Actavis appears to be in the centre of a social whirl, with reports emerging that it has been considering a takeover approach from Valeant, a merger offer from Mylan and the purchase of Warner Chilcott*. The first two appear to be connected, with Mylan attempting the white knight role after news of the Valeant approach leaked out, but the third is clearly the most interesting from Actavis’s perspective. On one level, all this activity is bizarre given that the ‘legacy’ Actavis was effectively up for sale for years without either Valeant or Mylan appearing to have any interest in buying it, albeit that any bid would have had to be in cash, not the stock being offered now. However, the various proposed deals also tell us something about both the companies involved and the way that the industry is heading.
The Valeant proposition is the most straightforward. Valeant is acquisition-driven and highly indebted – not entirely unlike legacy Actavis, in fact. In order to keep its business moving forward, it has to keep on doing deals, particularly as its strategy is to boost the short-term earnings of the companies that it buys by cutting R&D costs, thus making it less likely that they can deliver sustained growth over the longer term. Actavis would have been attractive to Valeant because a stock deal would have massively increased Valeant’s size without putting further strain on its already stretched balance sheet. Whether such a deal would have been so attractive to Actavis’s shareholders is less clear. Valeant is fascinating to watch from a distance, but probably dangerous to get too close to, as historical precedent suggests that it will ultimately reach a point at which it will be unable to make acquisitions fast enough to disguise the lack of organic growth in the base business, with the result that its share price will fall, preventing it from doing expensive deals for stock, and its debt will start to exert some real strain.
A deal with Mylan would have been something else altogether, although the rationale from Mylan’s perspective is a bit obscure, other than making sure that it didn’t suddenly find that Valeant was its closest rival in the US generics market. In Europe, an Actavis/Mylan tie-up would actually be quite a neat fit, since Mylan is strong in France and Italy, which are two very weak markets for Actavis, and the only serious overlap is in the UK. However, it is unlikely that Europe was foremost in Mylan’s thinking and in the US, the FTC would presumably have had a field day sorting out which products needed to be disposed of. On the upside, a combined Mylan/Actavis US operation, even if rather less than the sum of the parts, would be something that could stand as a serious rival to Teva and would further cement the big-to-big model that is developing in the US generic supply chain. It would also have brought Mylan franchises in controlled drugs and women’s health, among some other attractive assets. From the perspective of Actavis’s management, the unattractive elements of the proposed deal were presumably the valuation (Actavis’s share price is currently above the rumoured offer price of $120/share) and the fact that they would all have been out of a job. The latter all the more so because they are only part way through building Actavis into a global operation with a balance of specialty brands and generics, so they would have left the transformation half done.
Against this backdrop, buying Warner Chilcott would fulfil a number of aims simultaneously. First, it would make Actavis that bit bigger and hence more of a mouthful for either Valeant or Mylan to swallow. Second, it would boost the branded element of Actavis’s business, which has become very generics-heavy since the Watson/Actavis merger. Third, it would provide additional critical mass in some key therapeutic areas, particularly women’s health. Fourth, it would expand the brand business into Europe (Actavis’s existing branded products are mostly sold in North America only). Fifthly, it might enable Actavis to reduce its tax bill (Warner Chilcott is an Irish company and benefits from favourable tax treatment). And finally, it would significantly improve cash flow, helping Actavis to pay down its own debt pile.
Not that everything about Warner Chilcott is so positive. For a start, it is heavily indebted itself, due to its own acquisition-driven history. Indeed, in its early years, when it traded on the London stock exchange as Galen, the company combined Valeant’s appetite for acquisitions with some Elan-style sleight-of –hand accounting that left analysts wondering exactly what the end game was going to be. However, Galen was at least focused on specific therapy areas and on buying products rather than whole companies, which meant that its cash was real enough even if its reported profits needed some adjustment. As a result, the company (by this time trading under the name of its former US subsidiary, having sold the original Irish assets back to Galen’s founder) was ultimately taken private by a consortium of PE investors and subsequently re-floated in the US, at which point it went back on the acquisition trail.
Another concern about Warner Chilcott is the growth outlook. The company has total turnover of around $2.4bn, of which just over half comes from women’s health products (mainly the contraceptive pills Loestrin and Lo Loestrin, the osteoporosis drug Actonel and HRT cream Estrace) and most of the remainder from the ulcerative colitis treatment Asacol and the dermatology treatment Doryx. Doryx and Actonel both already have generic competition which is hitting sales, although Actonel retains market exclusivity in the US so far. Generics to Loestrin and Asacol are also expected soon (possibly as soon as October for Loestrin) and Warner Chilcott is undertaking an aggressive lifecycle management strategy by launching follow-up products and attempting a ‘hard switch’, ie taking the original drug off the market to force the market to move over to the new one quickly. The Loestrin follow-up is a chewable version of the drug and will be launched in August under the brand name Minastrin 24 FE. The Asacol replacement is called Delzicol and has already been launched. Its differentiating feature is that it replaces dibutyl phthalate as a placticizer in the capsule with dibutyl sebacate, which may not sound like much, but dibutyl phthalate has been implicated in endocrine disorders and has already been banned in children’s toys and other items in the EU. In additional to Minastrin and Delzicol, WC has also launched a new version of Doryx (200mg vs the existing 150mg) in an effort to dilute the impact of generics there.
The impact of withdrawing some products and launching others is producing highly lumpy results on a quarterly basis, but the net result is nevertheless expected to be a declining sales trend through 2013 and 2014, with a pick-up in 2015 and beyond, assuming no further acquisitions. As noted, WC has historically been driven much more by acquisitions than by organic growth (albeit that it has a highly effective sales force) but its gearing is currently proving a handicap to further expansion, which may partly explain why the management was open to talks with Actavis.
Thus, if Actavis pulls of this deal, it will be getting cash flow but not top line growth, plus taking the risk of the switches failing to convert as high a percentage of current scripts as is hoped. But even so, we believe that it is a deal worth doing. A look at the strategy of any of the larger generics firms shows that every one of them is focused on increasing the proportion of differentiated products in its portfolio, whether that means hard to make generics, patented brands or OTC products. Buying Warner Chilcott would give Actavis a big push forward in this regard, with the added advantage that it would get a ready-made sales force for the women’s health products that it developing itself, not to mention some possible tips on managing pharma assets for longer life that it could apply to some of its own drugs. And anything has to be better than being bought by Valeant.
*and possibly even a takeover offer from Novartis, although this seems somewhat far-fetched.