By Gustaf Baavhammar and Chris Leung (University of Warwick) (University of Warwick) - Date: 27/07/2019
Overview of the deal
Acquirer: AbbVie (NYSE: ABBV)
Target: Allergan (NYSE: AGN)
Estimated value: $63 bn
Announcement date: 25/06/2019
Acquirer Advisors: Morgan Stanley, PJT Partners
Target Advisors: J.P. Morgan
Amidst the backdrop of unprecedented levels of M&A activity in the healthcare space, AbbVie’s $63 bn acquisition of Allergan is the second largest takeover in the pharmaceutical industry this year, trailing behind Bristol-Myers Squibb’s $74 bn purchase of Celgene. According to the terms of the deal, AbbVie will shell out 0.866 of its shares and $120.30 per share of Allergan in a cash plus stock deal worth $188.25 per share – a 45.28% premium to Monday 22nd June’s closing price and which is expected to finalise early 2020.
M&A in the pharmaceutical industry has gained tremendous momentum where $310 bn worth of deals for American healthcare companies have already been announced thus far in 2019 – a record high for the first 6 months of a year according to Dealogic. AbbVie’s deal represents a rather traditional response to the perennial but inevitable challenge faced by the healthcare industry – loss of patent protection; further signalling big pharmas’ willingness to dig deep into their pockets for resolution and clarity over sustained future growth coupled alongside belief that even the world’s most dominant drug makers can aspire to become even bigger. The takeover will result in the world’s fifth largest drug company by valuation, with estimated consolidated revenues of $48 bn for 2019 at a market equity valuation of $153.3 bn.
“This is a transformational transaction for both companies and achieves unique and complementary strategic objectives,” -AbbVie’s Chairman and Chief Executive, Richard Gonzalez
Company Details (Acquirer - AbbVie)
Having spun off from Abbott Laboratories in 2013, AbbVie operates as a research-based pharmaceutical manufacturer, predominantly focused on treating chronic autoimmune diseases in rheumatology, gastroenterology, dermatology and oncology. Its main products include HUMIRA – which mainly treats rheumatoid arthritis and Crohn’s disease, and IBRUVICA – which treats B cell cancers.
- Founded in: 2013
- CEO: Richard Gonzalez
- Number of employees: 29,000
- Market Cap: $101.33 bn - EV: $133.58 bn
- LTM Revenue: $32.65 bn - LTM EBITDA: $13.95 bn
- LTM EV/Revenue: 4.09x - LTM EV/EBITDA: 9.58x
Company Details (Target - Allergan)
Allergan is a pharmaceutical company that resulted from a merger with Actavis in 2014. It acquires, develops and commercialises pharmaceutical products in 6 broad therapeutic areas: medical aesthetics, central nervous system, eyecare, rrology, gastroenterology and cardiovascular disease with Botox its headline product.
- Founded in: 1983
- CEO: Brenton Saunders
- Number of employees: 17,800
- Market Cap: $53.49 bn - EV: $75.41 bn
- LTM Revenue: $15.71 bn - LTM EBITDA: $7.06 bn
- LTM EV/Revenue: 4.80x - LTM EV/EBITDA: 10.68x
Projections and Assumptions
AbbVie has strategically built HUMIRA into the world’s bestselling drug today, treating autoimmune diseases such as rheumatoid arthritis and Crohn’s disease, through expanding its approved uses and price hikes. With sales at $19.9 bn in FY18, this accounted for 61% of AbbVie’s $32.8 bn revenue, and such dangerous dependence on a single revenue driver has forced AbbVie to make a statement move as means of reinvigorating an otherwise stagnating business. In the same vein, Allergan has also struggled for growth beyond its portfolio of aesthetic medications and Botox which drove top line revenue growth of 2%, ultimately bringing in $3.6 bn last year.
Since shedding more than a third of its market value since January 2018, AbbVie has been under pressure for diversification. The proposed takeover bears sound strategic rationale that offers a solution to long-standing challenges in both companies. The deal will help Allergan find stability following a 4-year slide in market price and offers a profitable exit for shareholders. With regards to AbbVie, the acquisition will most importantly, present immediate rescaling opportunity and enhanced profitability for its growth platform. Especially given the fact that cheaper competitive biosimilar alternatives are already available in Europe and scheduled for sale in the United States in 2023, the opportunity to access Allergan’s durable franchises coupled alongside ample cash flow from HUMIRA buys AbbVie time to deleverage and seek new areas of growth before its U.S. Loss Of Exclusivity (L.O.E.) in 2023. HUMIRA has already begun experiencing such burn as international sales plunged 23% in Q1’19, while simultaneously losing patent protection in much of the EU market since October 2018. By acquiring Allergan and its portfolio of well-established products, AbbVie is granted an easy way out, bypassing the risky process of R&D.
The transaction is also expected to be 10% accretive to adjusted EPS over its first full year with peak accretion estimated to be greater than 20%. Additionally, with the two companies generating a combined $19 bn in operating cash flow for FY18, the success and scale of the combined businesses will ensure sufficient funding and flexibility for robust pipeline investment and debt reduction – allowing them to sustain their focus on scientific development that will ease dependence on singular revenue drivers. It is evident that the transaction is not only a strategically viable move, but offers immediate compelling financial value to shareholders at a much lower risk profile.
The AbbVie Allergan deal is more than a story about healthcare consolidation but one that portrays the state of innovation among big pharmas who, despite their size and success, are still scavenging for ways to plug gaps in their revenue streams. Gonzalez will remain as CEO of AbbVie while Allergan’s chief executive, Brent Saunders, will join AbbVie’s board. Upon news of the acquisition, AbbVie’s shares slid 16.3% to $65.70 – marking its largest intraday drop since 2015, while Allergan shares were up 26.7% at $164.20 (see Appendix 1 and ‘Risks and Uncertainties’ for potential explanations).
Long Term Upsides
The deal earmarks AbbVie’s foray into the medical aesthetics space, which is expected to grow at a CAGR of 10.6% from $10.3 bn in 2018 to $25.6 bn in 2027. While much of the rationale for such a large purchase is reaped over the short term, AbbVie management still expects pretax savings and cost reduction of at least $2 bn by its third year after the deal closes. Such synergies will be the direct result of increasing efficiencies in SG&A, eliminating redundancies in manufacturing, leveraging procurement spend, as well as optimising research coupled with reduction of overlapping R&D facilities. AbbVie will seek to use the continual generation of cash flow from HUMIRA to service debt, targeting a debt reduction of $15 - $18 bn before the end of 2021, and at the same time, commit to continued dividend growth. AbbVie shareholders are anticipated to gain 83% majority stake in the combined companies while Allergan shareholders will retain a 17% ownership.
Risks and Uncertainties
It is without doubt that Gonzalez’s M&A track record since taking over as Chief Executive has not proven to be the best, following the $5.8 bn Rova-T Stemcentrx deal that had to be completely written off due to failures in clinical readouts. What could have been the winning piece for AbbVie is nothing more than a distant memory, and with such disaster still fresh in investors’ minds, it is unsurprising to see AbbVie’s share price plummet to new 52 week lows on the announcement of Allergan.
The fact that AbbVie has been underperforming for extended periods makes the deal seem almost forced without much conviction that AbbVie’s pipeline nor Allergan will be able to support AbbVie’s long term goals. Notably, Allergan’s R&D capability is rather limited, operating a model that is focused on acquiring assets that others have developed; and the fact that Allergan functions in an antithetical field to developing drugs for cancer and inflammatory conditions makes the takeover seem like the blind leading the blind. Despite the deal anticipated to bring in $2 bn in cost savings and synergies within three years, AbbVie’s pressing issues is not the near term, but life post-HUMIRA; and investors’ initial reactions have only expressed doubtful worry. To add fuel to fire, Allergan is plagued with issues much similar to AbbVie – Botox is facing increasing competition from rival Evolus Inc. whose wrinkle treatment, Jeuveau, received FDA approval earlier this year and plans to price at a 20-25% discount to Botox.
There’s also an issue of debt, as completion of the deal would see the company take on an addition $38 bn to finance the deal, ballooning its debt load to a hefty $73 bn. As Gonzalez is adamant on deleveraging $15 - $18 bn of debt through continuous cash flow from HUMIRA, this will significantly limit their ability to pursue other R&D opportunities. $1bn in cost reductions from merging R&D facilities would see the combined company spend $6 bn, otherwise 12.5% of revenue – well below the spending levels of competing big pharmas such as J&J who allocates 20.6% or Pfizer’s 15% – both of which generate significantly more revenue than AbbVie. The fact that management has also committed to stable dividend growth makes such aims simply unrealistic, and pressure is on Gonzalez for successful integration; otherwise, another botched merger would leave it trailing far behind predatory industry rivals.
“Two turkeys don’t make an eagle” - Piper Jaffray analyst Christopher Raymond
Appendix 1: Allergan Comparable Company Analysis(1)(2)
(1) Source: Respective company’s 10-K filing and Yahoo Finance. (2) Criteria for companies selected in the Comparable Analysis: extent of overlapping markets with Allergan and market capitalisation value.
From the analysis, we can see that Allergan’s EV/Sales ratio falls short of the general competitor field, as well as EV/EBITDA to a larger extent. This suggests that its EV appears larger by comparison to the field, implying that Allergan may be slightly undervalued, which considering the fact that the company came close to being purchased by Pfizer for a would-be record deal of $160 bn back in 2016, is certainly positive news for AbbVie. One interesting point to note is Allergan’s -$17.7 m of EBIT - a significant deviation from EBITDA of $6.729 billion. Such immense D&A costs reflect Allergan’s own business model of acquiring other companies and products such as LifeCell, Zeltiq Aesthetics, Keller Medical and Repros Therapeutics along with a host of other patents developed by other pharmaceutical firms. Although this highlights Allergan’s array of available assets, Restasis and Botox especially are coming towards the end of their useful life with the company anticipating amortisation expense to decrease to $3.669 bn by 2023.
Despite a tempting valuation and an attractive dividend yield of 6.5%, ABBV foresaw such a dramatic free fall in its share price perhaps due to a “lack of a clear line of sight toward substantially backfilling the $16 bn+ cliff that will be the US HUMIRA business come 2023” as Piper Jaffray analyst Christopher Raymond describes, who reiterated a Neutral rating on ABBV’s prospects.
Moreover, the 45% premium paid by AbbVie is steep which further explains the negative investor reaction at the announcement date. However, it is still lower than the average premium paid in other major healthcare transactions such as Takeda’s $62 billion Acquisition of Shire (69%), Eli Lilly’s $8bn Acquisition of Loxo Oncology (68%) or Bristol-Myers Squibb’s $74bn Acquisition of Celgene (54%). Hence, it may be concluded that investors have not been convinced by the growth potential and degree by which Allergan’s core products compliments AbbVie’s trajectory, thereby effectively making it an overvalued deal.
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