Actavis - A Potential Deal With Warner Chilcott Would Further Spur Interest In Actavis Itself

| About: Allergan plc (AGN)

Shares of Actavis (ACT) saw a big jump in Friday's trading session, to consolidate gains in the first two trading session of this trading week.

The pharmaceutical company announced that is has entered into early stage discussions with Warner Chilcott (WCRX) regarding a potential deal. Actavis stresses that no agreement has been reached as of yet, still shares jumped more than 12% in Friday's trading session, trading at fresh all time highs.

A Potential Deal

Actavis confirmed it has entered into preliminary discussions with Warner Chilcott, which has seen its shares advance by some 20% in Friday's trading session. Shares of Warner rose another 5% in Monday's trading session to levels around $19 per share.

Warner is a specialty pharmaceutical company focused on women's healthcare, gastroenterology, dermatology and urology, with a focus on North America.

For the year of 2012, Actavis generated revenues of $2.54 billion, down 6.9% on the year before. Net income advanced by more than 135% to $403 million.

After the recent jump, the market values Warner Chilcott's equity at $4.7 billion. The firm furthermore holds cash and equivalents of $474 million, while it operates with $3.80 billion in total debt, for a net debt position of around $3.3 billion.

With a total enterprise value of $8 billion, a potential deal at current levels would value the firm at 3.2 times annual revenues and 20 times annual earnings.


Actavis ended the first quarter of its fiscal 2013 with $337 million in cash, equivalents and marketable securities. The firm has $6.24 billion in short and long term debt outstanding, for a net debt position of around $5.9 billion. As such, a potential deal with Warner Chilcott would most likely be financed with a fresh offerings of shares in Actavis.

The company generated full year revenues of $5.91 billion for 2012, up 29% on the year before, as growth was driven by acquisitions. As a result of one-time acquisition-related charges, net income fell some 63% to $97.3 million.

First quarter revenues for 2013 advanced by 24.3% to $1.90 billion. The company reported a net loss of $102.8 million, driven by impairment charges on the acquisition of the legacy Actavis Group and Uteron Pharma.

Factoring in the 12% gains in Friday's trading session, the market values Actavis around $15.3 billion. This values the equity of the firm at 2.5 times 2012's annual revenues and an incredible 157 times 2012's GAAP earnings.

Given the lack of profitability and the levered balance sheet, Actavis does not pay a dividend at the moment.

Some Historical Perspective

Long term holders of Actavis have seen great returns. After shares have traded in a $20-$40 price range between 2004 and 2008, they broke out towards the upside as CEO Bisaro took the lead. Shares steadily moved upwards towards $120 per share at the moment, trading at fresh all time highs.

Between 2009 and 2012, Actavis has more than doubled its annual revenues from $2.8 billion to $5.9 billion over the past year. Net earnings fell from $222.0 million to $97.3 million in the meantime as the acquisition-driven growth strategy resulted in impairment charges in recent times.

Investment Thesis

Under command of CEO Bisaro, Actavis has rapidly grown its operations in recent years which has provided a boost to the share price. Last year, Whatson Pharmaceuticals acquired Actavis Group in a $5.5 billion deal. Following the deal the company changed its name into Actavis. The deal was followed by a $305 million deal with Uterson Pharma based in Belgium, announced earlier in 2013.

Actavis is currently the world's third largest generic drug manufacturer, and owner of a very promising pipeline. The company's operations are very promising, as such Valeant Pharmaceuticals (NYSE:VRX) was in merger talks with Actavis to create a leading generic drug manufacturer earlier this year. Yet a deal does not seem to materialize yet as Valeant was scared off by the price tag of the company. On Tuesday reports hit the news wires suggesting that Mylan (NASDAQ:MYL) offered $15 billion, or $120 per share for Actavis. According to people familiar with the matter Actavis rejected the offer.

At the same time the acquisition-based growth strategy of Actavis results in large discrepancies between GAAP and non-GAAP earnings. First quarter non-GAAP earnings per diluted share came in at $1.99 per share, up 21% on the year. The company reported a net loss as a result of $270 million in charges related to the deal with Actavis Group.

At this pace Actavis is on track to generate annual adjusted EBITDA of $1.95 to $2.03 billion for 2013, on which the firm could report non-GAAP earnings of $8.10-$8.50 per share.

With a potential acquisition of Warner Chilcott, Actavis could buy international assets in Ireland providing the company with an opportunity to improve its tax structure while increasing its presence in brand medicines in women's health. At the same time, Warner is a well known seller as the company tried to sell itself last year. On top of that, a possible deal would allow Actavis to sell Warner's drugs outside of North America. At the moment Warner generates 90% of total revenues in North America.

If a possible deal were to go through, Warner's equity is being valued around 1.8 times 2012's revenues, a discount to the company's own valuation of 2.5 times last year's revenues. On top of that come the revenue, cost and tax synergies which can reasonably be expected following a deal.

The potential of a deal with Warner further propelled shares of Actavis to fresh highs. As such, the move could be seen as a defensive move as suitors like Valeant and Mylon have shown an interest in Actavis.

As such a potential deal seems appealing for Actavis and it could even spark more interest in the company itself. Quite possibly, other large pharmaceutical giants besides Valeant and Mylon could have woken up as well. Large pharmaceutical giants which lack activities in the generic drugs space could go after Actavis to achieve a significant presence in the field.

Yet I remain on the sidelines for now. If a potential deal would go through, I might miss on further upside. While I applaud the strong growth and strong pipeline of Actavis, as well as the interest in the company by its competitors, I am holding off from making an investment due to the large discrepancy between GAAP and non-GAAP earnings. Impairment charges have become a structural expense given the acquisition-based growth strategy of the company. This makes me hesitant, especially after the recent strong price performance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.