Glossary of Hostile Takeover Terms with Discussion

Hey everyone, I haven't forgotten you; I am working on one massive post that will cover this entire eventful week. Dan.

 

The Beginning of the Endgame

Hi everyone;

Lot's of news this week, let's go at it.

Before I start, though, I'd like to again say that all my posts are my opinions and reads -- I have absolutely no sources of information other than everyone else; nor do I pretend to understand anything better than entire teams of highly-paid full-time professionals employed by the various players. Even by this standard, this post is particularly heavy with guesses and conjectures. I'll therefore try to point out whenever I'm drifting from the factual to the speculative. That said, I don't think I'm going on a limb by opining that Monday marked the start of the end-game. The strategies are now laid out, the plays are presented, and while there are still many details and scenarios to work out, and many twists and surprises still to surmise, we now know the war plans of both sides and the general schedule of the battles to come.

Readers of my earlier posts know that I've been developing two interconnected themes: (1) The concept of Soft and Hard Powers, where Soft Powers (such as Doctors letters, investors presentations, political and regulatory interventions, media barrages, law suits, etc.) can keep the other side off balance and distracted; but it is Hard Powers (restructuring, acquisitions, spin offs, other bidders, etc.) that, in the end, will win or lose.
(2) The assertion that "when companies do well management is in control, when not, investors are," which I have been using to argue that Valeant is not likely to win, because Allergan is doing well (selling drugs), and Valeant is not.
The events of this week are best understood within the framework of these two themes.

We had 16 (!) important pieces of news this week -- each of which, in a normal week, would have been momentous -- and next week may well be even more eventful. While most appear disconnected, I will argue that they are all part of the same thread. Here are the news items (apologies if I misdated some, by the time I read some news a day or two may have passed):

MONDAY (9/22)
1. The Treasury Department announced inversions crackdown
2. Allergan ordered to provide non-redacted Board Minutes to Valeant/PS lawyers
3. Leaked news that Allergan turned down an all-cash offer from Actavis
4. Leaked news that Allergan in advanced talks to buy Salix

TUESDAY (9/23)
5. Ackman threatens to sue Allergan if it buys Salix without a shareholder vote
6. Leaked news that Pfizer were in talks to buy Actavis

WEDNESDAY (9/24)
7. Leaked news that Actavis had preliminary talks to buy Salix
8. Valeant up guidance for Q3
9. Both Allergan and Valeant shares skyrocket
10. Valeant exchanges public letters with Allergan

THURSDAY (9/25)
11. Valeant announces successful Phase III trial for $1B Glaucoma drug
12. ValueAct returns to Valeant Board
13. Valeant share price continues spiking up in an otherwise very down market
14. Pentwater Capital letter to Allergan opposing Salix deal

FRIDAY (9/26)
15. T Rowe Price letter to Allergan opposing Salix deal without shareholder vote

SATURDAY (!) (9/27)
16. Letter from Jackson Square Partners to Allergan opposing Salix deal


While these events are, indeed, distinct developments, they are also a lot more connected than the media seems to notice (conjecture). Let's go over them in a lot more details.

MONDAY (9/22)
1 - Treasury Department Announcement: Normally, I don't put much short-term weight into announcements, however dramatically stated, by elected politicians, regulators, and high government officials -- by the time any of what they say becomes reality, if ever, current matters would have long resolved (one way or another), whatever rules they suggest would have been heavily defanged by the various status quo constituencies, and grandfather clauses and phase-in period would obliterate any remaining effects on such current matters. However, with Abbvie (who reportedly outbid Allergan to buy Shire for an inversion deal) initially dropping 5% on the news, the market shows it believes that this announcement will have immediate significant effect in taking the value proposition out of inversions.
Obviously, the Treasury Department announcement wasn't orchestrated by anyone in Allergan. As big a deal as the Allergan-Valeant battle is, the issue of inversions, and the current frenzy by proponents to get deals done and by opponents to stop them, is a much bigger matter (although it wouldn't surprise me if Allergan's plight, communicated through the array of elected officials that have publicly taken to defend Allergan, provided one of the many impetuses to get Treasury to act with uncharacteristic speed and resolve). Allergan was never a fan of inversions to begin with -- right from the first word of Valeant's offer, Allergan has been saying (apparently, quite insightfully) that inversion tax benefits are unsustainable. As the crackdown on inversion is becoming a reality, many playing pieces are moving Allergan's way: Foreign companies Allergan would be interested in buying are now less likely to be snapped up at premium pricing by inversion-seekers (as with Shire -- much as Abbvie may now regret "winning" this bid); domestic companies are less obsessed with finding an inversion themselves and thus more available to sell to Allergan for a realistic price (as with Salix, who is apparently dumping the already-signed Cosmo inversion deal to be acquired by Allergan); and, companies (foreign or domestic) that would consider bidding against Valeant for Allergan (such as Actavis), are too, not distracted by the inversion obsession (such as a Pfizer inversion bid for Actavis, apparently now dormant). Since the new rules are not yet announced, we don't know if they'll specifically and directly damage the tax saving component of the Valeant-proposed merger (an important constituent of the overall value-creation Valeant is claiming the merger will achieve), but even if not, the atmosphere of a forceful inversion crack down is damaging the credibility of any sustainable tax benefit Valeant is claiming.
By correctly foreseeing -- against the overall market sentiment, and certainly Valeant's position -- that inversions tax benefits are unsustainable and will be cracked down upon sooner than most thought possible, Allergan's board placed itself in a superior negotiating position with respect to all counter-parties that obsessed themselves with inversions! (opinion)
(Note: I'm liberally using the word "inversion" to describe all corporate transactions that have the intended effect of reducing overall tax load by expatriating the tax home of a US corporation -- to include the Valeant proposed merger, Abbvie buying Shire, Salix deal to buy Cosmo, and Pfizer talks to buy Actavis).

2 - Non-Redaction court order: This is a very routine and typically unimportant ruling, but it had the (possibly inadvertent) effect of setting off many of this week's remarkable events (heavy conjecture). With the Insider Trading injunction hearing (where Allergan is asking the court to bar Ackman from using his shares in any vote or count) scheduled for October 26 (so it would happen sufficiently in advance of the December 18 special shareholders' meeting), there is a rapid pace Discovery process going on right now. Discovery is a crucial process in every trial. In a Discovery, the lawyers for each side have the right to ask the other side for any documents -- however confidential -- that might plausibly be relevant for the case; and the request has the force of a court order. This sounds insane, I know -- how could it possibly be acceptable for a company (that hasn't even been found guilty of anything) to be forced to turn over their innermost confidential information directly to a competitor or hostile suitor? The answer is that they don't turn it over to the other side, but to the other party's LAWYERS. The LAWYERS, as part of their professional code and rules, are first OFFICERS OF THE COURT, and only second, SERVANTS OF THEIR CLIENTS. This means that the lawyers receiving the super-secret information of the Discovery, are supposed to scan it for anything that supports their case (defense or plaintiff), while keeping it all Chinese-Wall-secret from their own clients. If they don't, they face severe penalties that begin with losing their license, and might even go as far as prison time. But herein lies a huge temptation for leaks, errors, misdeeds, and malfeasance: Lawyers, who are paid, sometimes, millions in fees from their clients, know potentially decisive information that their client would absolutely crave to know, but are supposed to keep a straight face and a shut mouth. This situation creates a real issue for the side that is ordered to supply the confidential information. They don't likely trust the opposing side's lawyers to guard their own information with their lives, yet they are ordered to trust them nonetheless. This incongruence often makes the Discovery process complex and adversarial. One side asks for documents (making the request as broad as possible so as to maximize the chance of finding something useful -- and, while they are at it, to make the other side squirm with the confidential information they are asked to share), and the other side objects -- saying they are being asked to supply super-secret documents that are entirely irrelevant to the trial matters. The asking side then goes to the judge to compel the (non)responding side to supply the requested documents. Since the argument of "we are afraid the other side's lawyers will break confidentiality and cause us irreparable harm" will never fly with the judge (as it is tantamount to accusing an honorable OFFICER OF THE COURT of committing a future crime), unless the request is truly irrelevant to the matter of the lawsuit, the judge will almost always take the position that it is up to the requestor's side, not the responder's side to decide what's relevant and what's not.
In the Allergan Insider Trading lawsuit against Valeant/PS, Valeant has been asking for minutes of all Allergan Board meetings right up to the most recent. Of course, these would be the Board meetings where Allergan discussed and developed all their defensive strategies. If Valeant/PS lawyers were to leak any of that to Valeant, it would lay Allergan's defenses completely bare. So Allergan redacted (blacked out) all the really sensitive sections of the minutes and gave the Valeant legal team the redacted version. Allergan's claimed that since the trial is about Insider Trading that took place prior to the April bid by Valeant for Allergan, anything in *Allergan's* Board meetings many months *AFTERWARD* can't possibly be relevant, and that Allergan should be able to shield secret information as privileged. Valeant/PS said that Allergan Board meetings minutes, even months after the alleged insider trading, will show that Allergan considered PS to be a co-bidder (and therefore not an insider trader) with Valeant; and, in any event, there is no such thing as a "privileged information" for board minutes (only for attorney-client communications).
As expected, Judge Carter agreed that there is no such thing as a board meeting "privileged" communications, and that Allergan is ordered to supply all Board Meetings minutes to Valeant/PS lawyers. Valeant/PS lawyers were reminded (as if they didn't already know) by the judge that the content of these minutes are secret Allergan information and that they can't share any of it (except anything that actually supports the Valeant/PS legal position regarding Insider Trading) with their clients.

So, what was inside those super-secret board meeting minutes that Allergan was so desperately seeking to redact? You might ask. Well, they are still secret, but there are many interesting stories that may or may not be there, for instance the Pfizer interest in Actavis and the Actavis interest in Salix, and two very juicy pieces of information that we now all know are there: The Actavis offer for Allergan and the advanced Salix deal negotiations (speculative). All of these pieces of information, once passed to Valeant/PS lawyers, could easily be leaked, without a trace, to their own clients, allowing the latter an opportunity to try and sabotage secret deals that they aren't even supposed to know about. Allergan wasn't about to risk their entire master defense on the professional integrity of Valeant/PS lawyers, but was under a court order to do exactly that. So what did Allergan do (total conjecture): Stall, use the weekend (in anticipation of Monday's ruling) to wrap up negotiations with Salix, wait until the markets in the East Coast and Europe are all closed Monday, and then LEAK THE STORY THEMSELVES DIRECTLY TO THE WSJ before handing out the non-redacted documents to Valeant/PS lawyers (I can't tell from the news stories if the minutes were handed out yet, or if Allergan is still trying to stall a few more days with appeals or likewise). This way, by the time Valeant/PS has the documents, Allergan already controlled the release of the important information -- leaving nothing (crucial) to be trusted to the integrity of the opposing side lawyers. The downside for Allergan -- the information got out a few days earlier than they would have liked to (but, most importantly, Allergan -- not Valeant -- controlled the information release process). Still, even those few days gave opponents of the deal an opportunity to mobilize before it were to became a fait accompli (see news item #14-16, below)
While this sequence of events is a total conjecture on my side (I have not seen even one media story connecting the court order with any of the leaks), I think I have some compelling circumstantial evidence supporting this conjecture: The WSJ article attributed the story to a source "familiar with the matter" -- which to me implies an authorized leak (otherwise, the typical journalistic phraseology is something like "a source who requested/required to stay anonymous because they are not authorized to release this information"). Also, since the same story mentioned both the Actavis and Salix deals, it would have almost had to have come from Allergan. Why would Allergan choose to leak the Salix deal a few days before it's ready to formally announce? The only reason I could think of is to avoid the story breaking outside the control of Allergan, and once the non-redacted Board Minutes make it to the hands of the Valeant/PS lawyer, that risk is outside Allergan's control.

3 - The Actavis cash offer: While everyone is focused on the Salix deal, this, I think, is the biggest story of the week. Not necessarily because it is more likely to happen than Salix (right now, I'd lean in favor of Salix more likely to happen than Actavis), but because this one is the biggest death knell to the Valeant offer. The WSJ story said that the Actavis offer is all cash and is about the same price as the current share price. It also said that Actavis will only do a friendly deal and will keep R&D intact. It also said that Allergan politely declined Actavis to pursue the Salix deal, and that Actavis is still interested ("If your other date doesn't work out, give me a call"). This is huge. Even if Salix fails, and even if a majority of shareholders don't want to hear anything about Allergan's plans for staying independent -- they just want to cash-out at ~50% above where Allergan was before Ackman came along (and fear that if Allergan stay independent, and Valeant walks away, Allergan share price will drop -- maybe not all the way to $116, but somewhere far south of recent, post-Valeant-bid prices of $160's-$170's) -- they now have two choices of comparable value: An all cash offer from Actavis and a Cash-plus-stock offer from Valeant. Actavis and Valeant might even bid against each other (no one ever makes a bid for a company without being prepared to compete), but I wouldn't expect that bidding to get out of hand (highly speculative) because Valeant is already closed to being tapped out, and Actavis wouldn't have a reason to bid any higher (Actavis too may be easily tapped out -- more on that later). Actavis would have the advantage of being a friendly bid (which means that Allergan will allow them to inspect the books and labs so as to be able to develop the most value-creating merger plan in light of their own books and labs). If you accept the view that Allergan's research generates more value than it costs (a view that Actavis presumably accepts and Valeant doesn't), then Actavis will have the further bidding advantage that they value what they will be getting more, even if it will eventually turn out that Valeant is right and the research was a waste of money. (Imagine two bidders bidding for a goose that supposedly lays golden eggs. One bidder doesn't believe in golden eggs and is just bidding for the value of goose meat; the other one does believe in golden eggs and is bidding accordingly. Which will win the bid? Does it even matter if the goose turns out to lay golden eggs or not after all?)
The traditional view in M&A is that a bid with a stock component is worth more than a straight cash bid of the same amount (so, a bid of $100 in stocks + $72 in cash is worth more than a $172 cash). While a bit counter-intuitive, the rationale for this thinking is that the stock component (in the merged corporation) will be worth more after the merger than beforehand, because the actual value creation of the merger (the "synergies") will then became realizable. In effect, the seller is given the opportunity to share in the value creation of the merger, something that a cash offer won't do. Of course, if the seller has a dim view of the stock or business plans of the buyer, they'd happily forgo participating in this alleged value creation and just take the cash (in small unmarked bills, please ) and run. I'd venture to guess that with all the scorn heaped on Valeant in the past 5 months, even the hardiest investors will rather take cash than Valeant stocks. Ackman may cheerlead Valeant, and may even practice what he preaches, but the arbitrageur mercenaries he so successfully invited to join the feast on Allergan, have zero interest in sticking around to see if Valeant can execute on their promises; so if it's all the same and someone else is offering all-cash, they'll take the cash and run (my opinion).
So, the bottom line of the Actavis presence is that it makes a Valeant victory unlikely, since, at the very least, Valeant will have to be bidding against an all-cash bidder, with that bidder having multiple built-in advantages. The mere fact that Valeant chances of winning are materially degraded, and even if they do win, it will be at a higher price than if there were no other bidders, creates a vicious circle situation against Valeant. Whether Valeant wins a bidding competition with Actavis by paying more, or loses this acquisition on which they have bet much of their future, the value of Valeant to it's CURRENT shareholders is reduced. If it's reduced, the Valeant share price drops. If it drops, then to stay in the bidding, Valeant must increase the share portion of their offer (since the cash portion is substantially tapped out), which further dilutes current shareholders, which further depresses Valeant share price. Even the most ardent believer, last week, in the inevitability of Valeant winning this acquisition battle, must awake to the possibility that with two additional highly viable alternative scenarios on the table (Actavis and Salix deals), the chance of Valeant winning is perhaps 1/3 of what it was beforehand; and there is a very real chance Valeant won't complete this acquisition. If Valeant couldn't win Allergan, there probably aren't many other $50B companies it can gobble; and, in any event, it would have wasted a year on a failed acquisition effort with nothing to show for it. This means that one must start seriously thinking what is Valeant really worth if it isn't doing any more big acquisitions. And that picture isn't pretty at all. Valeant without acquisitions is a company heavily in debt, unable to spend on either research or market development, sending all their free cash flow to their lenders to pay down their debt just slightly faster than they are losing market share (due to lack of investment), meaning that by the time they finish paying off their debt, they won't have much market share of anything. That's not a company that's worth $40B! And that's the good scenario! the bad scenario has any of a long list of what elsewhere would be survivable setbacks (like a rise in interest rates from their current historic low levels, a big lawsuit loss, a major regulatory action, etc.) pushing Valeant over the cliff from just barely being able to pay their debts to not be able to, at which point the bondholders get the company and the shareholders are wiped out. Even some Valeant shareholders (speculative) believe Valeant is a pyramid scheme, but are hoping to have one more round (Allergan) before they get out; if there is a good chance that one more round doesn't happen -- the first ones to get off loses the least! I don't know how many Valeant shareholders share the concern that they are invested in a house of card, and if Allergan is not happening, they need to be out before everyone else bails. But if there is even a large minority of Valeant shareholders with such sentiment, then once they start exiting, Valeant share price drops setting off a potentially exit-less vicious cycle -- and all brought about the Actavis bid!
Ackman was well aware of the possibility that a White Knight (see Glossary entry) would demolish the entire Valeant play when he said (circa May) that there is no White Knight around, and if Allergan doesn't rash and accept Valeant's offer, in the absence of a competing bidder, Valeant will be able to reduce it's offer. By lining up a White Knight (Actavis) to be on standby, Allergan has clearly proven Ackman wrong!
One last word on the capacity of Actavis to make an all cash bid. I haven't studied Actavis in any details, but I did scan their most recent quarterly report. They have a market cap of about $60B, about $10B/year revenues, and about $10B long term debt. If they borrow ~$50B to buy Allergan, their debt will go up to $60B. If Actavis can generate, say, 70% free cash flow (about $7B/year), added to the $3B/year profits Allergan generates; that gives total free cash flow of about $10B/year, or about 6 years leverage for a $60B debt. This will make the surviving corporation slightly less leveraged than Valeant, but still solidly in junk bond territory. However, unlike the Valeant plan, with R&D (and therefore product pipeline) intact, the market share and revenues will increase each year, while debt interests costs decrease (because the debt will be shrinking as it is paid down), making for a far more viable future than the Valeant plan. Given these numbers, I'd assume that if there were to be a bidding competition, not just Valeant, but also Actavis, would immediately tap out on cash, and will have to start offering some equity to stay in the bidding.

4 - The Salix negotiations: An acquisition of this size is what has been speculated all along to be Allergan's top preference. It will allow Allergan to remain independent -- and thus all the wonderful opportunities management says are deep in the R&D pipeline will accrue to the benefit of Allergan's shareholders, and only Allergan shareholders. By borrowing the maximum amount that Allergan can without a reduction in credit rating -- and thus not requiring a shareholders vote -- Allergan will be reducing Valeant's ability to borrow against its own balance sheet to finance the cash portion. If Allergan pays $10-$12B borrowed cash for Salix, that's ~$30/share less that Valeant can borrow on the strength of Allergan's balance sheet. Valeant will have to reduce the cash portion of their offer by that much (they can compensate by increasing the share components, but, as explained before, this will dilute their own shareholders). If Salix had lots of revenues, or some other assets realizable by Valeant, this wouldn't break the Valeant deal -- Valeant will simply increase their borrowing on the strength of Salix revenues or assets (which they would now be getting together with Allergan) and be able to keep their offer about the same (in fact, if there is a lot of value creation in an Allergan-Salix merger -- which is the only justification allowable for Allergan to be buying Salix in the first place -- arguably, Valeant would even be able to INCREASE their offer!). However, Salix has almost no revenues at all. Their assets comes in exactly the one place that Allergan can realize them and Valeant can not -- you guessed it -- they have a strong R&D pipeline. Since Valeant's entire value creation acquisition business model is to shut down R&D, a Salix acquisition brings Valeant a lot of R&D (for which a $10-12B debt, that they will inherit, was incurred), with no realizable value. This won't guarantee the collapse of the Valeant deal. Just because Valeant doesn't believe in, or can't credibly realize Salix's, R&D doesn't mean they can't spin it out immediately after the acquisition. Presumably, whoever buys Salix from Valeant will be offering less cash than Allergan would have paid for Salix in the first place (since Salix would have sold to the highest bidder, and if Allergan were to win that deal it would have been because no one else is willing to pay more). However, even if the re-sale of Salix nets Valeant, say, $1B less than the cash Allergan paid for Salix; it would still allow Valeant to continue the offer for Allergan with a drop of only $3/share (under this scenario, the poor Salix people would have been sold 3 times in a few months -- to Allergan, then into Valeant as a part of Allergan, then out of Valeant to someone else; each time with potentially life-changing consequences to many people). Per News item #7, we know that there is at least one company, Actavis, is interested in Salix (and, from news item #3 we know they have the ability and inclination to come up with a ton of cash). This, however, would be a very complex transaction. Valeant will need to have Actavis (or whoever is planning to get Salix), become a co-bidder for Allergan; and, if the last 5 months taught the sector anything, being a hostile bidder (or co-bidder) for Allergan is anything but a pleasant experience. The consensus in Wall Street is that a completed acquisition of Salix by Allergan will shut Valeant out.

TUESDAY (9/23)
5 - Ackman threatens (again) to sue: He has threatened before, and he is renewing his threat to sue Allergan if it buys Salix (or any other acquisition that destroys the Valeant offer) without a shareholder vote. Courts, in general, unless there is strong evidence to the contrary, assume that Boards operating within the Bylaws are doing so with the fiduciary interest of all shareholders -- and therefore do not have to hold a vote for every action (even if some shareholder would like them too). The Bylaws are specifically intended to place a boundary on how much the Board can do before it needs to seek shareholders approval, and a Salix acquisition (by design) is just within that boundary. Nonetheless, with the totality of the situation, the upcoming shareholder meeting, the large number of proxies Ackman has, and the argument that if the Salix deal is so great, why would Allergan be afraid to place it for a shareholder vote?; a judge might very well concur with Ackman that there is more irreparable harm if a Valeant deal that is wanted by most shareholders is killed than if a shareholders vote is forced before a Salix deal can consummate.
There is one big problem, though, with Ackman doing the suing, he has a lot of warts. His first wart is that his deal with Valeant gives him a fixed number of Valeant shares (and no cash) for his Allergan stake. Therefore, the less other shareholders get from Valeant, the more his fixed number of future Valeant shares are worth. Allergan can solidly assert that the Board is presumed to be acting in the interest of all shareholders, whereas Ackman is presumed to be acting against the interest of all (other) shareholders. His second wart is the Insider Trading Federal lawsuit. The core of Ackman's defense is that he is a co-bidder with Valeant (and therefore not an Insider Trader). This will come to bite him in both courts. When he comes before a DE judge asking to block the Salix deal, he will have to explain how a co-bidder has a standing to claim to represent the interest of the acquisition target; then, some weeks later, when he comes before the Federal judge to defend against Insider Trading accusation, he will have to explain how he could be a co-bidder if he is suing in DE claiming to be doing so on behalf of Allergan shareholders. Maybe there is some legal gymnastics he can come up with that explains how he can be faithfully representing both buyers and sellers on the same proposed transaction, but when in uncharted legal territory, blatant incongruities like this one are hard to defend.

6 - Pfizer interest in Actavis: Another bombshell "people with knowledge of the matter said," (which, as explained above, I interpret to mean its an authorized leak), this time to Bloomberg, comes out minutes after the market closed. The story says that no offer was made and there are no active formal negotiations. This would be a classic Inversion Deal. After the collapse of the borderline-hostile takeover attempt of AstraZeneca, Pfizer is presumed to have continued looking for another inversion opportunity. In July, Actavis acquired Forest Laboratories for $28B, making it large enough (market cap, now, $60B) to be able to invert Pfizer ($190B). (Inversion tax rules require that the foreign buyers will own at least 20% of the surviving corporation, which usually means that the target has to be at least ~1/4 the market cap of the acquirer). However, with the treasury crackdown (news item #1), chances are that the Pfizer interest in Actavis is now reduced.
I don't know who leaked this story -- it could have been Pfizer or Actavis (in theory it could have also been Allergan, but I don't think so, as it would violate confidentiality and serve no purpose that benefits Allergan). My first guess is that it was Actavis -- sending a message to Allergan shareholders that if they wait too long, Actavis might not be there (literally) to bid for them. Why did they leak it now? Well, with the mention of the Pfizer interest in Actavis possibly in the Allergan Board minutes, that are now going to Valeant lawyers (per news item #2), the same calculus that had Allergan leak the Salix and Actavis deals (news items #3 and #4) -- when they can control timing and process of the release -- applies here. It is even conceivable that Pfizer, concerned that they are mentioned in the unredacted board minutes, decided to leak the news themselves for that same reason.
Since there are no active negotiations in the relevant time frame, and, in any event, with the treasury crackdown, the Pfizer interest is probably diminished, there is likely not a huge effect on the Allergan-Valeant battle. To the extent that there is, it is against Allergan, as a successful transaction by Pfizer to buy Actavis will likely remove Actavis as a potential bidder for Allergan. Even in the absence of an actual deal, the threat that one may be available reduces Allergan's hand whenever it negotiates with Actavis, and therefore it's hand overall.


WEDNESDAY (9/24)
7 - Actavis interest in Salix: Another day, another bombshell leak from "Sources familiar with the situation." This time it was CNBC that got the scoop, and they released it just as the market was opening. (BTW, I consider releasing important news or leaks while the market is open to be disrespectful to small investors since it gives professional and institutional investors, with staff that monitors the news throughout the day, the ability to react before retail share holders. By releasing all potentially market-moving news when the exchanges are closed, everyone has an equal chance to absorb the news and be ready with informed instructions when they reopen -- the same applies to the various Valeant and Ackman marathon investor teleconferences that were held during market hours. ) The CNBC story said that negotiations started a few days ago, are in early stages, and have already hit a speed bump and stalled. Once again, my speculation for the reason and timing of the leak, is those unredacted board minutes (news item #2). Since this is a complete triangle now, with all possible 2-way combinations involving Allergan, Salix, and Actavis now being seriously considered, there is a very interesting competitive dynamic. From the mathematics of Games Theory, complete triangles are unstable -- meaning that any deal that two parties can agree on, there is an offer that the third party can make to one of the other two that will be superior to the agreed deal and that will also be superior, for the third party, to being left out.
(The famed mathematician John Nash, co-winner of the 1994 Nobel prize in economics, and the subject of the 2001 movie A Beautiful Mind, created the branch of Game Theory dealing with 3 or more participants, which subsequently became the basis for studying the relative power of parties in negotiations. A typical Game Theory example, the 3-Players-Ultimate-Game, illustrates the instability of complete triangles [In math-speak, the lack of a Nash Equilibrium]. In this example game, 3 players are voting how to apportion amongst themselves some fixed amount of money. While, at first, it might seem, that a 1/3-1/3-1/3 division would be natural; 2 players will find it in their better interest to vote for a 50-50 division, freezing the 3rd one out. However, the 3rd player, not wishing to be frozen out, may offer a 60-40 to one of the first two, freezing the other one out. This process can continue indefinitely, never settling on any stable outcome).
In real life situations, with a finite time to make actual decisions, and additional factors in play, the pure math "infinite process" never actually happens, people just make a deal that works and stick with it. In this instance, Allergan is probably more motivated than either Salix or Actavis to make a deal, so a deal it will make; however, the fact that these two counter-parties have the realistic option of making a deal with each other robs Allergan of the negotiating strength of having an alternative (beside Valeant, that it); and gives both Actavis and Salix the stronger hand that they each do have an alternative.


HIGHLY SPECULATIVE THOUGHTS:
At this point, halfway through the week, Valeant is looking pretty bad. While everyone was assuming that the Allergan Board has spent 5 months looking for an alternative strategy and failing, just as Ackman said all along would happen, and will now be dragged into the Special shareholder meeting with nothing better to say than "trust us, continuing to do what we have been doing is better than accepting the Valeant offer," apparently those 5 months were anything but fruitless. Allergan has created not one, but TWO, viable alternatives to the Valeant deal. In addition, it has shaken the Pharma eco-system so hard that there are a half-dozen connected deal and proposed deals in play at the same time that are all directly associated with Allergan or it's potential partners. And while all this wheeling and dealing was going on, Valeant was left out in the cold, entirely un-clued as to what was transpiring, just pushing their one-trick-pony proposal (and not even doing a good job pushing it). Quite the irony that the biggest dealmaker in all of Pharma was left sitting out the biggest deal making year of recent decades. The market was also indicating a decreased faith in the Valeant deal by pushing the Allergan share price above the value of the (current) Valeant offer for the first time since it was made. The Valeant battle plan, all focused around winning the December 18 special shareholder meeting at Allergan, included the carefully staged releases of real and manufactured good news in the run-up to that meeting so as to drive up Valeant's share price (and thus the perceived value of the offer) and the general mood of it's inevitable win. However, with the very realistic possibility that the game would be over, and Valeant left out, long before December 18; and possibly within days, all stored ammunition was immediately fired. For the rest of the week, any piece of news that could possibly drive up Valeant share price -- even if blatantly deceptive -- was desperately put out.


8 - Valeant up Q3 guidance: The one piece of news that is sure to drive share price up is improved earning guidance. And, magically, as soon as Valeant needed to urgently drive share price up, an improved guidance came into existence. On July 31, when Valeant released their Q2 earning report and lowered their forward guidance, they took a huge share price hit. I speculated then that they are deliberately swallowing more poison than necessary, so that when the Q3 numbers are reported (October 20) they will be able to generate a positive surprise in time for the special meeting (even though the precise date of the special meeting wasn't firmed yet, it was clearly going to be after October 20). Well, with the game possibly over before we even get to October 20, Valeant released this guidance raise right now -- never mind that Q3 isn't even finished yet. The obvious question, for anyone suspicious that the guidance numbers are just being gamed, would be if the September 24 raise is more or less than the July 31 lowering. But, you won't find the answer to that question in the Valeant guidance raise release. Amazingly, the Valeant release claiming this guidance raise DID NOT HAVE ANY NUMBERS associated with it at all. Just like that. Their release said "Valeant 3Q Results Expected to Beat Consensus on Revenue and Be Better than Guidance on Cash EPS, Organic Growth, Restructuring Charges and Adjusted Cash Flow from Operations." They only two quantitative elements of their release are their claim of organic growth for B&L and for the company as a whole (10% and 15%, respectively), However, as these are unaudited numbers and they won't say how they are calculating them (and how much of that is from potentially unsustainable price increases), these was an amazingly vacuous guidance raise. It took less than 24 hours for our friends at Seeking Alpha, who've previously been on top of calling out Valeant's shenanigance, to point out just how little there is to the Valeant release, and how even the two numbers they did provide are suspicious.

9 - Valeant and Allergan share price skyrockets: The Valeant guidance news, I (and Seeking Alpha) would have thought, should have been laughed at out loud; but, apparently, MP knows how to read and play his investors better than do I (maybe that's why he is at the CEO office and I'm at the Cafe Pharma). They swallowed his story whole and drove Valeant share price up over $8 (from $116 to $124) -- almost exactly the opposite of what happened on July 31, when they reduced guidance and the share price dropped $8 (from $125 to $117). It would seem that when it comes to Valeant, a non-quantitative up-guidance has an equal (and opposite) effect as a quantitative down-guidance. Allergan, buoyed by the possibility that there would be a bidding competition for it, remained at $1 above the Valeant offer value, which now put it at $176 -- entering into lifetime high territory.

10 - Valeant exchanges letters with Allergan: With the guidance upping release up their sleeves (no matter how vacuous), Valeant took the opportunity to set Allergan up for some rhetorical point-scoring (very speculative). They sent a letter (dated MONDAY, released WEDNESDAY) saying that after 5 months of acrimony, maybe it's time everybody got over the bad blood and work out a deal that would be best for everyone. Some in the media pointed to the wording "begin a conversation that could lead to even more value for your stockholders" as a message that Valeant is more prepared to up their offer than previously. I'm not convinced, I just read it as a repeat of what Valeant, all along, has been saying (as all hostile bidders say) that they prefer a friendly deal and are prepared to offer better terms for such.
Allergan very predictable response two days later (WEDNESDAY) can be summarized in one sentence: "Thank you for being polite, your offer and your company still suck."
With the Allergan response in their hand, Valeant immediately released their upped guidance for Q3 (news item #8) wrote a letter back to Allergan saying "No, we don't suck, see our awesome new guidance upping just released; it's you who is being obstinate by not negotiating with a great company like ours," and immediately released all 3 letters (conveniently giving themselves both the first and the last word of the exchange).

THURSDAY (9/25)
11 - Valeant announces a successful Phase III trial of a $1B Glaucoma drug: The next best thing to upping guidance, when one wishes to push share price up, is the announcement of a major pipeline success. I don't know much about drugs, Phase III trials, or Glaucoma; so I can't make any intelligent comment here other than to point out just how convenient the timing of the announcement is to Valeant's desperate need to push the share price up. Our Seeking Alpha friends, who do have contributors that understand these domains, once again, took less than 24 hours to blast holes through the Valeant claim pointing out that the Phase III trial compared Valeant's product with generic, poorly selling, medically under-performing alternatives, rather than Allergan's (and others') branded market leaders; yet their projected revenue claims are as if they will dethrone the leaders.

12 - ValueAct return to Valeant Board: ValueAct is one of the hedge funds with a large (2nd largest, I believe) Valeant holding. They have been in Valeant since the early days (they were the ones who recruited MP) and have achieved a huge return on their investment. Shortly before the bid for Allergan in April, the head of ValueAct resigned his Valeant directorship. The official reason was his acceptance of a Board seat at the much more prestigious Microsoft (ok, but a hedge fund could send someone else in his place, why didn't they?). There was much speculation that the real reason for the departure was a disagreement over the wisdom of bidding for Allergan. Publicly, of course, ValueAct said that they are fully supportive of the Allergan bid (although, sometimes they would drop big hints that maybe it's time to move on). Some in the analysts community and media even speculated that ValueAct was looking for an opportunity to discreetly cash out of Valeant (without news of their departure crashing the Valeant stock price before they finished exiting, presumably). With Valeant pulling all the stops to boost share price, and with ValueAct still owning about 6% of Valeant, this was the time to ask ValueAct to help save Valeant with a symbolic vote of confidence (highly speculative). ValueAct agreed and sent one of their guys (Ubben) back to the Valeant Board. They also said that “we expect to increase our already substantial position” thus, according to the WSJ, proving wrong those who said ValueAct is on the way out of Valeant. Looking at SEC filing, I did find that ValueAct has indeed increased their Valeant position -- by about 5000 shares (which Ubben received for free in exchange for his upcoming services as a director...). Being suspicious as I am about anything coming from Valeant, particularly when it is always so conveniently timed, I see Ubben's statement as not having the force of a promise, and easily a smokescreen to cover a retreat.

13 - Valeant share price continues spiking: Not withstanding my suspicion of the validity of the news in light of it's super-convenient timing, between the Phase III results and ValueAct return to Valeant's board, Valeant share price again spiked; up another $4 (on top of $8 yesterday). This is particularly remarkable as it was a heavy down day in the market as a whole (Dow down about 265 points).

THURSDAY-SATURDAY (9/25-27)
14, 15, 16 - Three major Allergan shareholders separately release public letters opposing a potential Salix deal without a shareholder vote: The 3 letters, released, respectively, on THURSDAY, FRIDAY, and SATURDAY; all say largely the same thing: Allergan shouldn't just reject premium-priced acquisition offers from both Valeant and Actavis, and pursue a deal-ending acquisition of Salix without a shareholder vote. All 3 letters are quite sharply worded. I don't know if it is coming from funds that are already in Valeant's corner and have been mobilized in a desperate effort to forestall a Salix deal before it were to become a fait accompli, or if they are speaking entirely of their own initiatives. I would tend to think the latter. The letters did not specifically endorse Valeant and all were careful to place the Actavis option on equal footing with Valeant. The rapid barrage of letters from such heavy weights would be too much for Allergan to ignore, but Allergan does have an obvious response: It can point out that the letter writers are responding to "rumors," not facts. After all, no official source has ever confirmed either the Salix or Actavis deal possibilities -- never mind that the source of the "rumors" is, in all likelihood, Allergan itself (see news item #2, above). That said, Allergan would need to tread carefully before taking the precipitous step of signing a Salix deal if it does not intend to put it up for a shareholder's vote -- which is what the letter writers, presumably, wanted to achieve. Whereas Ackman may have some warts, if he were to try and sue Allergan to force a shareholder vote before a Salix acquisition (see news item #5, above); these other shareholders have no less standing to sue, and do not have Ackman's warts. The letters may well set the stage for exactly such a suit.
One should note that it is not a foregone conclusion that Allergan can't win a shareholders' vote to approve a Salix deal. Presumably, there is a compelling argument in favor of such a deal -- a strong scientific synergies between the two technology pipelines (otherwise, why would Allergan be paying $10B+ for a company that has a strong R&D pipeline and not much revenues?) By making an all-cash offer for Salix, all the benefits of such a combination (and the rest of the Allergan R&D pipeline) will accrue to the benefit of Allergan shareholders only. If Allergan will be able to convincingly make this case to the shareholders, some of which, as the letters indicate, are already becoming alienated from the board, remains to be seen.

What to expect next week (entirely guesswork):
Even more fireworks. Valeant will continue firing every real and fabricated piece of good news ammunition they have been saving up (but I think their magazine is going to run out very quickly, and I think the gullible shareholders are already maxed out). Allergan will probably issue an official response to the shareholder letters (there may be a few more of them before we are out of this phase). Two really big pieces of news that may just come out this week would be a Salix announcement and an increased Valeant offer. One REALLY interesting story that just might come out would be the possibility of a 3-way deal involving Actavis, Allergan, and Salix. I don't know if it's feasible, but it sure would be interesting if it were contemplated.

Dan.

 

Re: The Beginning of the Endgame

T Rowe Price: Ackman's warts stem from signed agreements. The agreements that created PS Fund 1 (the Ackman controlled fund that affected the alleged Insider Trading) and the agreement between Ackman and Valeant that he will take a fixed number of Valeant shares for his Allergan holdings (and thus is incentivized to minimize the price Valeant pays for Allergan). TRP is not part of any such agreement, as far as we know (and, as both know quite well, if there were any such signed agreements, these will come out in the Discovery and the poison pill will immediately hit both -- so I'm sure there aren't any).
Concurring with, being a friend with, or otherwise choosing to follow the lead of Ackman; without committing to do so in an agreement, does not a wart make. Nor is owning Valeant shares (unless the Valeant share ownership is so high as to cross accounting or SEC threshold to create some level of affiliation -- clearly not the case here).

I don't know much about the other funds, but right now there are 4 major share holders (counting PS) saying NO Salix without a shareholder vote, and not one saying YES. Allergan can make a case as to why PS voice is not the voice of the shareholders (the 'warts'), but the others -- even if they are event-driven or friends-of-Ackman -- are unquestionably legitimate shareholders with a voice to be listened to.

Dan.

 

If you are an employee, my best advice would be not to go off on your own initiatives. Win or lose, Management and the Board have been doing a far better job than anyone thought possible generating Soft Powers (we shall soon see, as we are entering the period where Hard Power plays will be made, if they are equally skilled in that arena as well).
Any self-initiated action, uncoordinated with management's master plan, creates more risks -- for yourself and possibly the company -- then potential benefits. I'd hate to sound like a corporate drone (especially since I'm not even connected to the company), but if management thinks that some sort of a mass actions from employees would nicely dovetail with whatever they are doing, they won't hesitate to call for one. If they don't, then don't.

Dan.

 

Re: The Beginning of the Endgame

From my Post Saturday night:

Well, it took no longer than 5AM Monday for that response to be published, and even filed with the SEC.
The Board of Directors of Allergan, Inc. (AGN) (“Allergan” or the “Company”) today issued the following statement:

There has recently been significant and potentially distracting market speculation regarding Allergan, so, as the Company’s Board of Directors, we think it is important to reiterate our unanimous perspective. Our conclusion that Valeant’s offer is grossly inadequate and substantially undervalues Allergan remains unchanged. ...

(I guess they like the word 'speculation' better than 'rumor')

The use of a singular (speculation, not speculations); is intended to emphasize that it is one very specific 'speculation' (imminent deal to buy Salix) that they are talking about, rather than the general rumor-mill of the week.

While Allergan hasn't tied it's own hands by an outright denial of the 'speculation,' it would be hard to make an announcement confirming the accuracy of the 'speculation' immediately after telling everyone not to be distracted by it.

Dan.