DEALTALK: Warner Chilcott buy may be Actavis' best takeover defense

NEW YORK Fri May 17, 2013 12:57pm EDT

NEW YORK May 17 (Reuters) - U.S. generic drugmaker Actavis , the subject of intense takeover speculation, may have found its best defense: a potential purchase of Warner Chilcott Plc, a specialty pharmaceutical company that has been for sale on and off for years.

Over the past several weeks, Actavis has spurned approaches from Canadian pharmaceutical company Valeant Pharmaceuticals International and U.S. competitor Mylan Inc, to instead pursue a bid for Warner Chilcott, people familiar with the situation have said.

Buying Warner Chilcott, a maker of women's health pharmaceuticals with a $4.8 billion market value, would put Actavis in the branded pharmaceutical space and reduce its tax rate because Warner Chilcott is based in Ireland.

For other healthcare companies, Warner Chilcott is far from a desired target. A big chunk of its revenue comes from drugs soon approaching patent expiration. Efforts to sell the company failed repeatedly over the years given little buyer interest.

A combination of Actavis and Warner Chilcott would likely kill chances of Actavis being taken over anytime soon by Valeant, Mylan or any other suitor eyeing the $15.8 billion company, according to analysts and people close to the situation who asked not to be named because the matter is not public.

Even Michael Pearson, the highly acquisitive chief executive of Valeant who routinely talks to other CEOs about acquisitions to test the waters, stayed away from Warner Chilcott so far.

Mylan, meanwhile, will not come back with another offer for Actavis if it goes through with its acquisition of Warner Chilcott, said one of the sources with knowledge of the matter.

If Actavis buys Warner Chilcott, it would be virtually impossible for Mylan, with a market value of $11.7 billion, to buy the combined firm. Mylan already has about $6 billion in debt and analysts estimate that a combined Actavis-Warner Chilcott would be closer to $21 billion.

"It is too big for Mylan and while Valeant could do it, I think it is unlikely given how much it would be outside their areas of expertise," said David Krempa, an analyst at Morningstar Inc.

Actavis and Mylan declined to comment. Calls to Warner Chilcott and Valeant were not returned.

BUYER OR SELLER?

Actavis has sent confusing signals to investors in recent weeks, reportedly engaging in talks to sell itself to Valeant at a low premium, then rejecting a higher offer from Mylan, and moving on to pursue a takeover of Warner Chilcott.

Valeant and Actavis were discussing an all-stock merger under which the Canadian drugmaker would buy its smaller rival for more than $13 billion, before the talks broke down in late April, people familiar with the matter said previously.

Mylan, thinking that Actavis could be a willing seller if it had been in talks with Valeant, then made its own offer on May 7, valuing Actavis at more than $15 billion, according to two of the people close to the situation.

Actavis, however, flat-out rejected Mylan's higher offer on May 10 without much of an explanation, and declined to engage in discussions, one of the people said..

On the same day, Actavis confirmed that it was in early-stage discussions to buy Warner Chilcott. The confirmation was triggered by Irish takeover rules.

A Mylan acquisition of Actavis would create the world's largest generics drugmaker with a 20 percent market share in the U.S. market, an important factor given that scale is the key to success in an industry that makes commodity products. .

Growth came easily to the generics industry over the past decade as blockbuster drugs like cholesterol-lowering Lipitor lost patent protection. That wave of patent expirations is slowing down, leading analysts to forecast a moderate 5 percent revenue growth for the generics industry in coming years.

Consolidation could help the industry to remain profitable, by allowing the companies to cut redundant capacity and scale up production to produce pills more efficiently.

Mylan was anticipating that a merger with Actavis would bring savings north of 10 percent of sales, or close to $1 billion annually, according to one of the sources with knowledge of the matter.

A JPMorgan analyst in a research note estimated that cost savings from such a deal would exceed $500 million annually.

A merger of Mylan and Actavis would have also meant significant slashing of revenues, given how similar the two companies' drug lineups are, said Corey Davis, an analyst at Jefferies & Co.

"They are almost completely duplicative in terms of products," he said. "To me it is almost an act of desperation in generics."

Stock markets liked the idea of a Valeant-Actavis tie-up, sending shares of Valeant up 3.8 percent and Actavis shares up 4.6 percent on April 29 after news of the merger talks was reported.

That acquisition would have been a very different kind of deal than a Mylan-Actavis merger because it would have brought together a branded pharmaceutical company with a generics company.

It is unclear why talks fell apart, but people familiar with Valeant CEO Michael Pearson, say that he often speaks to a number of acquisition targets before doing real due diligence.

"I could see him watching this for a year or two and seeing how it plays out," said one of the people familiar with Valeant. "It would not be the first time."

Amid intense takeover speculation, shares of Actavis have risen more than 22 percent and were trading around $123 Friday, above the latest offer of $120 per share from Mylan.

Actavis appears to be getting rewarded in the stock market whether it is buying or selling.

"The Street is already giving you $120-$125 just on the speculation that they will get the tax benefits from buying Warner Chilcott," said Jason Gerberry, an analyst with Leerink Swann. "Their ability to go out and find accretive transactions is going to be more value generating than just selling the business at $120 a share."

That is not to say that Warner Chilcott does not come with its share of warts. Around 40 percent of Warner Chilcott's revenue this year came from three drugs: Actonel, Losetrin 24 and Enablex drugs, all of which will go generic by early 2015, according to an analysis conducted by Jefferies.

"The fundamentals are not strong but that's why the stock is so cheap," Davis said.

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