Rumours have surfaced that Watson is working on the acquisition of Actavis, with the apparent transaction value being somewhere in the range of €4.5-5.5bn. As Watson was also one of the bidders when Actavis was up for sale in 2008, but chose to walk away, the first question has to be: what makes a tie-up more attractive now than it was then, given that Actavis itself is superficially much the same? We can think of four reasons. Firstly, Watson itself is in a much stronger position than it was in 2008, having been put firmly on a growth track by its CEO Paul Bisaro, who only joined the company in late 2007. This makes the deal far more affordable now than it was then. Secondly, Watson has been scouring the world (and Europe in particular) for acquisition targets and has presumably concluded that Actavis, for all its faults, is the best option available for a transformational deal. Thirdly, although Actavis hasn’t changed much from the outside, its new CEO, Claudio Albrecht, has been working very hard to improve it on the inside. And fourthly, in 2010, Watson hired Actavis’ former CEO, Siggi Olafsson, as its Head of Global Generics. Consequently, it can be confident that it won’t find too many skeletons in the closet. This would be a nice change from the Arrow deal, where Watson seems to have done most of its fact-finding after the transaction closed, rather than before. Indeed, buying Actavis would shift Arrow from being merely poor value to something close to a total waste of time and money, since Actavis’s assets almost completely overlap Arrow’s (other than in Canada). The same goes for Specifar, which would be made pretty much redundant by Medis, Actavis’ dossier development and third party supply arm. Watson spent a total of $2.3bn on Arrow and Specifar, something that needs to be borne in mind when considering the extent to which a tie-up with Actavis is going to be good value.
So, what would Watson actually be getting if it buys Actavis, and what could it do with it? According to data presented by Actavis at a recent conference, turnover in 2010 was around €1.7bn ($2.4bn), of which half was in Europe, a third in the US and the remainder divided between Medis (which supplies third parties, mostly in Europe) and direct sales in AsiaPac/MENA. This latter portion contains most of Actavis’ fastest-growing territories, but since it only accounts for 5% of total turnover (vs 12% for Medis), it is not going to be a growth driver for the group as a whole. Within Europe, Actavis is particularly strong in the UK and is also quite well positioned in the Nordic region, Russia, Turkey and CEE (particularly Romania and Serbia). The company also lists Germany its top 10 markets (at position five) but we suspect that third-party business accounts for much of this. Overall, Actavis is quite strong on the European periphery but lacks strength in most of the EU’s big markets, other than the UK. Consequently, it is not true to say that buying Actavis would give Watson a comprehensive European presence, although it would certainly help. We also note that there is no overlap at all between Actavis’ top 10 growth markets (of which the number 10 is Poland, growing at 13%) and its top 10 markets overall, implying that sales growth in established territories is relatively modest. Indeed, total turnover has been hovering around the €1.7-1.8bn level for the last two or three years, as Actavis has grappled with production problems in the US (now resolved) and plunging prices in Europe, as well as shedding some activities, such as its Bulgarian wholesale operation. The company has also made some progress towards plant rationalisation, which is a key objective of the current management. Because Actavis was built up via a rapid series of acquisitions, none of which was fully integrated into the parent company at the time, it ended up with multiple manufacturing sites. When it was taken private in 2007, it had 21 facilities, but this now seems to be down to about 16, after closures in the US and disposals in Bulgaria and Turkey, among other places. The company also has nine R&D centres, so it is fairly easy to see where Watson might find some synergy benefits.
Actavis has a declared policy of moving towards more specialist products, but its actual portfolio today is firmly oriented at the commodity end of the spectrum. That said, in the US, it has a strong presence in both liquids/creams and controlled drugs, both of which would be useful for Watson, and in Europe it has an injectables business, albeit mostly in Romania. Via Medis, it also has a tremendously strong pipeline of new products being developed for global sale, so Watson may find some cost savings by sourcing US products from Actavis, as well as broadening its portfolio in Europe. In general, though, the financial rationale for putting Watson and Actavis together comes from the potential to cut costs, not from sales synergies. Given its geographic spread, Actavis is going to find it hard to grow its top line by more than mid-single digit percentage points, so if anything, it more likely to be a drag on consolidated sales growth. The benefits – which are likely to be large – will come at the EPS level.
The financials of any transaction are rather unclear, as Actavis has not published any figures for several years. Cash EBITDA (i.e. after the deduction of all R&D costs) was about €260m back in 2009, but has presumably improved substantially since then. Certainly, the anticipated transaction price would imply an EBITDA of around €400m, since this would give a range of EV/EBITDA multiples of roughly 11-14x.
Watson’s share price has moved up sharply in the belief that the rumours are true and a deal with Actavis will be closed. It is fairly simple to see why, as buying Actavis would double Watson’s turnover (bringing very close to Mylan in total sales) and give it the potential to add a further several hundred million dollars to the bottom line through eliminating duplicated costs. On a more personal level, it would (presumably) give Siggi Olafsson a second chance at running Actavis, which would be satisfying given the way in which he was replaced at the helm back in 2010.
Financially, it is hard to argue that combining Watson and Actavis is a bad idea, but strategically, it is not so clear to us that it is the right thing to do. Even leaving aside the Arrow/Specifar issue mentioned earlier, why does Watson want to have another billion euros of sales in European generics? Claudio Albrecht himself has said that the generics industry is doomed in its current form and he is almost certainly correct. Buying Actavis would give Watson a lot more of the same, when what it really needs is something different. It already has an attractive specialty pharma business focused on women’s health and urology; why not spend the money expanding that into Europe? In our view, a company that doesn’t currently have a strong presence in European generics has no reason to want to acquire one, for the simple reason that there is no money in it. Prices are falling far faster than in the US, but without the compensation of high volumes, and even eastern Europe is no longer the safe haven that it used to be. Watson’s current European presence is extremely marginal and barely in the black, so the company could save quite a lot of money just by dumping it and then starting again using a branded model. Unfortunately, though, shareholders are always likely to prefer the big deal to any admission of failure, so we can only hope that Watson will take the cash flow that comes from consolidating Actavis and reinvest it in brands. And that it can make the deal work, of course.
Posted on 23rd March 2012