Healthcare Buyout Mania: Now What?

It feels like there's nothing to talk about in the pharmaceutical space these days other than the latest M&A bid. Just in the last day and a half, investors have seen news on five completed or proposed transactions. And I doubt the deal-making is done.

Pfizer and AstraZeneca
As of Tuesday morning, Pfizer remains committed to its charm offense, hoping to sway politicians in both the U.K. and the U.S. (but particularly in the U.K.) that a Pfizer bid for AstraZeneca is not going to result in sweeping cuts to R&D and that there is more to the deal than just a tax dodge. Pfizer continues to ask to meet with AstraZeneca to work out a mutually acceptable offer, while AstraZeneca continues to rebuff Pfizer.

Valeant and Allergan
As expected, Allergan formally responded to Valeant's  unsolicited takeover bid on Monday with a unanimous rejection. Everything about this is following the typical form - Allergan claims they carefully reviewed and considered the bid, determined that it substantially undervalued the company, presented various operational risks, and that the company's shareholders would be better off with Allergan sticking to its plan.

Valeant is likewise sticking to a familiar script. The company cited Allergan's unwillingness to discuss the bid with Valeant and then insulted Allergan for allegedly insulting them. Valeant also said that an improved bid would be forthcoming on May 28th - also very much in line with expectations.

Merck offloads some ophthalmology assets
While Pfizer and Valeant both tilt at decidedly unreceptive targets, there still are some friendly deals happening in the pharma sector. On Tuesday Merck  announced that it was selling the European and Asia-Pacific sales rights to eight drugs (plus one in development) to Japan's Santen for $600 million and additional sales milestones.

Merck generates about $400 million in revenue from this asset/territory combination and it's more than a "nice to have" acquisition for Santen. As Santen already sells some of these products through a licensing agreement, the net revenue addition to Santen will be more on the order of $200 million, but the gross margins on those products should increase considerably. Paying 3x sales upfront is not bad at all considering the current price/sales multiple for pharma deals and the margin leverage potential of the deal. For Merck, it's a good opportunity to monetize a business that now lies outside of its core focus on higher-growth markets like virology and oncology.

Akorn expanding its specialty portfolio
In another friendly deal, Akorn announced that it would acquire VersaPharm for $440 million. Akorn management is looking for $90 million to $100 million in near-term revenue accretion from VersaPharm, compared to a trailing revenue run-rate of $334 million. Akorn also noted that the drugs in VersaPharm's pipeline address $700 million in branded sales.

Akorn made a large specialty-oriented acquisition in 2013 when it acquired Hi-Tech Pharmacal, and VersaPharm brings in specialty topical treatments, with a focus on dermatology products. Dermatology remains a relatively specialized niche (it is an area of strength for Valeant) and Akorn is following in some pretty well-established footprints by using acquisitions to add formulation expertise, as categories like sprays and topical treatments can be more difficult for generic manufacturers and thus more lucrative for the companies who can do it (the fewer generic rivals there are, the less pricing competition/pressure).

Shire targets liver treatments
Amidst chatter that it itself is a high-value target for Allergan or AstraZeneca as part of their respective plans to avoid being taken out, Shire is jumping into deal market. Shire announced the acquisition of Lumena for $260 million in cash plus additional unspecific milestones. Lumena had been looking to raise $75 million in an IPO, but given how the biotech IPO market has soured, it seems likely that the company was having difficulty with the process.

Lumena vaults Shire into the suddenly hot liver therapeutics market. Lumena's lead products, LUM001 and LUM002, target conditions like primary biliary cirrhosis and nonalcoholic steatohepatitis. These markets have recently gotten considerably more attention lately due to investor interest in Intercept Pharmaceuticals and Conatus Pharmaceuticals, both of which have seen extreme movements in their share prices.

Liver disease is an attractive market, given the relative lack of effective therapies and the high cost of treating liver failure. As this is a pretty modestly sized deal, the acquisition of Lumnea isn't likely to have much bearing on the rumored acquisition interest in Shire.

The bottom line
While three of these M&A transactions are "done deals", I don't believe investors should expect the M&A merry-go-round in pharmaceuticals to end just yet. Between taxes, reimbursement pressures, and the high cost of de novo product development, M&A is one of the few tools that many drug companies have to show sales and earnings growth. Valuations are staying fairly reasonable so far, but as the game of musical chairs drags on, those remaining seats may well start getting pretty pricey.

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Stephen D. Simpson, CFA has no position in any stocks mentioned. The Motley Fool recommends Valeant Pharmaceuticals. The Motley Fool owns shares of Valeant Pharmaceuticals. 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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