There’s nothing on Wall Street that will bring you more ridicule in real time, and praise in good time, than buying low. The guy who buys at the bottom is always catching a falling knife while being eye-rolled by everyone else. Somebody’s got to do it though. Otherwise, there would be no bottoms. The criticism is even worse when indexes are at all-time highs and momentum-chasing is still in vogue.
Ridicule for buying low isn’t restricted to individual traders taking this or that position. It’s the same with companies in mergers and acquisitions. A company reaches out to buy a struggling competitor whose stock has been hated for years and gets criticized. AbbVie (ABBV) is feeling that same heat now with its proposed buyout of Allergan (AGN). Nobody likes Allergan because it’s down 50% from all-time highs hit July 27, 2015. Two months later, Hillary Clinton sent out that pharma-smashing tweet about price gouging, sending the whole healthcare complex into a tailspin, and Allergan never recovered.
There are other good reasons why Allergan has fallen so hard these last four years. You can find them in every negative article on the proposed merger and I can’t really argue with them. But what can certainly be said is that after a 50% price decline, no company looks great as sentiment is negative to the point that touching the stock’s shadow makes you unclean. Sentiment is much worse than it was in 2015, but Allergan is a much better value now than it was then. AbbVie sees this and is making its move.
Analysts are calling the deal boring, more of the same, and a combination of two challenged businesses. That may all be true, but being boring, more of the same, or combining two challenged businesses doesn’t make the deal bad. I wonder what the same deal would be called had AbbVie bought Allergan back in 2015 when it was flying high and analysts loved the company. A combination of titans maybe? And it would have been a bad idea.
Sexy vs Prudent
Here we have a case of Wall Street looking for something sexy rather than something prudent. FiercePharma, for example, quotes Piper Jaffray analyst Christopher Raymond, as praising the financial aspects of the deal but questioning the strategic benefits. But isn’t financial health a strategic benefit, especially in wild financial times like these? At the same time he criticizes M&A in pharma generally because of high valuations. Well Allergan does not have a high valuation, which is why AbbVie is buying it. So why the criticism? It’s just not exciting enough?
The strategic thinking here is simple enough though, outside of a pure balance sheet perspective. It's just too obvious to actually praise. AbbVie is a company constantly criticized for relying too heavily on patents for blockbusters, particularly Humira. Botox, Allergan’s bestseller, is trademarked rather than patented, so there is little danger of sales erosion from competition any time soon. AbbVie is finally making a move to counter the patent doomsday crowd and it’s still being criticized for finally doing it.
The global economy is slowing and signs of recession are increasing, so perhaps it is time to forego risky, bombastic deals for the sake of safer ones that just make financial sense but don’t necessarily generate fireworks. AbbVie already took a big risk on a glitzy deal back in 2015 with Pharmacyclics. Now it’s doing something more conservative by buying a company out of favor.
Allergan Doing Just Fine
The other problem is that negative sentiment tends to obscure positive fundamentals. How has Allergan been doing, fundamentally, since its great fall that began 4 years ago? Pretty well, actually, for a company whose share price has been cut in half. EBITDA for 2018 was $384M for 2018 versus $34.7M in 2015. Long term debt is down 43%. Annual debt service costs are down 24%. Revenues up, debts down, sounds strong enough to me. Not enough to attract the momentum-chasers, but they don’t contribute to longevity.
Now is the Time
If AbbVie was ever going to make a move like this, then now is the best time to do it.
- Allergan just lost nearly $2.5 billion in goodwill due to the failure of Rapastinel and the delayed launch of brazikumab, lowering the price tag substantially.
- AbbVie still has about 3 full years until it loses exclusivity on Humira in the United States, which will help pay for much of the Allergan acquisition. Without Humira exclusivity in the US, Humira sales will be about 40% lower than they are now. 40% of current US Humira sales times three and we have about $16-18B that AbbVie would otherwise not have, which pays for about a quarter of the purchase price.
- Interest rates are plummeting again, unbelievably. Whenever this mania ends, bond traders and financial historians will look back at this period as the most warped, irrational debt market in world history. If you’re going to take out a huge $38B bridge loan like AbbVie just did, now is the time to do it.
- There is even the possibility that rates will be nominally negative in the US by the peak of the upcoming rate-cutting cycle, so when AbbVie refinances its bridge loan into long term bonds at fixed rates (hopefully), and hedges with swaps to go back to floating if needed (this is how it handles its current debt), AbbVie could be paying negative rates eventually on this deal.
Hopefully, whoever structured AbbVie’s finances also sees serious debt market problems down the road and will be quick about refinancing quickly and locking in low rates as far out as possible.
If AbbVie can hit the top of the bond market or near it, it will be in very good fiscal shape once interest rates head the other direction. This is inevitable, and it will surely happen way before AbbVie finishes paying all this off. It will most likely be an extreme, era-defining event in finance, considering how crazy the bond market has become globally.
The Combined Debt Picture
The two companies have about $23 billion in principle due by 2022, so that will have to be refinanced at fixed rates as well. Hopefully this will be done sooner rather than later, and believers in this deal should hope that the combined company refinances all this pretty soon. Getting caught in an interest rate tsunami is a real possibility, though it’s one that most pharma analysts ignore because debt isn't that much of an issue with large pharmaceutical companies generally.
In order to ensure that this deal is indeed bullish, it would be prudent to wait and see how the debt load is refinanced going into next year. It must be done before rates reverse.
Assuming AbbVie plays its cards right and fixes its remaining debt service costs, then the deal makes perfect financial sense. That’s enough in the context of the environment I believe we are headed into. If the deal makes financial sense, why should it result in the erasure of $8B in market cap, which was the combined reaction when the deal was initially announced? It shouldn’t. It's just traders reacting negatively to a deal that won't generate spectacular growth numbers, until buyers come in realizing that fundamentally, the deal has legs. The combined company will make more money than otherwise and spend less than otherwise. That's the bottom line
Disclosure: I am/we are long ABBV. 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.