The pursuit of Allergan Inc. is taking on a frantic air.
Perhaps that's because Valeant Pharmaceuticals International Inc. sees huge untapped value in the Botox maker. More likely, though, it's because the strategy that has turned the Canadian drug peddler into a stock market superstar is reaching its natural limit.
Valeant's share price has soared tenfold over the past five years, bolstered by a wave of acquisitions – 11 of them in 2013 alone. Mike Pearson, the company's CEO, avoids spending huge amounts on research and development and prides himself on cutting out waste at the companies he buys. Valeant doesn't dream of discovering a cure for cancer; its vision is to make its fortune by selling mundane products, ranging from lens cleaner solution to teeth whitening systems.
As a strategy, that sounds benign enough; what may be dangerous for investors is assuming that the magic carpet ride can go on forever. In many ways, Valeant resembles an old-fashioned roll-up play – a point that Allergan, its latest quarry, makes with unusual passion.
In a roll-up play, a company sets out to acquire other related businesses. As it gobbles up those rivals, its revenue soars, bolstering its stock price. That makes it easier for the company to issue new shares at the enriched price, or use existing ones to help pay for fresh acquisitions. Each additional takeover adds to the appeal of the enlarged operation, making its shares even more valuable and easing the way to still bigger purchases.
The problem comes when the supply of potential acquisition targets begins to thin out or when acquisitions don't prove quite as profitable as the acquirer hoped. At that point, a roll-up play often runs into problems. Investors are no longer eager to load up on its shares and the momentum that sustained the growth strategy falls apart.
Is Valeant at that dangerous stage? It began by offering $46-billion (U.S.) for Allergan; it has now bumped up the ante to $54-billion. That represents 29 times Allergan's cash flow, which is far from bargain territory, and speaks to Valeant's burning desire to get the deal done.
Valeant may not have much choice. To keep its growth story alive, it needs to make acquisitions, but as it grows bigger, it needs larger and larger takeovers to drive it forward. With a market cap of nearly $45-billion, it has to look for equally sizable prey – and Allergan, which sports a market cap of $51-billion, qualifies quite nicely.
Allergan doesn't want to be taken over and has already attacked Valeant's accounting and growth record. On Monday, Bill Ackman, the hedge fund manager who has joined forces with Valeant in the takeover, fired back by threatening to depose six Allergan directors. As threats and allegations fly back and forth, the hostility level is rising quickly.
No matter who wins, the battle demonstrates that some investors don't seem particularly eager to become Valeant shareholders. Only $72 of Valeant's $181-a-share offer for Allergan is in the form of cash; the remainder is in Valeant stock. Despite the 40-per-cent premium the deal would offer compared to Allergan's share price before the bid, the Botox maker's board seems less than enamoured with the prospect of accepting Valeant shares.
It's easy to understand their concerns. If Valeant takes over Allergan, the combined company will have a market cap close to $100-billion, which would make it bigger than Eli Lilly or Bristol-Myers Squibb and not that much smaller than Bayer.
The combined company would find the supply of meaningful acquisition targets to be severely limited. And that could spell an abrupt end to Valeant's long reign as a growth stock.
Ian McGugan