Valeant Pharmaceuticals announced that is has agreed to acquire Obagi Medical Products, a leader in topical aesthetic and therapeutic skin-health systems. The company is known from leading dermatology brands including Obagi Nu-Derm, Condition & Enhance and Obagi-C, among others.
Valeant will pay $19.75 per share in cash for Obagi Medical, valuing the company around $344 million. The deal value represents a 28% premium compared to Tuesday's closing price.
CEO and Chairman J. Michael Pearson commented on the deal, "The acquisition of Obagi will be a valuable supplement to Valeant's current dermatology portfolio and will further build upon growing aesthetics franchise. Obagi is a leader in the physician dispensed market and enjoys a strong brand perception among physicians. The addition of their products will not only strengthen and diversify our dispensed portfolio, but also expand our market presence with dermatologists and plastic surgeons."
Obagi generated annual revenues of approximately $120 million for the year of 2012. The company ended September 2012, with roughly $21 million in cash and $1 million in debt, for a net cash position of $20 million.
As such, the deal values the operating assets of the company at 2.7 times annual revenues. The company net earned $9.4 million in the first nine months of the year, valuing it at approximately 25-26 times annual earnings
Valeant expects to achieve cost synergies of at least $40 million per annum within six months from closing the deal. As such, Valeant expects that the deal will be immediately accretive to cash earnings.
The deal is expected to close in the first half of this year and has already been unanimously approved by Obagi's board of directors.
Just a month ago, Valeant Pharmaceuticals reported its annual results for 2012. The company ended the year with $920.5 million in cash, equivalents and marketable securities. The company operates with $11.0 billion in short and long term debt, for a very sizable net debt position of little over $10 billion.
For the full year of 2012, Valeant generated annual revenues of $3.55 billion, up 44% compared to the year before. The company reported a $116 million loss as a result of $1.35 billion in restructuring charges and the amortization of intangible assets.
The market currently values Valeant at $22.3 billion. This values the company at approximately 6.3 times annual revenues for the past year.
Given the weak balance sheet, Valeant Pharmaceuticals does not pay a dividend at the moment, unlike many of its competitors.
Some Historical Perspective
Shares of Valeant have seen a fair bit of movement over the past years. Shares traded as high as $40 back in 2003 and steadily fell to lows of $8 during the financial crisis. From that point in time shares have steadily and quickly gained ground, currently exchanging hands around $73 per share. This level represents an all time high for the shares.
The company has aggressively grown its operations. Between 2009 and 2012, Valeant has more than quadrupled its annual revenues from $820 million in 2009, towards $3.55 billion over the past year. The company reported both modest losses as well as profits in recent years. The acquisition-based growth strategy has resulted in a severe dilution of the shareholder base. At the moment, Valeant has roughly twice the amount of shares outstanding compared to 2009. At the same time, the company has taken up $10 billion in debt in recent years.
Investors seem to applaud the recent deal, which is not that large for a company the size of Valeant. The deal with Obagi will increase annual revenues by some 3-4% and will be slightly accretive to earnings. As a result, the net debt position of the firm is expected to increase to roughly $10.3 billion on a pro-forma basis.
The deal seems a no-brainer. Valeant pays a significant premium, which values operating assets of Obagi at merely $320 million. The company earns approximately $12 million per annum, but Valeant expects to achieve another $40 million in annual synergies. As such, the deal values the company at approximately 6-7 times incremental earnings.
As such the deal seems extremely attractive, no wonder why investors send shares higher on the back of the announcement. Given the modest impact of the deal, this does not necessarily mean that Valeant represents an attractive investment on an overall basis.
In September of last year, I last took a look at Valeant's prospects after the company announced the $2.4 billion acquisition of Medicis Pharmaceuticals. At the time I concluded that the difference between GAAP earnings and cash-earnings, driven by impairment and restructuring charges related to past acquisitions, was too large to pass my margin of safety test.
Unfortunately I missed out on a roughly 33% rally over the past six months. Today, I reiterate my stance. Even if Valeant were to close the difference between GAAP and adjusted cash earnings overnight, the company would still trade at 16 times annual earnings. The company will furthermore still carry along a very sizable $10 billion net debt position.
I think investors might be overreacting at the moment, bidding shares up to fresh highs with every newly announced acquisition. While the addition of Obagi is a no-brainer if management can achieve its planned synergies, I remain on the sidelines. At these levels in the share price, there is not enough margin of safety to still step in.