Cephalon, Valeant Trading Higher on Hostile Takeover Bid, Investors Should Use Caution

Includes: CEPH, VRX
by: NakedValue

Valeant Pharmaceuticals International (NYSE:VRX) went public with a hostile proposal to buy out drugmaker Cephalon Inc. (NASDAQ:CEPH) for $5.7 billion or $73 per share. The proposal is all cash and is expected to be financed 100% with debt. According to Valeant, "Goldman Sachs & Co. (NYSE:GS) has provided a highly confident letter for the full amount of the financing."

After hours, Cephalon Inc stock jumped to nearly the buyout price. NakedValue.com recently featured Cephalon in a list of companies whose stock prices languished despite having high return businesses and low price/earnings. While the company faces looming sales pressures when their main drug Provigil comes off patent protection in April 2012, we are not surprised that the company has drawn interest in a buyout friendly environment. Even with the $73 per share proposal occuring 29% above Cephalon's 30 day moving average, the valuation ratios would still make the deal highly accretive to Valeant's results.

Another observation that we find noteworthy is Valeant's financial condition. The company has a more than $13.5 billion market capitalization, but with around $3.5 billion of long term debt as on December 31, 2010, tangible book value of -$4.4 billion and trailing twelve month revenues of around $1.2 billion, investors would be justified in wondering about Valeant's ability to secure financing for the deal.

Finally, another stumbling block might be Cephalon's management. While the company was seen as in play following the passing of founder and CEO Dr Frank Baldino last year, but this may not be the case. Their recent acquisition of Gemin X seems to send a message that they are committed to remaining indepedent and agressive as they expand their pipeline. Based on the most recent proxy, management has long dated options with exercise prices as high as $76.11. This may create a strong reason for insiders to dislike the deal if the low implied valuation on the $73 per share wasn't reason enough.

This announcement is clearly great news for existing Cephalon shareholders. Regardless of whether or not their shares are acquired, this hostile bid has been a great catalyst for an inexpensive stock. After hours, the announcement caused both VRX and CEPH to trade higher. Potential investors in VRX and CEPH should exercise caution buying at these elevated prices, especially when it comes to Valeant. We at NakedValue.com feel that the deal is unlikely to succeed at the current price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.