, yet they involve huge complexity compared to the North American market.
On the conference call, Actavis said that it expected to achieve $1bn of synergy benefits from the deal, excluding the $500m cost savings that Forest was already expecting from Project Rejuvenate and the synergies coming from Actavis’s previous acquisition of Warner Chilcott. Around $100m of the benefit is likely to be tax (Forest has a handy Irish tax domicile) and the remainder is likely to come from combining central functions (including regulatory and QA), from manufacturing (although this is likely to be limited given Forest’s relatively modest number of facilities) and from whatever top line benefits can be derived from promoting some of Actavis’s products using Forest’s sales force. For instance, Actavis only promotes its women’s health products via specialists, whereas most of the prescriptions for its oral contraceptives are written by family doctors. Consequently, sales could potentially be boosted by actually promoting these products to GPs. Similarly for Actavis’s BPH drug, Rapaflo.
Paul Bisaro, who will be leading the enlarged operation, refused to be drawn on the composition of the management team beneath him. This is fair enough given that it will be some months before the two companies formally become one. However, with Siggi Olafsson having recently been appointed head of Actavis’s branded operations as well as its generics arm – cementing, in our view, his position as Bisaro’s heir apparent – it would be amazing if he doesn’t emerge as Actavis’s number two (or CEO, if Bisaro restricts his role to Chairman). It has already been announced that Brent Saunders, the current CEO of Forest, will join Actavis’s Board, so we assume that he will not also get an operational role. Given Forest’s superior strength in brands, it would seem reasonable for a Forest manager to run the branded business, while someone from Actavis takes generics (despite Actavis having just combined the two functions in its own operation, the larger size of the combined business would probably justify separating them out again).
There have been some suggestions from analysts that other companies may attempt to enter a bidding war over Forest, notwithstanding the break fees that have been agreed with Actavis. While this cannot be ruled out, we consider it to be fairly unlikely, not least because Forest relies on the goodwill of its licensors, most (if not all) of which have change of control clauses in their contracts. It would therefore be fairly easy for it to deter unwanted suitors by threatening them with the loss of key products. Valeant, in particular, is unlikely to be viewed very favourably by most of Forest’s partners, given its track record of aggressive cost-cutting in the companies that it acquires. We therefore assume that the deal will go through as planned.
On this basis, investors will probably be asking what Actavis is likely to do next. In the short term, it will need to focus on keeping the banks happy by getting its debt down, but credit is now relatively easy to find, so further deals are more than likely. The most obvious move would be to acquire some more primary care brands that fit into the ‘verticals’ that Forest has already identified (CNS, CVS, GI etc…). Adding products of this type would be a much easier way of getting value from the Forest sales team than trying to shoehorn Actavis’s existing drugs into the reps’ bags. As noted above, Actavis also needs to decide whether it is still trying to be a global company or whether it is happy to be a North American one. If the former, then it needs to do something fairly dramatic to bolster its business outside the US. Buy up a big pharma established products division, perhaps?