Allergan’s (AGN) $40.5 billion sale of its generic drug unit to Teva Pharmaceutical (TEVA) is a clear example of addition by subtraction.
Before the deal Allergan was the third largest global generic drug company, according to Standard & Poor’s, with global generic sales of $6.5 billion. With generics accounting for 73% of sales, Allergan is clearly going to be a very different company after the deal.
But what, exactly?
Well, the combination of Allergan’s cornerstone Botox franchise and the recent acquisition of Kythera Biopharmaceuticals for $2.1 billion gives some clues. Botox, a neurotoxin, is a key drug in the growing aesthetics market. Medically Botox is injected in small amounts to weaken a muscle in order to reduce spasms. In the aesthetics market, Botox is injected to reduce wrinkles, crow’s feet, frown lines, and other signs of aging. Because manufacturing neurotoxins is a tricky process and because minute differences in neurotoxins can produce radically different results, Allegan has been very successfully in defending Botox’s market share, estimated at 76% globally. Botox revenues are about $2 billion annually.
Kythera’s key product, recently approved by the Food & Drug Administration, is Kybella, an injectable drug for reducing double chins. Like Botox, Kybella provides a non-surgical option in facial aesthetics. It’s an alternative to surgical methods for reducing subcutaneous fat such as liposuction.
Allergan has already started to expand Botox into new applications. For example, Senrebotase, is a derivative of Botox that only affects pain receptors. And I’d expect a similar effort to expand the market for Kybella.
According to Transparency Market Research the facial injectable market had sales of $3.4 billion in 2013 and is projected to grow at a compound annual rate of 14.6% from 2014 to 2020 to $9.4 billon in 2020.
Now there’s no guarantee that Allergan will spend the $34 billion in cash it received as a result of the Teva deal (the rest of the purchase price was in Teva stock) on building up its aesthetics portfolio. It could also go hunting for new high margin generics to supplement the biosimilar business that it retained in the Teva deal.
But the logic of the Kythera acquisition does point Allergan in that direction and so does the valuation of the opportunities in front of the company. The team of executive chairman Paul Bisaro and CEO Brent Saunders showed a laudable (from a shareholder’s perspective) sensitivity to valuations in the timing of the sale of its generic business to Teva. Teva’s earlier bid for fellow generics maker Mylan (MYL) had pushed valuations for generic drug companies to what looked like a peak so Allergan sold to Teva at a top price. That kind of attention to valuation limits the number of big deal candidates that make sense for Allergan. For example, on valuation it wouldn’t make a whole lot of sense for Allergan to buy AbbVie (ABBV), one of the names floating in the rumor mill after the Teva news broke, at a higher multiple and a lower growth rate than Allergan’s own numbers. On that basis Allergan would find smaller deals, such as the one for Kythera, a better fit.
And unless Allergan wants to attract a bid itself from somebody like Pfizer (PFE) is will have to make a number of acquisitions. The cash from the Teva deal is enough to pay off all of Allergan’s debt and fund a buyback program—both of which would make Allergan a very attractive acquisition candidate itself.
As of July 29 I’m adding Allergan to my Jubak Picks portfolio with a target price of $385 a share by January 2016. The shares closed at $337.99 on July 8.