Salix Pharmaceuticals - Fresh Highs On The Santaurus Deal

Nov.11.13 | About: Salix Pharmaceuticals, (SLXP)

Shares of Salix Pharmaceuticals (NASDAQ:SLXP) jumped up on Friday after the company announced the acquisition of Santaurus (NASDAQ:SNTS).

The deal unleashes great diversification and synergy benefits which continue to drive the long term value of Salix. The $1.5 billion increase in the combined market valuation of both firms, combined with the excessive recent momentum already, makes me a bit cautious for now.

The Deal

Salix announced that it has entered into a definitive agreement under which the company will acquire the common stock in Santaurus for $32 per share in cash.

The all-cash deal values Santaurus at $2.6 billion and represents a 36% premium over the closing price of the stock on Wednesday, and a 39% premium over the average closing price over the past month.

Following the deal, Salix will have a strong portfolio with 22 marketed products, with no overlap between the products of both companies.

CEO Carolyn Logan commented on the rationale behind the deal, "We are extremely pleased with the Santarus acquisition, which is transformative for Salix both commercially and financially, fulfilling many of our strategic needs while providing immediate and significant accretion in 2014 and beyond."

Santaurus ended its third quarter with $169 million in cash and equivalents. The company operates with a solid net cash position as the firm has no debt outstanding.

Revenues for the first nine months of the year came in at $267.6 million, up 81% on the year before. Income before taxes roughly five-folded to $67.9 million as net earnings came in much higher on the back of income tax benefits. At this pace, annual revenues of $360 million and earnings of around $90 million on a pre-tax basis are attainable.

The reported $2.6 billion price tag, values operating assets of the firm at little over $2.4 billion when factoring in the net cash position of the firm. This values operating assets of Santaurus at 9 times annual revenues and 26-27 times pre-tax earnings.

The deal has already been approved by the board of directors of both companies and is expected to close in the first quarter of 2014.

Valuation

Salix ended its third quarter with $818 million in cash and equivalents and $876 million in total debt, for a very modest net debt position. The deal will be financed with roughly $800 million in cash at hand and a $1.95 billion financing commitment from Jefferies.

Salix generated revenues of $676.2 million for the first nine months of the year, up by nearly 26% on the year before. Net earnings roughly doubled to $90.8 million. At this pace annual revenues of around $900 million and earnings of $120 million seem attainable.

Factoring in gains of 18% on Friday, with shares exchanging hands at $84 per share, the market values Salix at $5.2 billion. This values the company at 5.8 times expected annual revenues and 43 times annual earnings.

Salix Pharmaceuticals does not pay a dividend at the moment.

Some Historical Perspective

Investors in Salix have seen great upside in recent times. Between 2004 and 2009 shares lost roughly half their value fall from $20 per share to levels around $10 per share.

Ever since, shares have seen steady returns, currently trading around all time highs of $84 per share. The reason is simple, Salix has seen very strong growth increasing revenues from just $233 million in 2009 to possibly $900 million in 2013. The company turned losses into solid earnings.

Investment Thesis

Investors in Salix and Santaurus are both enthusiastic about the proposed deal. The market valuation of both firms increased by roughly $750 million, for a combined market value increase of $1.5 billion. As such, the combined valuation of Salix and Santaurus has risen to nearly $8 billion.

On a pro-forma basis, Salix is being valued around $5.2 billion, while operating with a net debt position of $2.6 billion.

Combined, both firms have reported annualized revenues of $1.35 billion over the past year, valuing equity in the new Salix at 3.8 times annual revenues. GAAP earnings for 2014 are seen around $3.85 per share, excluding upside from revenue synergies, product approvals or launches. This values Salix at 22 times GAAP earnings for next year, with strong growth and additional synergies expected into 2015.

While Salix pays a premium for Santaurus at roughly 9 times annual revenues, compared to an own valuation at nearly 6 times revenues, Santaurus is much more profitable, trading at much lower profit multiples. Note that Santaurus is showing much more rapid growth as well.

Clearly the market likes the deal, on the back of prospects for a much more diversified player with meaningful cost and revenue synergies. Yet the market has cheered already and boosted the combined valuation of both firm by some $1.5 billion. Still, the newly formed Salix appears interesting in the long term. The 22 times GAAP earnings multiple for 2014 is not excessive, especially not given the strong growth at both companies and opportunities for higher synergies going forwards.

After a great run-up over the past years, shares in both firms had a great run already. While the current valuation is not cheap, the continued growth and deal-related synergies could continue to create value going forwards.

While I could easily see such a scenario materialize, I am cautious in the short run after very strong momentum already this year. I remain on the sidelines.

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.