Salix Scores Santarus in a Savvy Deal

Salix Scores Santarus in a Savvy Deal

Salix Pharmaceuticals has long been a solid, if volatile, specialty pharmaceutical company. Salix has long relied upon its rifamycin-based drug Xifaxan for a significant percentage of its revenue (almost two-thirds as of the most recent quarter), while hoping that other approved products like Apriso and Solesta and pipeline drugs like Relistor (for opiod-induced constipation) could add both growth and diversity.

Now the company has taken a significant step forward in diversifying its revenue base and leveraging its balance sheet. Last week, Salix announced an agreement to acquire Santarus for $2.6 billion in cash. The deal may look expensive at more than seven times estimated 2013 sales, but the collection of assets that Salix is acquiring should deliver above-average growth with strong synergies with Salix's existing business.

What Salix is getting
In buying Santarus, Salix is getting a business that should both complement and enhance its existing operations. Sell-side analysts expect Santurus to generate nearly $370 million in revenue for 2013, with more than 40% of that coming from Glumzeta, the company's extended release version of metformin, a diabetes drug with a very long history of use. Another quarter or so of Santarus's revenue comes from Zegerid, the company's version of the protein pump inhibitor omeprazole.

Those drugs are interesting in their own right, but they carry the risk of losing patent protection in 2016 (or perhaps sooner). More critical to the story is the sales ramp of Uceris, a novel oral formulation of budesonide for the management of ulcerative colitis. This is a market that Salix already knows well (Aprio is also a UC drug), but Uceris has the potential of growing into a drug worth $400 million to perhaps as much as $700 million in annual sales. Salix's long experience and expertise in the gastrointestinal drug market should be a significant asset when it comes to maximizing the value of Uceris, and I believe investors could argue that the potential value of Uceris alone justifies at least two-thirds of the Santarus purchase price.

These aren't the only assets Salix is acquiring in the deal. Salix had already announced its intentions to expand its sales force to support potential launches like Xifaxan in IBS and Relistor, and absorbing the Santarus sales force should largely fill that need.

Then there is the Santarus pipeline. Ruconest -- the company's recombinant human C1 esterase inhibitor for hereditary angioedema, a rare but potentially fatal condition -- is an important drug to watch. Ruconest has been filed with the FDA and the efficacy, safety, and cost all compare favorably with existing drugs from ViroPharma, Shire, and CSL. Should Ruconest ultimately secure FDA approval for acute and prophylactic HAE as well as pancreatitis, there is an outside shot that this could become a blockbuster ($1 billion-plus in revenue) drug.

Execution risk should be lower, but it's still there
When considering the execution risk from this large deal, a significant mark in Salix's favor is that the key near-term catalyst (the launch of Uceris) fits very well within Salix's existing wheelhouse. On the other hand, Glumetza is marketed largely to primary care physicians and endocrinologists, and Ruconest (assuming the FDA grants approval, likely a 2014 event) will likewise be marketed outside the company's historical GI physician base.

It's also well worth noting that Salix has enough company-specific challenges to deal with in the near term. Solesta (a bulking agent for fecal incontinence) may have multi-hundred-million-dollar potential, but the drug has been a slow performer for Salix so far since its acquisition of Oceana and the company likely will need to intensify its sales and reimbursement efforts. In addition, the company's efforts to develop/market Xifaxan for IBS may fail, and there are no guarantees that the company will win its appeal of the FDA's rejection of the sub-q formulation of Relistor, nor find a viable path forward for the oral version.

The bottom line
I liked Salix prior to the Santarus deal announcement, but the 20% move since the announcement has taken the low-hanging fruit off the tree. I believe that the Santarus deal is a value-creating deal for Salix shareholders and that the shares could still produce 10% annual returns from here, but investors who are new to the story should probably wait for some of the excitement to die down in the hopes of getting a better valuation on the shares.

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Editor's note: A previous version of this article referred to Santarus' drug rifamycin CV MMX, but all rights to this compound have been returned to Cosmo Pharmaceuticals. The Fool regrets the error.

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Stephen D. Simpson, CFA has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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