Valeant’s Battle for Allergan is a case study by HBR. You can find the link to the actual case study here. Answers to all the questions are available here
Valeant’s Business Model
Pharmaceuticals are the business that Valeant, based in Canada, specializes in. As part of its plan to expand through acquisitions, the organization has closed more than one hundred transactions while Michael Pearson serves as its Chief Executive Officer.
During the conference call for Valeant’s first quarter, Pearson stated that the company was able to close 10 transactions during that time period alone. Pearson provided a further explanation regarding what Valeant looks for in an acquisition by stating that the company considers cash flow as well as what he referred to as a “…certain return to our shareholders.”
When Pearson talks about a “certain return” for shareholders, he is essentially making a criticism of Valeant’s business model, which is that Valeant eliminates costs from the companies it acquires, including research and development, and then just sells the finished products of those companies.
Allergan CEO David Pyott wrote a letter to Valeant CEO Pearson in which he stated that the most recent offer made by Valeant does not include enough “sufficient or certain value” to warrant discussions between Allergan and Valeant. According to him, Allergan’s customer-focused strategy and Valeant’s strategy directly oppose one another.
To be more specific, the question is how Valeant would be able to achieve the level of cost cuts that it is proposing without negatively impacting the long-term viability of Allergan’s business as well as its growth trajectory. Due to these factors, Allergan is of the opinion that the current business model utilized by Valeant cannot be maintained.
Low Investment in Research & Development
Additionally, one of the most significant issues that Allergan has with the way that Valeant conducts business is the fact that the company does not invest in research and development.
The market has paid significant attention to Valeant because of the company’s aggressiveness. Jeremy Levin, who had previously served as CEO of Teva Pharmaceuticals, was quoted as saying that “Valeant will eventually run out of things to buy… A business that does not invest in research and development may be profitable in the short-term or the middle-term, but not in the long term.
Also in the wake of Valeant’s initial proposal for Allergan, John Gapper of the Financial Times argued that if the entirety of the pharmaceutical industry adopted Valeant’s approach, drug discovery would come to a complete and utter halt.
After Ackman and Valeant made their most recent offer, Ackman revealed in a filing with the SEC that the Pershing Square fund he manages is preparing an unsolicited offer for Allergan.
A potential acquirer is said to be engaging in a hostile bid when they communicate directly with the shareholders of a company rather than with the board of directors of the company regarding their takeover proposal.
Why does Valeant wish to acquire or merge with Allergan?
The inorganic model of growth is one that is utilized by Valeant, which is a company. Michael Pearson, the current CEO of Valeant, has extensive experience working as a consultant at McKinsey and is known for his history of making multiple acquisitions. During the first six years of his tenure as CEO, he was responsible for the acquisition of more than one hundred different companies as well as licensing deals. He searched for businesses that exhibited significant synergies and made an effort to acquire those businesses.
Allergan has a robust culture of research and development and adheres to the organic growth model in its business practices. Its research and development department has been responsible for the creation of a wide variety of ground-breaking goods, such as the anti-wrinkle treatment Botox. It started out as a modest eye care business but has since expanded into the pharmaceutical and medical device industries. Valeant will have its very own research and development engine after it completes the acquisition of Allergan.
Pearson was known for instituting extreme capital discipline and cutting costs in businesses. He believed that he could increase the value for Allergan’s shareholders by instituting extreme capital discipline and cutting costs that were not necessary.
He also desired to acquire the specialty pharmaceuticals sector, which included high-cost, high-complexity, and high-touch products that were not included in Valeant’s product mix. This sector belonged to the specialty pharmaceuticals sector.
What potential value does Valeant believe it can create with the merger with Allergan?
Michael Pearson, the CEO of Valeant, held the belief that the pharmaceutical industry should practice stringent financial restraint. He desired to capitalize on all of the cost synergies that could be achieved through the merger of Valeant and Allergan while narrowing his attention to only those products that offered the highest margins. Valeant was already treating wrinkles with its product Dysport and providing solutions for contact lenses with its product ReNu, whereas Allergan is known for its highly successful products such as Botox, Restasis, and Lumigan. As a result, there were numerous synergies to be had in terms of the product portfolio and the various customer segments.
In addition to this, Valeant intended to utilize Allergan’s research and development capabilities in order to develop new products. The combined operational efficiencies of the two businesses were estimated to be worth $2.7 billion. Pearson’s core beliefs led him to the conclusion that the R&D expenditures of Allergan should be reduced from 17% to somewhere around 3%, similar to what was done at Valeant.
Allergan was presented with multiple offers from Valeant, each one being superior to the one that came before it.
On April 21, 2014, Valeant made an open proposal to the top executives at Allergan regarding a possible merger of the two companies. For each share of Allergan, Valeant proposed an exchange of $48.30 in cash in addition to 0.83 shares of Valeant (which were trading at $126 per share on that day), for a total value of $152.88 per share.
This represented a premium of 31% over the stock price of Allergan, which was $116.63 on April 10th. The cash component of Valeant’s offer was raised by $10 per share on May 28th, bringing the total to $58.30 per share, up from $48.30 per share previously. As a result, the total offer has increased to $166.16 per share, consisting of $58.30 in cash and 0.83 shares of Valeant that are currently trading at $126.95 per share.
On May 29th, Bill Ackman came to the conclusion that in order to receive support for the offer, the price of the offer needed to be increased to an effective level of $180 per share.
On May 30th, Valeant added yet another increase to the offer price. The cash component was increased to $72 per share, up from its previous price of $58.30. The previous day, the share price of Valeant had closed at $129.22, which brought the effective offer up to $179.25 per share. Additionally, there is the possibility of a contingent value right (CVR) of $25 per share.
As a result, Valeant was willing to offer the shareholders of Allergan a substantial premium in exchange for the change in control of the company.
Because Valeant hopes to profit from the drugs that are still in the development stage, the company has increased the price it is willing to pay for Allergan. Once the drugs have been developed, Valeant will be able to market them and make a profit without having to invest anything in the drug’s research and development. This would have been in line with the company’s initiative to cut costs, so this would have been acceptable. The profits that Valeant would have gotten from the successful drugs would have made the company’s retained earnings and share price go up even more.
What do you make of Allergan’s reluctance to talk to Valeant? Would there be any harm in talking to the potential suitor?
Because Allergan and Valeant are two entirely distinct types of businesses, the former does not wish to communicate with the latter. The philosophy of Valeant, which aims to maximize shareholder value, is propelled by a high degree of leverage, the selection of novel ways to avoid paying taxes, cost leadership achieved by minimizing r&D expenditure, and inorganic growth brought about by acquisition.
When the economy is doing well, all of these moves point to positive outcomes, but the viability of these moves over the long term is in question. In point of fact, Valeant is not profitable at the moment and racked up a sizeable loss in the most recent quarter of its operations.
On the other hand, Allergan is a company whose management adheres to the time-tested management practices of the traditional business era. They put a significant amount of money into research and development, and as a result, they are able to develop products that are commercially successful and pay back investors, despite the fact that the company’s growth has slowed in recent years.
Despite this, there has been a positive profit, which can be attributed to the strong corporate governance that they have. Mr. Pyott did not want to talk to Mr. Pearson because he despises Valeant and their business practices, and this reflects his unwillingness to negotiate any kind of deal with Valeant. Mr. Pyott did not want to talk to Mr. Pearson.
The high PE multiple that Allergan stock had was a strong indicator of the company’s high growth potential in the years to come. Even though the investors in Allergan will receive cash in addition to shares of Valeant as part of the deal, the fundamentals of the company do not appear to be very appealing despite the company’s rapid rate of growth and appear to be reaching a plateau in the near future. In the event that a significant number of investors hold the same viewpoint, the share price of Valeant would unquestionably drop, and investors in Allergan would suffer financial losses. On the other hand, if the products that are currently in the pipeline are successful, the company will be able to exercise their CVR option and ultimately obtain a better price. However, selling off immediately after the transaction is completed may not be the best choice for Allergan investors in the long run.
Explain in detail the nature of the debate between Allergan and Valeant as to whether Valeant’s business strategy is capable of sustaining business growth.
The point of contention between Allergan and Valeant is that Allergan is raising objections to its acquisition or merger by Valeant Pharmaceuticals on the grounds that Valeant’s business strategy is inappropriate, and Allergan has serious doubts as to whether or not Valeant’s strategy is capable of sustaining business growth.
Because Allergan is a multinational specialty pharmaceutical company, Valeant is attempting to acquire it. Valeant’s target is Allergan. They are involved in the marketing and production of products for eye care, facial care, and cosmetics, but Botox was what brought them the most notoriety.
In April of 2014, Valeant made its initial approach to Allergan. It has twice increased its offer, which it is making with hedge fund manager Bill Ackman, but was unsuccessful in all of its attempts to woo Allergan; Valeant’s most recent offer was made on May 30. Valeant’s competitor, Allergan, made its most recent offer on May 30.
But Allergan turned it down as well, citing the fact that the reason it isn’t accepting Valeant’s bid is because of the price, but rather because it doesn’t agree with the way Valeant runs its business.
What was the role played by William Ackman and his firm Pershing Square in this?
Additionally, one of the most significant issues that Allergan has with the way that Valeant conducts business is the fact that the company does not invest in research and development.
The market has paid significant attention to Valeant because of the company’s aggressiveness. Jeremy Levin, who had previously served as CEO of Teva Pharmaceuticals, was quoted as saying that “Valeant will eventually run out of things to buy… A business that does not invest in research and development may be profitable in the short-term or the middle-term, but not in the long-term.
Also in the wake of Valeant’s initial proposal for Allergan, John Gapper of the Financial Times argued that if the entirety of the pharmaceutical industry adopted Valeant’s approach, drug discovery would come to a complete and utter halt.
After Ackman and Valeant made their most recent offer, Ackman revealed in a filing with the SEC that the Pershing Square fund he manages is preparing an unsolicited offer for Allergan.
A potential acquirer is said to be engaging in a hostile bid when they communicate directly with the shareholders of a company rather than with the board of directors of the company regarding their takeover proposal.
Why weren’t Ackman’s actions considered insider trading?
The investment firm led by Ackman, Pershing Square, did not have any kind of fiduciary relationship with Allergan. A person or entity that beneficially owns more than 10% of a company’s voting shares is considered to be an insider of that company.
A director or senior officer of a company is also considered to be an insider of that company. Therefore, Ackman does not meet the criteria for an insider according to the definition. They have successfully preserved their standing in the company through a variety of cunning maneuvers.
Ackman and Valeant were not in possession of any non-public information regarding Allergan, as stated by sections 10b and 14e of the Securities Exchange Act of 1934.
Ackman’s actions were not considered to be illegal insider trading because Valeant and Ackman were both operating within the confines of the laws governing insider trading.
Which one out of these three options will you recommend to the management of Allergan: (a) stay single, (b) go with Valeant or (c) go with Actavis.
Because Valeant received backing from investor Bill Ackman’s hedge fund Pershing Square Capital Management, they signed a collaboration agreement under which Pershing Square bought 9.7% of Allergan’s stock prior to Valeant officially announcing their approach. As a result, Allergan had no choice but to pursue a merger with Actavis; remaining independent was not an option. Allergan should go with a merger with Actavis. Staying single was not an option.
In order to complete the takeover of Allergan by Pershing Square, six of the company’s nine directors were removed from their positions. Because of insider trading and other violations of the law, Allergan filed a lawsuit to prevent Valeant, Pershing Square, and Ackman from voting in the company’s shareholder vote.
Because Valeant was built on a rapid series of acquisitions with very little underlying growth, a merger with Valeant would not be sustainable for the business of Allergan, which is why Allergan has decided against pursuing this option. The fact that Valeant is known for significantly lowering the amount of money it spends on research and development is one of the primary reasons why you should not go with it. A low level of R&D spending cannot be maintained over the course of time.
Allergan would be well served by a merger with Actavis for two reasons: first, it would prevent the company from being acquired by Valeant, which uses unethical business practices; second, it would result in the formation of the pharmaceutical company with the most rapid and dynamic growth in the world’s healthcare industry; third, it would help Allergan become one of the largest pharmaceutical companies. The merger with Actavis would result in long-term growth, which would be supported by leading, world-class blockbuster franchises as well as a premier late-stage pipeline. This would accelerate the company’s commitment to building an exceptional, sustainable portfolio.
The combined business will have a robust balance sheet, expanding product portfolios, and extensive commercial reach that spans the globe’s various markets. The combined experienced management team would be able to drive strong organic growth while simultaneously capturing synergies and maintaining a robust investment in R&D that is strategically focused.
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