(This story originally appeared on IFR, a Thomson Reuters
By Danielle Robinson
NEW YORK, April 28 (IFR) - The heightened level of event
risk in the pharmaceutical sector was demonstrated when
Allergan, the pharma giant behind Botox, saw its bonds plunge
some 10 price points on news that activist investor William
Ackman and Valeant Pharmaceuticals International are
spearheading an attempted hostile takeover of the company.
Moody's and Fitch both moved Allergan's rating outlook to
negative, warning that a successful takeover by the Canadian
"serial acquirer" and Single B rated Valeant would crush
Allergan's A3/A+ investment-grade credit rating.
Allergan's 2.8% March 2023s plummeted on Tuesday to 84.58 in
the secondary market on the news, where they were quoted at
225bp bid/175bp offer over Treasuries - sharply off from 94.53
and 80bp/70bp bid/ask the day before.
Although Allergan quickly adopted a "poison pill" defence in
an attempt to prevent a takeover, its spreads failed to return
to their former levels, with the 2023s at 200bp on Thursday.
Like many bonds of the best-rated pharmas, Allergan's US$2bn
of outstanding debt does not have change-of-control covenants,
leaving them open to being subordinated to secured debt of an
acquirer like Valeant and a rapid tumble into junk-bond status.
Even if the acquisition is not successful, the name has now
been tainted by the agitating presence of Ackman.
"Negative ratings pressure would stem from significant
shareholder-friendly actions if Allergan stays
independent, including leveraged share repurchases or special
dividends," said Fitch pharma analyst Michael Zbinovec.
Ackman's Pershing Square Capital Management, which currently
holds 9.7% of Allergan, has teamed up with Valeant to mount the
takeover bid, currently valued at US$45.6bn.
Valeant is aiming to become one of the world's top five
pharma companies by the end of 2016 and is just one of a swarm
of companies in the sector on the hunt for acquisitions.
"We expect the next few years to be particularly active from
an M&A perspective and pivotal in the reshaping of the
industry," wrote Shubhomoy Mukherjee, a senior pharma credit
analyst at Barclays, in an April 3 report, issued before the
Valeant is proposing to swap each Allergan share for US$48.3
in cash and 0.83 Valeant shares. It says it has committed
financing from Barclays and Royal Bank of Canada for about
US$15.5bn, which would be broken into "secured bonds, unsecured
bonds and bank debt [at an] expected interest rate of around
5.5% on new debt," Valeant said in a filing.
That compares with Allergan 2023s yielding around 4.6% after
news broke of the hostile takeover attempt.
Big pharma companies such as Pfizer, Merck & Co and Sanofi,
are seeking "strategic options for non-core assets", according
to Barclays' Mukherjee, while generic drug companies suffering
from slowing growth in that business are looking to build
portfolios of branded drugs via acquisition.
In the past week it was revealed that Pfizer, which has
plans to split into three parts, had made an unsuccessful
US$101bn run at AstraZeneca. Novartis also announced a flurry of
purchases and divestments involving GlaxoSmithKline and Eli
Lilly, which will see both Novartis and Lilly tap the bond
markets for funds.
Meanwhile, Teva has stated it is open to acquisitions and
Mylan, which has just had its bid for Meda rejected, is looking
to do a substantial transaction this year.
"The opportunity is in the fact that the many participants
grow so scared of M&A that credit spreads tend to overreact".
US companies seeking to lower their tax rates by
re-domiciling to lower tax jurisdictions such as Ireland are
also spurring acquisitions.
The shareholder activist hook-up with a lower-rated firm to
buy a higher-rated one is one of the more disturbing trends for
"Historically we have seen highly rated pharma companies
taking over lower-rated ones," said Michael Levesque, pharma
ratings analyst at Moody's.
"In today's landscape the shape of M&A is up in the air -
and as the Valeant/Allergan situation demonstrates, it could
mean a lower-rated company successfully taking over a
higher-rated one and saddling it with much higher leverage
levels," he said.
Many total return investors benchmarked to an index are
avoiding the sector because of the event risk. "The
Valeant/Allergan deal has certainly raised red flags for us,"
said a senior portfolio manager of a total return fund with more
than US$10bn in assets under management.
But not all M&A is bad for investors, and with spreads at
all-time tights, getting on the winning side of an M&A trade can
generate significant alpha.
"Frankly, in the bond market, the opportunity is in the fact
that many participants grow so scared of M&A that credit spreads
tend to overreact," said Scott Kimball, senior portfolio manager
at Taplin, Canida & Habacht, part of the BMO Global Asset
"Yields spiking beyond those justified by the transaction
leave companies that look fundamentally solid trading cheap."
(Reporting by Danielle Robinson; Editing by Philip Wright)