On the Recent Allergan Restructuring
Until now, Allergan takeover defenses has been, exclusively, what I call soft powers: Doctors' letters, press releases, slide presentations, media barrage, attention from elected officials, and other verbal attacks. (In addition, of course, to the poison pill). These have served an important purpose: They kept Valeant share price unstable, and near the lower edge of the trading range since the initial bid was made. This is very important, since more than half the value of the bid is in Valeant shares, and since Valeant's borrowing power is tapped out (in fact, the cash portion of the Valeant offer is entirely made up of Allergan's, not Valeant's borrowing power); there is very little room for Valeant to raise, or even maintain, the value of their offer with a depressed share price (they could offer more Valeant shares to Allergan's shareholders; but that will dilute the current Valeant shareholders and further depress their share price). Allergan hasn't delivered a downward-spiral punch to Valeant, but they blunted and reversed the initial rapid price rise following the bid (when Valeant shareholders believed that they would quickly, easily, and cheaply gain control of Allergan and it's spectacular balance sheet).
The current restructuring, is the first use of what I would call hard powers: A material change in the capitalization dynamic of the company. By itself, it provides some level of defense; but not a complete defense. By halting some of the longest term research, and reducing sites duplication, Allergan becomes more profitable in the immediate future. That increased profitability is entirely to the benefit of Allergan shareholders. If those steps were taken after an acquisition, only 44% of the gain would benefit Allergan's shareholders (since Allergan shareholder will, collectively, own 44% of the combined company). Valeant promises to cut much more (so much more that Allergan and most independent observers think it's unrealistic and would destroy too much valuable research), but the incremental benefit they can gain is now reduced, and therefore the attractiveness of the deal is diminished. To put some numbers behind this: Valeant promises to cut $2.7B expenses per year. Let's say that $2B is the most they can realistically achieve even when they completely eliminate R&D (there is a minimum level of expenses a pharma company is legally obliged to incur just to stay in business). 44% of that benefit, $880M, are to the benefit of Allergan shareholders. By reducing $475M worth of expenses, Allergan is more than halfway there without sacrificing any of the high-potential R&D. Since Allergan has now sucked the best cost-cutting opportunities entirely to the benefit of Allergan shareholders (rather than just 44%), to continue offering the same premium to Allergan shareholders, Valeant will now need to offer more (analysts are using words like "North of $200"). Since Valeant is effectively tapped out, and can't easily increase their offer, their value proposition is now less attractive than it was beforehand.
However, just a restructuring doesn't provide a complete defense; but it sets the stage for the next step -- most likely a large acquisition (but potentially a stock buyback). While I'm not fluent in Allergan's bylaws, typically, a company of this size would be allowed to borrow money and make acquisitions without shareholder vote (which may now be hard to secure), so long as no new shares are issues (treasury shares, if any exist, typically may be used) and there is no degradation in credit rating. Allergan's current credit rating is near the top (it was at the very top, but took a bit of a dent with the Valeant offer, since bondholders are concerned that Allergan debt would become Valeant's -- which has Junk Bond status), and it's actual debt level is very low. Since the dominant factor in establishing credit rating is how many years' worth of profit will it take to pay the debt amount (Valeant's is around 4 -- making their bonds "junk," Allergan's is less than 1 -- making their debt "low risk"), an increase in profitability add several times it's own worth in borrowing capacity (and, if the target company also has a low-debt balance sheet, than their borrowing capacity is also available). By making Allergan more profitable, through restructuring, it is able to buy much larger companies than otherwise. The larger the company Allergan buys, the harder it becomes for Valeant to keep their offer viable. By using much of its borrowing power, Allergan will deny Valeant the ability to borrow the money needed for the cash portion of their offer. Some analysts (including Seeking Alpha -- the same guys whose analysis of this deal heralded the media barrage that so damaged Valeant earlier) have gone as far as saying this will get rid of Valeant altogether.
On a personal note, as I pointed in my opening remarks, while I have no relationship with Allergan whatsoever, a family member with a different last name (specifically, my wife) is an employee. We have just learned that the facility where she works is among those that will close. We don't yet know if she'll be offered to transfer, and if she does, if it will be an offer she will want to accept. Nonetheless, I'll try to stay here with periodic commentary intended to explain to people impacted by, but not familiar with, the mechanics and language of this hostile takeover attempt.
Dan.
