The battle between Allergan Inc. (NYSE:AGN) and Valeant Pharmaceuticals International Inc. (NYSE:VRX) is continuing. Earlier this week, Allergan commented on Valeant's second-quarter results, saying that Valeant's lack of transparency with regards to information and data to support its performance is a major concern for Allergan's stockholders. Valeant, along with Pershing Square Capital Management L.P., meanwhile, has cited Institutional Shareholder Services' (ISS) recommendation, which supports Pershing Square's effort to call a special meeting of Allergan shareholders. Activist investor Bill Ackman's Pershing Square is the biggest shareholder of Allergan, with a 9.7% stake. Pershing has also teamed up with Valeant to acquire Allergan. Amid all of this, the crucial question for Allergan shareholders is whether their company should remain independent or be acquired by Valeant.
The Story So Far
The takeover battle for Allergan began in April this year. On April 10, Ackman's Pershing Square acquired 5% of Allergan's shares, taking its stake in the Botox-maker to 9.7%. Almost two weeks after Pershing Square's move, on April 22, Valeant Pharmaceuticals submitted a proposal to acquire Allergan in a transaction valued at $45.7 billion. Valeant offered 0.83 of its common shares and $48.30 in cash for each Allergan share.
The offer was rejected by Allergan Board in May following a review. David E. I. Pyott, Chairman and CEO of Allergan, said that the Board unanimously determined that Valeant's unsolicited proposal "substantially undervalues Allergan." Subsequently, Valeant raised its offer to 0.83 of its common shares and $58.30 in cash per share for each share of Allergan. Valeant raised the offer further to 0.83 of its shares and $72 in cash per share for each share of Allergan common stock.
In June, Allergan Board once again rejected Valeant's offer. Once again, the Board said that the offer "undervalues Allergan." The Board also noted that the transaction "creates significant risks and uncertainties for Allergan stockholders." Valeant eventually took its proposal directly to Allergan shareholders, commencing an exchange offer on June 18. Under the offer, Allergan stockholders would be able to elect to exchange each of their shares for $72 in cash and 0.83 in Valeant common stock, or an amount of cash, or a number of Valeant common shares, in each case subject to proration. The offer represents a significant premium over Allergan shares. However, in my view it does not create value for Allergan shareholders, who will end up with 43% of the combined company in the long-term.
All the while Valeant has been pursuing Allergan, the Canadian company has been backed by Ackman. The activist investor has been also seeking shareholder support for a special meeting of Allergan shareholders. Pershing said in a letter last month that the special meeting will allow Allergan shareholders to give their opinion on several crucial matters, which include the removal of six existing members of Allergan Board, as well as the appointment of an independent slate of directors. Without taking over the Board, it will not be possible for Valeant and Ackman to take their offer directly to shareholders. Ackman needs support of over 25% of shares in order to call the meeting.
Earlier this week, Pershing and Valeant commented on ISS's recommendation in support of Pershing's effort to call a special meeting of Allergan shareholders. Another proxy firm, Glass Lewis, has also supported Pershing's effort to call a special meeting.
On Wednesday, Allergan commented on the two recommendations, saying that they do not change the fact that Valeant's "offer is grossly inadequate, substantially undervalues Allergan, creates substantial risks and uncertainties for Allergan stockholders and is not in the best interest of the company and its shareholders." Allergan certainly has a point about the offer not being in the best interest of the company and its shareholders. However, the company is not right in not letting shareholders to meet to decide on the issues raised by Pershing.
Allergan, meanwhile, has also raised questions over Valeant's recently reported second-quarter results. In a press release, Allergan said, "Valeant's failure to provide complete, fully transparent information and relevant supporting data for its performance remains a significant and growing concern among Allergan's stockholders."
While Allergan has raised questions over the second-quarter results, investors have been more disappointed with Valeant's guidance. Valeant slashed its revenue and earnings guidance for the year, which pushed its shares sharply lower. That should worry Valeant, given that more than half of its offer for Allergan is in stock. Lower price for Valeant stock means a lower offer for Allergan.
The Legal Issue
Amid all the allegations, a legal issue has also popped up. Allergan has filed a lawsuit against Valeant, Pershing Square and Ackman. Allergan has alleged that they violated federal securities laws prohibiting insider trading, engaged in other fraudulent practices, and failed to disclose legally required information.
I am sure that Pershing and Valeant looked at all the legal issues before bidding for Allergan. Indeed, as the New York Times notes, there was not a secret deal between Valeant and Ackman. Apparently, Valeant CEO approached Ackman directly, informing him about Valeant's plan and seeking a partnership in which Ackman would acquire a large position in Allergan stock. However, Allergan alleges that when Ackman was building his stake in Allergan, he was aware that Valeant would eventually need to launch a hostile takeover offer. Not surprisingly, Valeant and Ackman have called the claims baseless. Of course, this is something that the regulators will have to decide. For Allergan shareholders, the most important question is whether they should agree to Valeant's offer. In my opinion, Allergan shareholders' interests would be best served if the company remains independent.
Allergan Should Remain Independent
In the last five years, Allergan shares have gained more than 180%, while Valeant shares have gained more than 700%. There is no doubt that Valeant has created significant value for its shareholders. Valeant says that the combined companies will create an unrivaled platform for growth and value creation.
But when I look at Valeant shares' recent performance, I am a little concerned. In the past one year, Allergan shares have gained more than 73%, while Valeant has gained nearly 19%. The last six months, though, have seen Valeant shares have fallen more than 20%. In the same period, Allergan shares have gained more than 33%. Of course, Allergan shares have partly benefited from the unsolicited offer from Valeant.
Over the years, Valeant has grown through acquisitions. But those acquisitions have stretched its balance sheet. Valeant has a debt/equity ratio of 3.42, compared to Allergan's 0.31. I don't think it makes sense for Allergan shareholders to gain exposure to a highly leveraged company. In fact, high leverage is possibly one reason why Valeant shares have struggled in the last six months.
In a low interest rate environment, Valeant's debt-fueled acquisition strategy might make sense. But, with the U.S. economy improving, there is a strong possibility that interest rates will start rising sooner-than-expected.
My concern is that the combined company will struggle to invest in growth, something that Allergan can do if it remains independent. That will leave Valeant with only one option, continue to grow through acquisitions. This creates uncertainly for Allergan shareholders.
On the other hand, Allergan has taken a number of steps lately that could create value for shareholders. The company will execute a restructuring that is expected to deliver pre-tax savings of approximately $475 million in 2015. The company already plans to reduce its workforce by 13% as part of the restructuring. Allergan expects its strategic plan to deliver compounded annual growth rate of over 20%. Considering all these factors, I believe it is best for Allergan if it remains independent.
Disclosure: The author is long AGN. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.