Shares of Akorn (AKRX) spiked upwards in Tuesday's trading session after the generic pharmaceutical company announced the acquisition of Hi-Tech Parmacal.
The excellent addition, both financially as well as strategically, does boost the overall appeal of Akorn. Yet I remain cautious on the back of a high current valuation of the shares, after they have roughly 20-folded from 2009s lows.
Akorn announced that it has entered into a definitive agreement under which it will acquire Hi-Tech Pharmacal (HITK). Akorn will pay $43.50 per share in cash for Hi-Tech, valuing the business at $640 million.
The proposed deal price represents a 23.5% premium over Monday's closing price, the day before the deal was announced.
Just like Akorn itself, Hi-Tech is focused on the development, manufacturing and marketing of generic, as well as branded prescription and over-the-counter products. The company focuses on difficult to manufacture forms including creams, nasal sprays, otics and gel products, among others. CEO Raj Rai commented on the rationale behind the deal:
This is a transformative event for our company. The portfolio of Hi-Tech products is a great strategic fit to our currently marketed products as it diversifies our offering to our retail customers beyond ophthalmics to other niche dosage forms such as oral liquids, topical creams and ointments, nasal sprays and otics. In addition, we are excited about Hi-Tech's product pipeline which would further enhance growth opportunities for the combined platform.
Hi-Tech generated annual revenues of $232.4 million over its past fiscal year, up just slightly from the year before. GAAP earnings plunged from $48.4 million to just $16.3 million after the company reported a fourth-quarter loss on the back of falling sales and increasing costs.
For the quarter ending in April of this year, Akorn ended with $100.6 million in cash and equivalents. The company held $9.0 million in debt for a solid $91 million cash position. The $640 million price tag therefore values operating assets around $550 million. This values Hi-Tech at 2.4 times annual revenues and 33-34 times annual earnings.
As a result of the deal, Akorn expects to realize $15 to $20 million in annual synergies within 12 months of the close. As such the deal is expected to be accretive to non-GAAP adjusting earnings per share immediately after closing.
Akorn ended its second quarter with $58.4 million in cash and equivalents. The company operates with $106.7 million in total debt, for a net debt position of $48.3 million. To finance the deal, Akorn has found committed financing from J.P. Morgan (JPM).
Revenues for the first six months of the year came in at $150.9 million, up 31.2% on the year before. Net income almost doubled to $23.5 million in the meantime.
Akorn sees full-year revenues of around $310 million and GAAP net income of $47 to $50 million.
Factoring in gains of 10% on Tuesday, with shares exchanging hands at $18 per share, the market values Akorn at $1.8 billion. This values operating assets of the firm at $1.75 billion, or 5.6 times annual revenues and 36 times annual earnings.
Akorn does not pay a dividend at the moment.
Some Historical Perspective
Long-term holders in Akorn have seen great returns. Shares peaked around $7 back in 2007 before falling to lows of $1 in 2009. A great run up ever since has sent shares to all-time highs around $18 per share.
Between the calendar years of 2009 and 2012, Akorn has more than tripled annual revenues from $75.9 million to $256.2 million. The company turned losses into a $35.4 million profit last year.
Investors are very pleased with the deal. After the 10% jump, the market valuation of Akorn has been boosted by a cool $150 million.
The main reason behind the move is the great synergies that will bolster earnings per share. Akorn states that if the deal had been executed on January 1, of 2013, full-year non-GAAP adjusted earnings would have seen some 40% accretion.
As such the deal is a game-changer for Akorn. The company is spending roughly 30% of its market capitalization, after backing out the net cash position, to acquire a firm which generates revenues equivalent to 75% of its own annual revenues. While Hi-Tech's earnings have been falling hard over the past year, the earnings multiple is in line with Akorn's own valuation.
While sales declines at Hi-Tech need to be addressed and justify a serious discount to Akorn's own valuation, the synergy estimates provide a great margin of safety. Synergy estimates of $15 to $20 million should boost net profits by some $10 to $15 million, assuming statutory tax rates.
Combined both firms should generate annual revenues north of $500 million while earnings should top $65 million easily, assuming synergies pay for increased interest expenses. This would value the combination at 3.3 times annual revenues and 27 times earnings, thereby making the overall valuation a bit more appealing.
On top of that come strategic benefits including having more diversified operations, broadening the appeal of product offerings and boosting the presence in prescription and OTC products.
Merger and acquisition activity has picked up in the sector in recent times. Emerging generic drug manufacturers are combing operations to achieve scale synergies, while many traditional pharmaceutical companies are picking up generic companies or acquiring biotechnology companies to built up their drug pipeline, or diversify their cash flows.
While the deal makes sense, and the synergy estimates more than justify Tuesday's jump I remain on the sidelines on the back of a premium valuation. That being said, the news flow might have put Akorn on the radar again, and make the company subject to takeover rumors going forward.