Depomed: Acquisition Target?

| About: Depomed Inc. (DEPO)

Summary

Recently rumors surfaced that the company may be preparing for a possible sale of the company after last years $29 a share failed hostile take over attempt from Horizon.

Based on a discounted cash flow analysis, acquirers with an existing US pain franchise, favorable ExUS tax status and/or access to cheap financing are likely to be potential suitors.

There are several companies that meet two of these criteria with potential to pay $30 a share or more.

At the current price of $24 a share, the market appears to be pricing in only roughly 50-50 odds of a deal occurring.

Background:

Depomed (NASDAQ:DEPO) is specialty pharmaceutical company focused on pain and related central nervous system disorders.

The company markets a portfolio of pain products in the US that includes the following diversified portfolio of FDA approved products: NUCYNTA ER (tapentadol), NUCYNTA (tapentadol), Gralise (gabapentin) Cambia (diclofenac potassium for oral solution) Lazanda (fentanyl nasal spray) and Zipsor (diclofenac potassium liquid capsules). Current annualized sales are at a ~$470 Million run rate with the Nucynta franchise accounting for ~60% of those sales.

(Editor's note: A previous version of this story said that Depomed announced preparation for a possible sale of the company. A spokesperson for Depomed has contacted us to say that no announcement was made, and the article has been updated to reflect this.)

On September 16th, rumors surfaced that Depomed may be preparing for a possible sale of the company after an upcoming court decision on Nucynta patents. This comes after last year's failed hostile takeover attempt last year by Horizon Pharmaceuticals (NASDAQ:HZNP) for $29 a share and with increasing pressure from activist investors at Starboard to advocate for a sale of the company.

This article will assess the potential value of Depomed to a strategic acquirer and identify companies that might be interested in acquiring the company.

What is Depomed worth as a stand alone entity?

Since the withdrawal of Horizon's hostile offer, the stock price has traded on average near the $18 a share level. With about 61 Million shares outstanding this values the equity at ~$1.1 Billion. Factoring in the $720 Million in long term debt less the $120 Million in cash yields a baseline enterprise value of ~$1.7 Billion.

Using the key metrics of gross sales, COGS rate, SG&A expense, R&D expense from recent financials and assuming a base 35% tax rate I built the simple discounted cash flow model below. Assuming a 10% cost of capital and 9.5% gross sales growth through 2028 (with no terminal value) I was able to derive a simple stand alone P&L for Depomed that yields a stock price near $18 a share.

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What might Depomed worth to an acquirer?

I believe that there are three potential categories of acquirers that could be interested in Depomed:

1. An acquirer with an Existing US Pain Franchise

2. An acquirer with Favorable International Tax Status

3. An acquirer with both an Existing US Pain Franchise and Favorable Tax Status

I've used this simple base case model and adjusted key assumptions to illustrate what Depomed might be worth to an acquirer. In addition I applied a range of discount rates from 10% to 6% to illustrate the potential impact for those companies that may have access to low cost debt financing.

1. Acquirer with Existing US Pain Franchise

In the hands of an acquirer with an existing US commercial pain franchise I believe there is the opportunity to cut the ~$200 Million in annual SG&A by 90% to ~$20 Million. This takes out the costs related to the sales force, commercial support functions, finance, IT, HR, etc. that could be all be handled by the acquirers existing infrastructure at minimal incremental cost. It does leave some direct brand related costs associated with promotion and manufacturing, etc.

In this scenario, cutting out 90% of SG&A expense yields a potential price per share of ~$31 assuming a 10% discount rate. Assuming cheap financing were available to cut the discount rate to 6% drives the price up to ~$42.

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2. Acquirer with Favorable Tax Status

In the hands of an acquirer with favorable tax status, I believe there is the opportunity to cut the ~$200 Million in annual SG&A by 60% to ~$80 Million. This takes out the costs related to finance, IT, HR, etc. that could be all be handled by the acquirer, but it does leave in the direct brand related expenses (~$20 Million), plus the cost of retaining the pain sales force (~$60 Million for 250+ reps). In addition, I assumed the tax rate would be cut from 35% to 15%.

In this scenario, cutting out 60% of the SG&A expense and cutting the tax rate to 15% yields a potential price per share of ~$27 at a 10% discount rate. Adding in cheap financing at a discount rate of 6% drives the price up to ~$37.

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3. Acquirer with Existing US Pain Franchise and Favorable Tax Status

In the hands of an acquirer with an existing US commercial pain franchise and favorable tax status, I believe there is the opportunity to cut the ~$200 Million in annual SG&A by 90% to ~$20 Million. In addition, I assumed the tax rate would be cut from 35% to 15%.

In this scenario, cutting out 90% of the SG&A expense and cutting the tax rate to 15% yields a potential price per share of ~$44 at a 10% discount rate. Adding in cheap financing at 6% boosts the price per share to ~$59 a share.

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So are there any companies meet any of these criteria?

Based on the analysis above, the most likely buyers would have some combination of an existing US pain business, favorable ExUS tax status and availability of cheap financing.

Given this criteria, the following companies are examples of likely potential candidates that might be interested in acquiring DepoMed:

Company

Existing US Pain

Favorable Tax Status

Cheap Financing

Endo (NASDAQ:ENDP)

Yes

Yes

Mallinckrodt (NYSE:MNK)

Yes

Yes

Horizon (HZNP)

Yes

Yes

Purdue

Yes

???

Pfizer (NYSE:PFE)

Yes

Yes

Shire (NASDAQ:SHPG) and Multiple Others

Yes

Yes

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So what are the potential outcomes?

Like all M&A deals this is likely to be a fairly binary event based on if a sale occurs or not. I believe the table below summarizes the following possible outcomes:

Scenario Description Share Price
Worst Case Lose patent case & No acquisition Less than $18
Downside Case No acquisition ~$18
Upside Case Acquisition single bidder ~$30
Best Case Acquisition multiple bidders Greater than $30
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At a current price of $24 a share the market appears to pricing in roughly 50/50 odds of a move to $18 or lower (no deal) vs. a move to $30 or higher (deal). Given the number of potential suitors who could extract value from an acquisition, the recent pace of M&A activity and the potential for bids north of $30, the current share price may not yet appear to fully reflect the acquisition potential.

Disclosure: I am/we are long DEPO.

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.