Money and the Med World

The complex three-way love triangle between Mylan Pharmaceuticals Inc. (NASDAQ:MYL), Teva Pharmaceutical Industries (NYSE:TEVA) and Perrigo Company PLC. (NYSE:PRGO) intensified this week, as Israel’s Teva made an unsolicited $40 billion offer for Mylan in what would be the tenth largest pharmaceutical in the history. The hostile takeover bid, aimed at strengthening up Teva’s generic drugs business, comes just weeks after Mylan announced it was attempting to buy Perrigo for approximately $30 billion.

Source: Bloomberg/WSA Please Click to Enlarge
Source: Bloomberg/WSA
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Combining Teva, the world’s largest generic drug maker, with Mylan, the third largest, would create a company with nearly $30 billion in revenue and more than 400 drugs in the pipeline which are awaiting regulatory approval.

Why Teva wants to Acquire Mylan

For Teva, the logic of the cash-and-stock bid is quite straightforward. Like many big pharmaceutical companies, Teva is also facing risks from patent expirations; with one example being Copaxone, Teva’s multiple sclerosis drug, which accounted for one-fifth of 2014 sales, is going to expire in 2016. Growth has long been scarce at Teva. Operating profit was just 2.8% higher in 2014 as compared to 2010.

One obvious solution is to bulk up Teva’s generics business, which accounted for nearly half of 2014 revenue, and find value from cutting costs. Mylan is certainly a good target to meet this strategic goal. Generics account for most of Mylan’s sales and earnings growth has been steady for the company. And Teva believes it can find $2 billion in annual cost and tax savings from the combination.

Synergies from the merger, if it happens, would provide support for earnings over the next couple of years as Copaxone sale dwindles. Teva says buying Mylan could add significantly to adjusted earnings per share from the deal’s first year and by nearly 30% by year three.

Mylan’s Rejection

Mylan has its own complex chessboard as it both tries to complete a takeover of Perrigo and fend off interest from Teva. The former effectively guarantees victory for the latter, and thus it is probably where Mylan focus is right now. But there are challenges in acquiring Perrigo.

When Mylan became a Dutch entity in 2015 in connection with an “inversion,” a merger enabling foreign incorporation, it authorized a Dutch-type of poison pill-style takeover defense called a “stichting.” In doing so, Mylan empowered a group of independent individuals to acquire a majority of the votes of (but not a significant economic interest in) Mylan if they think it is appropriate to protect Mylan’s interest. Mylan’s cash- plus- stock offer for Perrigo would likely require Mylan’s shareholders’ approval. If Teva’s offer is attractive enough conditioned on a Perrigo deal not happening, approval for a Perrigo deal could be difficult to get.

In addition, Perrigo’s board of directors on Tuesday, April 21, 2015 rejected Mylan’s takeover proposal. Irish regulations generally prevent directors from blocking hostile bids. However, Mylan could have time restrictions in getting the deal approved under the Irish regulations if and when it takes an offer directly to Perrigo’s shareholders. Depending on what Teva does and how Mylan’s shareholders react, these time limits could be a challenge to meet.

Perrigo’s Angle

From Perrigo’s perspective this whole situation probably looks unappealing. For the deal to go through, Mylan’s shareholder approval would be required, it will be fraught with risk for Perrigo to negotiate with Mylan without the prior approval. Perrigo could easily find itself in a situation agreeing to a deal that Teva and/or the Mylan’s shareholders can disapprove. Sometimes sellers protect themselves from these risks with large reverse breakup fees in case the deal does not go through, but Mylan may find those unattractive.

The Frenzied Acquisition

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Please Click to Enlarge

Generic-drug makers announced or completed deals worth more than $100 billion in 2014, worth five times more than any year in the last decade. The buying spree by global pharmaceutical companies is being driven in part by depleting drug pipelines and decreased fruitful investments in drug discoveries. Drug companies are also facing greater competition from new drugs, and a race to the bottom on corporate tax rates.

Low borrowing costs have opened the door for new players to bulk up through deal-making. Countries including Ireland have offered lower-tax havens for companies that bought native firms and relocated. Once reincorporated, these companies. Mylan’s $5.3 billion acquisition for a major portion of Abbott Laboratories’ non-U.S. operations, completed in February, 2015 is an example of this. Mylan reincorporated in the Netherlands, but maintains its corporate offices in Cecil.

To Spend on R&D or To M&A?

With many best-selling products recently losing market exclusivity and advances in biotechnology undercutting the entire concept of a drug, the pharmaceutical industry is being pushed to fill product pipelines faster than individual R&D departments can develop new compounds or transform them for commercialization. Despite the claims that it costs billions to bring a drug to market, new technologies such as Molecular modeling and computer assisted drug design and DNA sequencing have enabled research to occur at lower costs, especially in the early stages. A small team of expert scientists, can advance an investigational product into Phase II clinical trials far less expensively today than ever before. It shows that Large Pharmaceutical companies do not necessarily hold an advantage over start-ups especially during the early stages of the product lifecycle. However, even if the small company has an approved drug, when it comes time to leave the lab and commercialize a product, Big Pharma’s big resources make a huge difference.

The recent M&A trend in the biopharma sector depicts the industry more like a pyramid where small companies develop drug molecules at the bottom only to be acquired by their bigger counterparts to commercialize these products at the top. It remains to be seen how this will affect the healthcare market in the long term

The Med Money World

Source: Bloomberg/WSA Please Click to Enlarge
Source: Bloomberg/WSA
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Prescription drugs are a $271 billion dollar business in the U.S. The generic market, once considered to be the low-cost, low-profit drug business has become highly profitable as generic manufacturers close the price gap between their products and more expensive exclusive drugs. Today 80% of U.S. prescriptions are written for generics and whichever way Teva/Mylan/Perrigo merger is concluded, a combined company could control almost a quarter of the unbranded generic market which could equate to more than $50 billion in sales. Just looking at the Teva/Mylan merger it could eventually result in the creation of the fourth largest international pharmaceutical company by revenue, edging out Pfizer Inc. (NYSE:PFE) and trailing only Johnson & Johnson (NYSE:JNJ).

Teva, Mylan and Perrigo are all competent and resourceful companies that make safe and reliable products. However, in an industry where the elimination of redundant infrastructure is instantly accretive to the bottom line, this has almost become a necessity to satiate Wall Street’s hunger for sequential EPS growth. The Teva transaction may very well be a template for maximization of margins, ironically in this case made easier by Federal Trade Commission (FTC) divestiture rules. There are doubts that a merger at this scale is too large a pill to swallow, however it is the size that will be a critical to its success. The real question here is if that the pill would be too bitter to swallow

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