- Shoham Nov 19, 2014 at 05:04: AM
Shoham
Member
Re: The Beginning of the Endgame
Hi everyone.
So, the Hard Power play is finally here!
As I shall motivate later, I do believe that this deal is more good news than bad news for most (not all!) employees. The combined company will be the dream of the pharma world; and the current employees are already in the door of what will soon be one of the most prestigious labels in the for-profit sector. Contrasting this with the awful fate under the Valeant proposal, and even the most doubting Cafe Pharma whiner will have to admit that this is the superior outcome.
Before I get into it, allow me to recall what I said, 2 months ago, when the Actavis talks were first leaked. I am not recalling my words (just) to gloat, but because it provides the key elements to understanding why this deal happened, and what it means:
As we can now see, the two themes developed here correctly foresaw this outcome. Valeant's effort were indeed defeated, and it was, indeed, a Hard Power (the Actavis deal) that ultimately won, whereas the Soft Power plays that kept them distracted for a very long time proved absolutely crucial in buying the time needed for the winning Hard Power play (Actavis did not even exist -- at least not in a form that could bid -- back in April 2014).
As we can also see now, the day the Actavis interest story broke out (9/22/2014) did, indeed, mark the beginning of the endgame; and Actavis did, in fact, provide the death knell to the Valeant offer.
(As a footnote, we also now know that, at the time, Salix was, in fact, the preferred deal, but the Allergan due diligence team, backed by a disciplined Board realized it was an accounting fraud and walked away).
Allow me to continue carrying with the golden eggs goose analogy developed in that post. (Just in case my analogies are not as clear to others as I think they are: The living goose is the Allergan R&D machine, the golden eggs are the valuable products in creates, and goose meat is what you get if you destroy the R&D machine and just keep the existing product lines). Listening to the conference calls and reading the release material, it is very clear that Actavis really does believe that this goose lays golden eggs, and was bidding accordingly. Listening to the Valeant propaganda, right up to the last minute, it is equally clear that Valeant considers claims of gooses that lay golden eggs to be mythical, not worthy of serious attention by grownups. Whats more, Valeant seems to be utterly convinced their view is so universal, that the market will instantaneously rebuke anyone who thinks otherwise. As the leaks of the upcoming Actavis deal were becoming more definitive, Valeant asserted, and Ackman even articulated in a public letter, that there is no way Actavis could pay more because Valeant values goose meat more than anyone else. Even in the Sunday before the announcement, when authoritative leaks said that the price was going to be above $200 (a number that Valeant previously uttered, but was clearly having difficulties formalizing), Valeant leaked back that market will punish Actavis for going so high, Actavis price will drop, and with it the value of the Actavis offer, and then Valeant will be back to win the deal after all. (I do believe that Valeant wasn't just spouting propaganda -- since there isn't much benefit in propagandizing on Sunday against a pre-market Monday deal -- I think they really believed what they were saying). I really wish I was there to see MP jaw drop when he heard that the deal was for $219. I even more wish I was there to see him shaking his head in disbelief when, within minutes of the market opening, ACT was up $10. It was 9:58AM, 28 minutes after the market opened, with not the slightest sign that ACT was crushing, that Valeant put out a brief press release throwing in the towel. By the time the market closed today (Tuesday), ACT is up more than $25 from the last pre-deal price (which makes the deal now worth $227). The market does believe that this goose lays golden eggs!
So, back to our own world. We have been hearing so much Valeant-speak in the past 7 months, that it's hard to avoid thinking that all outsiders are just different shades of Valeant. That the word "synergy" is synonymous with brutal layoffs. That the only difference between one acquirer and another is how long they like to marinate goose meat and what spices they plan to cook it in. That acquirers are here to impose their own way of doing business -- be it generic drugs or zero-R&D -- on our goose, and will end up killing it in the process.
Maybe.
I can't for sure say that it won't turn out this way. What I can say is that the price Actavis paid, the business plan they articulated, and the loud cheer the market gave it, is not the price of goose meat (Valeant, indeed, would have valued goose meat more). Actavis paid the full price of a gold eggs laying goose. And, they didn't pay that kind of price for the purpose of testing the hypothesis if you can starve the goose and still get golden eggs. They paid this price, with the full intention of giving that goose all the feeding and care it needs to continue laying golden eggs.
So, what of the "synergies" they did announce? I didn't crunch all the numbers, but in the overall scheme of things they didn't sound very big (I know, I know, if it's my job being cut, "didn't sound very big" isn't a huge comfort). A sizable portion of the total is not even from job cuts (for instance tax savings -- sustainable or not, it's part of the plan for now). The rest is spread over a much larger company (meaning many of the cuts will hit Actavis, not Allergan, people). And, an important element: These are 2016 numbers, meaning some of them are against future growth plans, or obtainable through normal attrition, rather than laying off current employees (in the conference call, they did say most will be achieved by the end of 2015, but even that is quite some time into the future).
Also, importantly, the type of positions that will be affected. I don't want to be insensitive to anyone, and I certainly don't want to imply that one person's hardship is somehow less heartbreaking than another's. However, the Valeant plan to layoff thousands of highly specialized scientists and other R&D professionals in Irvine would have been a huge human calamity. There is no way the local economy could absorb so many specialized individuals. Most would have had to relocate -- meaning uprooting families, taking kids out of school, potentially breaking relationships, disrupting spouses careers, and otherwise inflicting vast toll on people who are blameless and very productive members of society. Some would have had to transition out of their area of specialty -- a vast waste of education and human potential. With that many high-end positions eliminated, secondary effects would have reverberated throughout the county -- damaging real estate prices, depressing localities tax base, and harming local businesses. Under the Actavis acquisition, the only category of Allergan employees that will likely take a lot of layoffs would be the G&A (and many, I imagine will be offered a transfer to New Jersey) -- General and Administrative (accounting, legal, HR, etc.). Again, I don't want to minimize, but these professions are not locked into a single industry. A laid off Allergan accountant can go work a block away for Hyundai the next day. Chances are, the severance package will exceed the between-jobs lost wages (not for everyone, of course, and the stress of losing a job and looking for another one -- even if in the end the package exceeds the lost wages -- does not make for an experience I'd wish on anybody here).
I don't expect any substantive sales layoff -- although any acquisition is an excuse to lay off a few people that management wanted to fire anyway and skip the annoying PIP phase -- the new company will still need to sell all the products of the prior companies, and the only people who know how are the existing sales forces.
Likewise with R&D. If there are any layoffs, they would probably hit the Actavis people mostly (some will probably be offered to relocate to Irvine).
But enough about the downside. There is also an upside, which, for most employees, I believe, will outweigh the negatives. The upside comes from understanding the type of company that is being created. It will be a top-10 Pharma company, itself a prestigious labeling; but, more importantly, it will be in the Growth Pharma category. What is this Growth Pharma category, and who is in it right now, you might ask? Well, no one actually. It's a newly created category. The Allergan-Actavis combination will be it's first member. Growth Pharma, if I can try to formulate a definition for a category that has only one, future, member, is the category of pharmaceutical companies that have the scale and breadth to do deep R&D, product development, approval, marketing, branded products, durable products, and generic drugs; and is able to keep the R&D pipeline hot enough to generate double-digit top-line growth into the indefinite future. No one does this today. We have biotech categories, we have generic categories, we have branded categories, and so on; but nothing that remotely resembles this Growth Pharma concept.
If it works, then the name of the combined company (whatever that name will turn out to be) will be the hottest name in the industry, and introducing yourself as an employee (or, in some future point, listing it on your resume) will command immediate attention. If it doesn't work, but still makes a lot of waves and shakes the industry, it will still raise the cachet of anyone associated with it. Of course, this whole idea could be a huge flop (always a possibility when a new category is created); and then we just hope that there enough smart people at the top to steer the ship toward a more tried-and-true business model. Will it work? I guess we will find out. However, the market was perfectly happy to bid up the value of the two companies by tens of billions in a few days betting that it will work!
So, there you have it. If this isn't exciting, just think what it would be like with Valeant... (ok. bad joke, not funny, I'm sorry).
Dan.
PS: I do realize that I may come across as putting a positive spin on everything. I do admit that I'm more interested in finding, and building upon, the positive than dwell, and complain about, the negative. Nonetheless, I don't 'spin.' I call it as I see it. Over the life of this thread I was called out several times for being too positive (and sometimes, regretfully, not very politely). But, each time, subsequent events proved my writings accurate. I do not have a crystal ball, or any information that others don't have; I just look past the emotions of any particular moment (and, being some steps removed, it is easier to be less emotional). My own family has suffered some disruption consequent to the Endurance restructuring. We will be relocating, selling a house we really love, and uprooting a toddler from his friends. Nonetheless, we choose to be optimistic and positive about the overall experience and look at the bright side of every eventuality. Is it spin, or is it attitude? You decide!
Hi everyone.
So, the Hard Power play is finally here!
As I shall motivate later, I do believe that this deal is more good news than bad news for most (not all!) employees. The combined company will be the dream of the pharma world; and the current employees are already in the door of what will soon be one of the most prestigious labels in the for-profit sector. Contrasting this with the awful fate under the Valeant proposal, and even the most doubting Cafe Pharma whiner will have to admit that this is the superior outcome.
Before I get into it, allow me to recall what I said, 2 months ago, when the Actavis talks were first leaked. I am not recalling my words (just) to gloat, but because it provides the key elements to understanding why this deal happened, and what it means:
...
I don't think I'm going on a limb by opining that Monday marked the start of the end-game. The strategies are now laid out, the plays are presented, and while there are still many details and scenarios to work out, and many twists and surprises still to surmise, we now know the war plans of both sides and the general schedule of the battles to come.
Readers of my earlier posts know that I've been developing two interconnected themes: (1) The concept of Soft and Hard Powers, where Soft Powers (such as Doctors letters, investors presentations, political and regulatory interventions, media barrages, law suits, etc.) can keep the other side off balance and distracted; but it is Hard Powers (restructuring, acquisitions, spin offs, other bidders, etc.) that, in the end, will win or lose.
(2) The assertion that "when companies do well management is in control, when not, investors are," which I have been using to argue that Valeant is not likely to win, because Allergan is doing well (selling drugs), and Valeant is not.
...
MONDAY (9/22)
...
3 - The Actavis cash offer: While everyone is focused on the Salix deal, this, I think, is the biggest story of the week. Not necessarily because it is more likely to happen than Salix (right now, I'd lean in favor of Salix more likely to happen than Actavis), but because this one is the biggest death knell to the Valeant offer. The WSJ story said that the Actavis offer is all cash and is about the same price as the current share price. It also said that Actavis will only do a friendly deal and will keep R&D intact. It also said that Allergan politely declined Actavis to pursue the Salix deal, and that Actavis is still interested ("If your other date doesn't work out, give me a call"). This is huge. Even if Salix fails, and even if a majority of shareholders don't want to hear anything about Allergan's plans for staying independent -- they just want to cash-out at ~50% above where Allergan was before Ackman came along (and fear that if Allergan stay independent, and Valeant walks away, Allergan share price will drop -- maybe not all the way to $116, but somewhere far south of recent, post-Valeant-bid prices of $160's-$170's) -- they now have two choices of comparable value: An all cash offer from Actavis and a Cash-plus-stock offer from Valeant. Actavis and Valeant might even bid against each other (no one ever makes a bid for a company without being prepared to compete), but I wouldn't expect that bidding to get out of hand (highly speculative) because Valeant is already closed to being tapped out, and Actavis wouldn't have a reason to bid any higher (Actavis too may be easily tapped out -- more on that later). Actavis would have the advantage of being a friendly bid (which means that Allergan will allow them to inspect the books and labs so as to be able to develop the most value-creating merger plan in light of their own books and labs). If you accept the view that Allergan's research generates more value than it costs (a view that Actavis presumably accepts and Valeant doesn't), then Actavis will have the further bidding advantage that they value what they will be getting more, even if it will eventually turn out that Valeant is right and the research was a waste of money. (Imagine two bidders bidding for a goose that supposedly lays golden eggs. One bidder doesn't believe in golden eggs and is just bidding for the value of goose meat; the other one does believe in golden eggs and is bidding accordingly. Which will win the bid? Does it even matter if the goose turns out to lay golden eggs or not after all?)
The traditional view in M&A is that a bid with a stock component is worth more than a straight cash bid of the same amount (so, a bid of $100 in stocks + $72 in cash is worth more than a $172 cash). While a bit counter-intuitive, the rationale for this thinking is that the stock component (in the merged corporation) will be worth more after the merger than beforehand, because the actual value creation of the merger (the "synergies") will then became realizable. In effect, the seller is given the opportunity to share in the value creation of the merger, something that a cash offer won't do. Of course, if the seller has a dim view of the stock or business plans of the buyer, they'd happily forgo participating in this alleged value creation and just take the cash (in small unmarked bills, please) and run. I'd venture to guess that with all the scorn heaped on Valeant in the past 5 months, even the hardiest investors will rather take cash than Valeant stocks. Ackman may cheerlead Valeant, and may even practice what he preaches, but the arbitrageur mercenaries he so successfully invited to join the feast on Allergan, have zero interest in sticking around to see if Valeant can execute on their promises; so if it's all the same and someone else is offering all-cash, they'll take the cash and run (my opinion).
So, the bottom line of the Actavis presence is that it makes a Valeant victory unlikely, since, at the very least, Valeant will have to be bidding against an all-cash bidder, with that bidder having multiple built-in advantages. The mere fact that Valeant chances of winning are materially degraded, and even if they do win, it will be at a higher price than if there were no other bidders, creates a vicious circle situation against Valeant. Whether Valeant wins a bidding competition with Actavis by paying more, or loses this acquisition on which they have bet much of their future, the value of Valeant to it's CURRENT shareholders is reduced. If it's reduced, the Valeant share price drops. If it drops, then to stay in the bidding, Valeant must increase the share portion of their offer (since the cash portion is substantially tapped out), which further dilutes current shareholders, which further depresses Valeant share price. Even the most ardent believer, last week, in the inevitability of Valeant winning this acquisition battle, must awake to the possibility that with two additional highly viable alternative scenarios on the table (Actavis and Salix deals), the chance of Valeant winning is perhaps 1/3 of what it was beforehand; and there is a very real chance Valeant won't complete this acquisition. If Valeant couldn't win Allergan, there probably aren't many other $50B companies it can gobble; and, in any event, it would have wasted a year on a failed acquisition effort with nothing to show for it. This means that one must start seriously thinking what is Valeant really worth if it isn't doing any more big acquisitions. And that picture isn't pretty at all. Valeant without acquisitions is a company heavily in debt, unable to spend on either research or market development, sending all their free cash flow to their lenders to pay down their debt just slightly faster than they are losing market share (due to lack of investment), meaning that by the time they finish paying off their debt, they won't have much market share of anything. That's not a company that's worth $40B! And that's the good scenario! the bad scenario has any of a long list of what elsewhere would be survivable setbacks (like a rise in interest rates from their current historic low levels, a big lawsuit loss, a major regulatory action, etc.) pushing Valeant over the cliff from just barely being able to pay their debts to not be able to, at which point the bondholders get the company and the shareholders are wiped out. Even some Valeant shareholders (speculative) believe Valeant is a pyramid scheme, but are hoping to have one more round (Allergan) before they get out; if there is a good chance that one more round doesn't happen -- the first ones to get off loses the least! I don't know how many Valeant shareholders share the concern that they are invested in a house of card, and if Allergan is not happening, they need to be out before everyone else bails. But if there is even a large minority of Valeant shareholders with such sentiment, then once they start exiting, Valeant share price drops setting off a potentially exit-less vicious cycle -- and all brought about the Actavis bid!
Ackman was well aware of the possibility that a White Knight (see Glossary entry) would demolish the entire Valeant play when he said (circa May) that there is no White Knight around, and if Allergan doesn't rash and accept Valeant's offer, in the absence of a competing bidder, Valeant will be able to reduce it's offer. By lining up a White Knight (Actavis) to be on standby, Allergan has clearly proven Ackman wrong!
One last word on the capacity of Actavis to make an all cash bid. I haven't studied Actavis in any details, but I did scan their most recent quarterly report. They have a market cap of about $60B, about $10B/year revenues, and about $10B long term debt. If they borrow ~$50B to buy Allergan, their debt will go up to $60B. If Actavis can generate, say, 70% free cash flow (about $7B/year), added to the $3B/year profits Allergan generates; that gives total free cash flow of about $10B/year, or about 6 years leverage for a $60B debt. This will make the surviving corporation slightly less leveraged than Valeant, but still solidly in junk bond territory. However, unlike the Valeant plan, with R&D (and therefore product pipeline) intact, the market share and revenues will increase each year, while debt interests costs decrease (because the debt will be shrinking as it is paid down), making for a far more viable future than the Valeant plan. Given these numbers, I'd assume that if there were to be a bidding competition, not just Valeant, but also Actavis, would immediately tap out on cash, and will have to start offering some equity to stay in the bidding.
...
Dan.
As we can now see, the two themes developed here correctly foresaw this outcome. Valeant's effort were indeed defeated, and it was, indeed, a Hard Power (the Actavis deal) that ultimately won, whereas the Soft Power plays that kept them distracted for a very long time proved absolutely crucial in buying the time needed for the winning Hard Power play (Actavis did not even exist -- at least not in a form that could bid -- back in April 2014).
As we can also see now, the day the Actavis interest story broke out (9/22/2014) did, indeed, mark the beginning of the endgame; and Actavis did, in fact, provide the death knell to the Valeant offer.
(As a footnote, we also now know that, at the time, Salix was, in fact, the preferred deal, but the Allergan due diligence team, backed by a disciplined Board realized it was an accounting fraud and walked away).
Allow me to continue carrying with the golden eggs goose analogy developed in that post. (Just in case my analogies are not as clear to others as I think they are: The living goose is the Allergan R&D machine, the golden eggs are the valuable products in creates, and goose meat is what you get if you destroy the R&D machine and just keep the existing product lines). Listening to the conference calls and reading the release material, it is very clear that Actavis really does believe that this goose lays golden eggs, and was bidding accordingly. Listening to the Valeant propaganda, right up to the last minute, it is equally clear that Valeant considers claims of gooses that lay golden eggs to be mythical, not worthy of serious attention by grownups. Whats more, Valeant seems to be utterly convinced their view is so universal, that the market will instantaneously rebuke anyone who thinks otherwise. As the leaks of the upcoming Actavis deal were becoming more definitive, Valeant asserted, and Ackman even articulated in a public letter, that there is no way Actavis could pay more because Valeant values goose meat more than anyone else. Even in the Sunday before the announcement, when authoritative leaks said that the price was going to be above $200 (a number that Valeant previously uttered, but was clearly having difficulties formalizing), Valeant leaked back that market will punish Actavis for going so high, Actavis price will drop, and with it the value of the Actavis offer, and then Valeant will be back to win the deal after all. (I do believe that Valeant wasn't just spouting propaganda -- since there isn't much benefit in propagandizing on Sunday against a pre-market Monday deal -- I think they really believed what they were saying). I really wish I was there to see MP jaw drop when he heard that the deal was for $219. I even more wish I was there to see him shaking his head in disbelief when, within minutes of the market opening, ACT was up $10. It was 9:58AM, 28 minutes after the market opened, with not the slightest sign that ACT was crushing, that Valeant put out a brief press release throwing in the towel. By the time the market closed today (Tuesday), ACT is up more than $25 from the last pre-deal price (which makes the deal now worth $227). The market does believe that this goose lays golden eggs!
So, back to our own world. We have been hearing so much Valeant-speak in the past 7 months, that it's hard to avoid thinking that all outsiders are just different shades of Valeant. That the word "synergy" is synonymous with brutal layoffs. That the only difference between one acquirer and another is how long they like to marinate goose meat and what spices they plan to cook it in. That acquirers are here to impose their own way of doing business -- be it generic drugs or zero-R&D -- on our goose, and will end up killing it in the process.
Maybe.
I can't for sure say that it won't turn out this way. What I can say is that the price Actavis paid, the business plan they articulated, and the loud cheer the market gave it, is not the price of goose meat (Valeant, indeed, would have valued goose meat more). Actavis paid the full price of a gold eggs laying goose. And, they didn't pay that kind of price for the purpose of testing the hypothesis if you can starve the goose and still get golden eggs. They paid this price, with the full intention of giving that goose all the feeding and care it needs to continue laying golden eggs.
So, what of the "synergies" they did announce? I didn't crunch all the numbers, but in the overall scheme of things they didn't sound very big (I know, I know, if it's my job being cut, "didn't sound very big" isn't a huge comfort). A sizable portion of the total is not even from job cuts (for instance tax savings -- sustainable or not, it's part of the plan for now). The rest is spread over a much larger company (meaning many of the cuts will hit Actavis, not Allergan, people). And, an important element: These are 2016 numbers, meaning some of them are against future growth plans, or obtainable through normal attrition, rather than laying off current employees (in the conference call, they did say most will be achieved by the end of 2015, but even that is quite some time into the future).
Also, importantly, the type of positions that will be affected. I don't want to be insensitive to anyone, and I certainly don't want to imply that one person's hardship is somehow less heartbreaking than another's. However, the Valeant plan to layoff thousands of highly specialized scientists and other R&D professionals in Irvine would have been a huge human calamity. There is no way the local economy could absorb so many specialized individuals. Most would have had to relocate -- meaning uprooting families, taking kids out of school, potentially breaking relationships, disrupting spouses careers, and otherwise inflicting vast toll on people who are blameless and very productive members of society. Some would have had to transition out of their area of specialty -- a vast waste of education and human potential. With that many high-end positions eliminated, secondary effects would have reverberated throughout the county -- damaging real estate prices, depressing localities tax base, and harming local businesses. Under the Actavis acquisition, the only category of Allergan employees that will likely take a lot of layoffs would be the G&A (and many, I imagine will be offered a transfer to New Jersey) -- General and Administrative (accounting, legal, HR, etc.). Again, I don't want to minimize, but these professions are not locked into a single industry. A laid off Allergan accountant can go work a block away for Hyundai the next day. Chances are, the severance package will exceed the between-jobs lost wages (not for everyone, of course, and the stress of losing a job and looking for another one -- even if in the end the package exceeds the lost wages -- does not make for an experience I'd wish on anybody here).
I don't expect any substantive sales layoff -- although any acquisition is an excuse to lay off a few people that management wanted to fire anyway and skip the annoying PIP phase -- the new company will still need to sell all the products of the prior companies, and the only people who know how are the existing sales forces.
Likewise with R&D. If there are any layoffs, they would probably hit the Actavis people mostly (some will probably be offered to relocate to Irvine).
But enough about the downside. There is also an upside, which, for most employees, I believe, will outweigh the negatives. The upside comes from understanding the type of company that is being created. It will be a top-10 Pharma company, itself a prestigious labeling; but, more importantly, it will be in the Growth Pharma category. What is this Growth Pharma category, and who is in it right now, you might ask? Well, no one actually. It's a newly created category. The Allergan-Actavis combination will be it's first member. Growth Pharma, if I can try to formulate a definition for a category that has only one, future, member, is the category of pharmaceutical companies that have the scale and breadth to do deep R&D, product development, approval, marketing, branded products, durable products, and generic drugs; and is able to keep the R&D pipeline hot enough to generate double-digit top-line growth into the indefinite future. No one does this today. We have biotech categories, we have generic categories, we have branded categories, and so on; but nothing that remotely resembles this Growth Pharma concept.
If it works, then the name of the combined company (whatever that name will turn out to be) will be the hottest name in the industry, and introducing yourself as an employee (or, in some future point, listing it on your resume) will command immediate attention. If it doesn't work, but still makes a lot of waves and shakes the industry, it will still raise the cachet of anyone associated with it. Of course, this whole idea could be a huge flop (always a possibility when a new category is created); and then we just hope that there enough smart people at the top to steer the ship toward a more tried-and-true business model. Will it work? I guess we will find out. However, the market was perfectly happy to bid up the value of the two companies by tens of billions in a few days betting that it will work!
So, there you have it. If this isn't exciting, just think what it would be like with Valeant... (ok. bad joke, not funny, I'm sorry).
Dan.
PS: I do realize that I may come across as putting a positive spin on everything. I do admit that I'm more interested in finding, and building upon, the positive than dwell, and complain about, the negative. Nonetheless, I don't 'spin.' I call it as I see it. Over the life of this thread I was called out several times for being too positive (and sometimes, regretfully, not very politely). But, each time, subsequent events proved my writings accurate. I do not have a crystal ball, or any information that others don't have; I just look past the emotions of any particular moment (and, being some steps removed, it is easier to be less emotional). My own family has suffered some disruption consequent to the Endurance restructuring. We will be relocating, selling a house we really love, and uprooting a toddler from his friends. Nonetheless, we choose to be optimistic and positive about the overall experience and look at the bright side of every eventuality. Is it spin, or is it attitude? You decide!