Glossary of Hostile Takeover Terms with Discussion

When the buyer has the option of issuing either shares or (debt-financed) cash, there are many considerations. Not the least of which would be what the sellers prefer (many times buyers who have such option would give the seller a choice). By offering cash, they get to keep all the value-creation of the acquisition to their own shareholders (which is the only constituency they are serving); by offering equity, they keep their debt down. There are pros and cons either way.

If I were a selling Allergan shareholders, and the buyer was Valeant, I would want cash and only cash -- because I don't think much of Valeant shares and I don't believe there will be any value creation in the merger (in fact, I think there will be a lot of value destruction). However, if the buyer is Actavis, I would prefer shares, because Actavis intends to keep the Allergan R&D pipeline intact, and there are a lot of major upside opportunities in that pipeline.

Even if Actavis were to tap out their cash borrowing potential through an all-cash transaction for Allergan, they could still make further acquisitions with equity. Alternatively, they can go ahead and execute the value-creation elements of the merger, prove to the market that they are all for real (causing the share price to correspondingly increase) and then issue more shares (at the newly high price) to retire or pay down the debt.

The bottom line is that when the business model is sound, when the R&D pipeline is solid, and when value is being created (as with Allergan and an Allergan-Actavis combination), there are many options to finance profitable opportunities, including additional acquisitions; when all you got is unsustainable financial engineering (Valeant) based on shutting down research and raising prices, you must keep running faster and faster to just to survive, and eventually you run out of maneuvering room.

Dan.

 

Skepticism is healthy, but when it comes to master business plans, outright deception is rarely viable. Unless there is strong evidence to the contrary, I will take General Managers at their word when they articulate an acquisition business plan (but I'll be quite skeptical about their numbers, claims, and assumptions!). They need to sell their plan to a very wide variety of constituencies (seller shareholders and board, buyer shareholders and board, financiers, regulators, bondholders, and even non-financial participants such as customers, vendors, and employees). They can't sell different stories to different constituencies. In the case of serial acquirers (which includes Valeant and presumably Actavis), the constituencies of their future acquisitions are also, indirectly, in the audience.

I'll rephrase the skepticism rather than a question of what they are planning to do, but rather what will they do the first time (after an acquisition) that things aren't going according to plans. If they have a quarter (or year) when earning targets are going to be seriously missed, are they going to stand firm, explain what happened and take the (share price) hit, or are they going to knock out some R&D that they are only committed to in fair weather? No one knows. This is really when we will find out if, as you put it, "they got religion."

Valeant's business philosophy is that R&D is a money loser. They point to studies showing that the number of pharma patents per billion dollars have been halving every nine years or so -- a perverse opposite of the famous Moore's law that is a bedrock of the computing industry (Moore's law, which has reliably predicted the development of computer hardware technology since proposed in 1965, states that the amount of computing power per unit cost doubles every 2 years). Therefore it is financially foresighted to just stop all R&D, except very low-risk near-term R&D, and just make money selling products. If others, such as government funded universities, biotech, and other companies continue to do R&D, great; we (Valeant) will buy the ones that produce profitable products without having to throw money away on the many failed efforts and dead leads. Essentially the entire Pharma industry and media (to include the authors of the studies their philosophy is based on) disagree, pointing out that the costs of the failed R&D efforts is baked into the price of the products created by the successful ones. Valeant is not avoiding the cost of failed R&D, they are just paying it upfront with their acquisition costs (and "one time" charges).

As for Actavis, I have to agree. I don't think they'll cut R&D wholesale. Why pay $60B in cash (as opposed to Valeant who is offering $20B in cash and $30B in questionable shares) for a company making just $3B/year, unless you believe that there a lot of value in the pipeline that will allow for extended and sustainable growth.


Just to be clear, I'm not looking at Actavis with naive enthusiasm. They will cut that which they don't believe in, that which is duplicate with their own capacities (although that cutting is as likely to hit their own employees as Allergan's -- in that respect they have no differential allegiance -- they'll do whatever they think is best for the shareholders), and they will certainly remove a lot of duplicate G&A (General and Administrative) costs (such as accounting and HR). But, unlike Valeant, this will all be done for the purpose of creating real value; not just to feed a financial engineering machine (aka "house of cards") to keep it running a little longer before it runs out companies it can feed ion.

Dan.

 

This is all speculation, of course.

Personally, I think Salix is not yesterday's news by any means. It will keep coming back to the forefront with some regularity, until the music stops and we know who got a seat and who got left out. As Actavis and Allergan get into serious discussions, leaks about on-again-off-again discussions with Salix will be used by either side to create negotiating leverage against the other. For such leverage to be credible, there has to be genuine preparedness to carry through with a Salix deal (shareholder letters or meetings notwithstanding). The Salix board, presumably, won't sit still either, and would try hard to interject itself into the discussion -- knowing that they can get a better price if Allergan and Actavis are bidding against each other than if they will end up negotiating with the subsequent combined Allergan-Actavis entity (where Salix will have a lot less pricing power).

I am still most intrigued by the question if a 3-way merger is feasible (even if achieved through rapid succession of two 2-way mergers).

My long standing belief is that Valeant won't win because their value creation story is fundamentally flawed (I have many posts that develop this thinking in more details). Whether it's Actavis, Salix, or any other scenario; there are many ways to outbid a flawed story with a legitimate one.

Dan.

 

I try not to criticize the media, including opinion pieces, by attacking the presenter. I try to just address content. But I don't consider The Motley Fool media. I've been reading some of their pieces since the mid-1990's. Their tag line is To Educate, Amuse & Enrich; and I'll give them one-out-of-three. During the tech-bubble of the late 1990s, their stories sometimes moved stocks (I think because their deliberately silly demeanor was a lot more attractive to the tech-nerds who were driving the startup and VC scene than the buttoned-up attitudes of Wall Street); but their influence largely disappeared with the 2000 tech crash. Their style of openly advocating stocks that they own was acceptable then (under the thinking that it's legitimate for a commentator to put their money where their mouth is), but out of favor now (under the thinking that someone who owns stocks would be motivated to write one-sided opinions). The Motley Fool has openly disclosed that they own Valeant (and not Allergan) and their pieces have consistently backed Valeant and the Valeant-proposed merger.

Leaving the messenger issue aside, and focusing on content; the gist of their story is that Actavis couldn't afford Allergan, but want to buy Salix. Allergan is fearful Valeant will buy it cheaply and to block this is competing for Salix and driving Salix's price up. Actavis, through a maneuver the author labels False Flag, is feigning an interest in Allergan, at a reasonable valuation, to push Valeant's bid to a more acceptable range and thus negates Allergan's need to compete for Salix.
In addition to the fanciful assertion that anyone would attempted such a foolish (shall I say Motley) "False Flag" play when all participants have legions of MBAs and attorneys to exhaustively study every development and scenario, there is a very fatal flaw of this line of thinking. It all start with the author's assertion that Actavis can't afford Valeant. In his words "The bottom line is this: Actavis has taken on a large amount of debt through all these deals, and a $60 billion buyout of Allergan would put the company deep into the hole." The problem with that line is that all of these assertions are ten-fold more true for Valeant: Valeant has made many more deals, is far more in debt, and would be paying more to acquire. Furthermore, Actavis starts with a higher market cap (by about 50%) and vastly larger (about 3 times) revenues and earnings (Actavis is profitable, Valeant is losing money).
My math shows that Actavis can, just barely, afford to buy Allergan for cash, and can easily throw some equity in (which, unlike the Valeant equity, as a shareholder, I'd want). There is no debate that Valeant CAN'T buy something as big as Allergan for cash, and their equity -- which must be over 60% of the offer value -- is less than stellar. As for Salix, it's a small potato. If it is gobbled up by Allergan or Actavis, it won't stop the viability of an Allergan-Actavis deal, just change the terms (it will, likely, stop the viability of a Valeant deal, since that deal is a big stretch to begin with).

Dan.