Allergan (NYSE:AGN) announced a few updates in the past 24 hours. We welcomed the first and met the second with understanding and approval. The first [closing the Teva (NASDAQ:TEVA) transaction] was something anticipated, and yet fraught with uncertainty given the delays and the potential downside risk to the stock had the sale failed to close.
We previously addressed what Allergan plans to do with the proceeds in our last article. One update to our last article was that Allergan received 100.3M shares of Teva based on the accurate VWAP calculation (vs. our assumed 98M shares), so Allergan owns slightly more of Teva than we anticipated.
Some have wondered why there was no "pop" to the shares post-announcement, we think the market had priced in the completion of the sale already. The market is forward looking and certainty for closing the transaction gained momentum a few weeks ago. Then Teva announced a bond sale and finally the imminent close. The bond sale certainly bolstered confidence. Why take out a mortgage for a home purchase if you're not sure escrow will close?
So with that, Allergan's shares had already began trading higher before yesterday's close, 10-15% in a few weeks. Now that the close is behind us, Allergan can begin its share buyback program. Also look out for smaller M&A transactions [leaving aside the Biogen (NASDAQ:BIIB) rumor that has since been debunked] and in-licensing deals to come.
Sale of Anda Distribution Segment
The second announcement made in short-order was the sale of Allergan's Anda Distribution segment. Per the first quarter Form 10Q, the Anda Distribution segment:
"includes distribution of generic and branded pharmaceutical products manufactured by third parties, as well as by the Company, primarily to independent pharmacies, pharmacy chains, pharmacy buying groups."
The Anda business operating results excluded sales of products developed, acquired, or licensed by the US Brands, US Medical Aesthetics and International Brands segments. As the generics business was reported within Discontinued Operations, the Anda Distribution segment included revenues and expenses related to Company manufactured generics products sold through Anda. This essentially meant that the Anda business became a pure distributor for the generic products that were to be sold to Teva.
We believe that this transaction was likely pre-negotiated given the speed of the announcement, the multiple paid and largely because Anda as a standalone business would have been unviable now that Allergan had sold the generic business. The business historically generated a 6% operating margin and based on the press release today was forecasted to contribute 4% to EPS in 2016 or $0.15 a share. Both of these figures were certain to continue trending down as Teva slowly migrated the generic business to its distribution platform, something Allergan would have anticipated. Given that the priority was to sell the generic business, the parties likely agreed to divest that first, then deal with the distribution business later and mitigate regulatory risks.
Selling Anda will have a few immediate benefits.
1. Eliminating a business with a 6% contribution margin will immediately increase the average overall operating margins as the three remaining businesses (US Brands, US Medical Aesthetics and International Brands) generate a combined operating margin of over 60%. Consequently, the "drag" of the Anda will now be removed. This is another way of saying that although the company makes slightly less overall, the activities that it focuses on are much more profitable.
2. $500M purchase price represents an 8x multiple on a distribution business that had little value going forward. This is a fair multiple and the $60M "hit" to EPS (i.e., $0.15 per share or $60M) can be partially mitigated by paying down additional debt, or fully mitigated by acquiring an asset or company that generates a margin better than 6%.
3. The company is now more focused as the Anda became a legacy distribution business tied to the Teva generic assets. We believe also the litigation risks associated with generic distribution also falls away (although this is to be confirmed as we've yet to see the agreement).
Clean-up Items and Q2 2016
A few other clean-up items to note. When the Teva transaction closed, two generic products, Carafate and Actonel were excluded from the sale, and Teva reduced the purchase price by $221M. We believe Allergan will likely sell these assets, and although the valuation will be impacted there's still some value to be had, so look out for this.
Earnings release for Q2 2016 is scheduled for next week (August 8th) and revised 2016 guidance will be forthcoming. We eagerly anticipate this now that Allergan is a "cleaner" and a more focused company going forward. Since the company has paused in its acquisition spree, the year-over-year comparisons will now be somewhat easier (until the next major acquisition of course).
We also believe that Allergan may need to further tighten/reorganize its internal organizational structure given the various divestitures and cancelled Pfizer transaction. The company until recently was a "roll-up" so legacy systems, redundancies and even operational risks must exist. If the company is pushing forward as a stand-alone specialty pharma player, a renewed focus on reducing costs, capturing efficiencies and operational excellence is paramount. The company has great assets, talented leadership and a bright future, but only if it executes well.
Disclosure: I am/we are long AGN.
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.