Is Allergan Inc. (NYSE:AGN) A Good Stock To Buy?

Before we spend many hours researching a company, we’d like to analyze what hedge funds and billionaire investors think of the stock first. We would like to do so because the elite investors’ consensus returns historically managed to outperform the market. You probably won’t agree with this statement if you have been reading headlines about hedge funds’ losses in Valeant (VRX) since last September. Although the elite funds occasionally have their duds our research have shown that the hedge fund picks seem to work on average. For example the 30 most popular large-cap stocks among hedge funds generate an annual alpha of 2 percentage points in our backtests. On the other hand, hedge funds’ consensus small-cap picks historically outperformed the market by double digits annually.

This year isn’t an exception. Insider Monkey tracks more than 800 hedge funds. We created a giant portfolio of hedge funds’ top 2600 stocks where each position’s weight in the portfolio is proportional to the total dollar value of aggregate hedge fund long positions in the stock. This portfolio lost 4.7% this year through the end of February vs. 5.2% loss for the S&P 500 Total Return Index and 8.8% loss for the Russell 2000 Index. This isn’t a small portfolio either. The total value of this hedge fund portfolio is $1.6 trillion and each percentage point outperformance corresponds to $16 billion in “value added” by hedge funds.

Overall, these results tell us three things. First, it really doesn’t make sense for investors to invest in an average hedge fund that invests in large-cap stocks because most hedge funds charge astronomical fees for their slightly improved performance. Second, it may be a good idea to invest in a hedge fund that plows through undercovered small-cap stocks. Last but not least, the best strategy for investors to take advantage of hedge funds’ superior stock picking ability is to imitate their consensus stock picks by themselves. In any case, we believe, every investor should check out the hedge fund sentiment in the stocks that they are considering to trade. In this article we will take  a closer look at Allergan.

Allergan, Inc. (NYSE:AGN) has been hedge funds’ top choice for a while now. AGN was in 159 hedge funds’ portfolios at the end of the fourth quarter of 2015. There were 151 hedge funds in our database with AGN holdings at the end of the previous quarter. The level and the change in hedge fund popularity aren’t the only variables you need to analyze to decipher hedge funds’ perspectives. A stock may witness a boost in popularity but it may still be less popular than similarly priced stocks. That’s why at the end of this article we will examine companies such as Unilever plc (ADR) (NYSE:UL), Amgen, Inc. (NASDAQ:AMGN), and PetroChina Company Limited (ADR) (NYSE:PTR) to gather more data points. But first we will share a few quotes from hedge fund investor letters that explain why hedge funds like Allergan. Here is what Dan Loeb said about the stock last year:

“We first became involved in what is now Allergan in 2013, when it was the much smaller company, Actavis. It had recently completed its acquisition of Warner Chilcott and we believed it was poised to leverage its new Irish domicile to conduct additional accretive transactions. Over the last 20 months, this management team has done just that, closing large transactions in Forest Laboratories ($21 billion) and Allergan ($65 billion), along with many smaller deals. While critics say they are acquisition-happy, Bisaro and Saunders have articulated a strong strategic vision for Allergan and a coherent framework for pursuing deals. Their mission is to create a growth-oriented pharmaceutical company with attractive long-duration assets while implementing strict expense controls and avoiding high-risk and undisciplined R&D spend. Over the past two years, Allergan has used its formidable cash flow to acquire derisked assets and build a broad based pipeline, in line with its stated goals.On July 27, 2015, the company announced its latest transaction: the sale of its generic drug business to Teva Pharmaceuticals for $40.5 billion in cash and Teva shares. Financially, the transaction is a home run for Allergan; they sold a structurally mature business for ~17x 2015 EBITDA while delevering the balance sheet from $40 billion in net debt to nearly zero. The strategic vision of the transaction is equally impressive. Despite the fact that generic drugs were Allergan’s original business, Bisaro and Saunders recognized that the legacy segment had become an anchor on valuation and that its divesture was the right course of action for Allergan shareholders. While shareholders applauded the decision, driving Allergan stock nearly 10% higher in the ensuing three days, we believe that there is still a meaningful valuation gap to close.

Following the close of the TEVA transaction in Q1 2016, Allergan will be a pure-play growth pharmaceutical company with long duration branded assets in seven therapeutic areas, an underappreciated pipeline, an unlevered balance sheet and most importantly, a bold and forward thinking leadership team. Despite this successful track record, on July 31, 2015, Allergan stock traded at $329 per share or only ~16.5x estimated pro forma earnings of $20 per share, a valuation below comparable growth pharma companies like Celgene, Biogen, Bristol Myers, Shire, and Novo Nordisk who trade at an average 2017 earnings multiple of ~19x. Moreover, the 2017 earnings estimate assumes neither any accretive acquisitions nor the use of cash for any other purpose such as buybacks. However, on several occasions, Saunders has talked openly about the opportunity for a “transformational” transaction. Looking across the pharmaceutical industry, we see several companies who could benefit from Allergan’s operating discipline and focus and whose acquisition by Allergan would drive significant accretion and shareholder value. While many management teams would be patting themselves on the back for a job well done, Paul Bisaro and Brent Saunders have consistently demonstrated a drive to create shareholder value in Allergan with bold strategic action and focused operational execution. To align themselves with shareholders, they and the rest of the senior management have tied their long-term compensation to achieving an aspirational $25 per share earnings target in 2017. We believe that they are among the best leaders in business today and are glad to have put a significant portion of our investors’ capital in their hands.”

Dan Loeb isn’t the only activist who is bullish about Allergan. Another billionaire activist hedge fund manager, Barry Rosenstein, said the following about Allergan in his 2015 Q3 investor letter:

“We first invested in Allergan (through its predecessor Actavis) in November 2013. Since then, we have watched the company increase per share value through three transformative transactions: the acquisition of Forest Laboratories Inc. (announced February 2014), the acquisition of Allergan, Inc. (announced November 2014), and in July, the announced sale of its generics franchise to Teva Pharmaceutical Industries, Ltd. (TEVA), which we expect to close in the first quarter of 2016. When the TEVA transaction closes, the new Allergan will be a branded pharmaceutical company with six key therapeutic areas and $15 billion of revenues, expected to grow its top line at low double digits and earnings per share at 20 percent per annum. It will also have close to zero net leverage when adjusted for the proceeds from TEVA. The AGN of tomorrow looks nothing like the small generic company of Watson Pharmaceuticals Inc. that Paul Bisaro took the helm of in 2007. Importantly, it also looks nothing like certain of its specialty pharma peers, which have been tarnished by the cascade of bad news and government inquiries into aggressive business practices. We recognized this distinction and swapped our Valeant position into an increased Allergan stake in September. We think it is important for our investors to note that though certain specialty pharma names (Allergan, Endo International PLC (ENDP) and Valeant) have become popular longs across many managers (2), we are not Johnny-come-latelies to this group and have developed a nuanced understanding of the key distinctions among their assets, their business strategies and their management teams. Our buy and sell discipline in all or the positions we have transacted in has been quite good. We owned Mallinckrodt PLC (MNK) from June 2013 through August 2014; we exited at the time of the Questcor Pharmaceuticals Inc. acquisition announcement because we believed Questcor was a low quality asset. We owned Endo from September 2013 through August 2014; we exited when the multiple had expanded from roughly 11x earnings at our cost to roughly 15x – at the time a premium to the peers. We owned Valeant from September 2014 through September 2015, acquiring the stock at about 11x earnings and having sold much of the position to respect its expanded multiple before the September drawdown — and all of it before the October collapse. At the time or this writing, Allergan is the only of these companies trading above its “pre-Hillary tweet” September levels as the stock price has moved to reflect news of Pfizer Inc.’s (PFE) potential interest in Allergan – interest that we believe confirms the quality of Allergan’s assets, management and business practices.”

How are hedge funds trading Allergan, Inc. (NYSE:AGN)?

Heading into 2016, a total of 159 of the hedge funds tracked by Insider Monkey were bullish on this stock, a change of 5% from the previous quarter. With hedge funds’ positions undergoing their usual ebb and flow, there exists an “upper tier” of key hedge fund managers who were upping their holdings significantly (or already accumulated large positions).

According to Insider Monkey’s hedge fund database, Andreas Halvorsen’s Viking Global has the largest position in Allergan, Inc. (NYSE:AGN), worth close to $1.87 billion, comprising 7% of its total 13F portfolio. Sitting at the No. 2 spot is Paulson & Co, managed by John Paulson, which holds a $1.73 billion position; 10.3% of its 13F portfolio is allocated to the stock. Other members of the smart money with similar optimism encompass Dan Loeb’s Third Point, Matthew Halbower’s Pentwater Capital Management and Paul Singer’s Elliott Management.

As industrywide interest jumped, specific money managers have jumped into Allergan, Inc. (NYSE:AGN) headfirst. Pentwater Capital Management, managed by Matthew Halbower, initiated the most valuable call position in Allergan, Inc. (NYSE:AGN). Pentwater Capital Management had $466.2 million invested in the company at the end of the quarter. Zach Schreiber’s Point State Capital also made a $326.1 million investment in the stock during the quarter. The other funds with new positions in the stock are Eric Mindich’s Eton Park Capital, Paul Singer’s Elliott Management, and John Overdeck and David Siegel’s Two Sigma Advisors.

Let’s check out hedge fund activity in other stocks – not necessarily in the same industry as Allergan, Inc. (NYSE:AGN) but similarly valued. We will take a look at Unilever plc (ADR) (NYSE:UL), Amgen, Inc. (NASDAQ:AMGN), PetroChina Company Limited (ADR) (NYSE:PTR), and Taiwan Semiconductor Mfg. Co. Ltd. (ADR) (NYSE:TSM). This group of stocks’ market valuations are closest to AGN’s market valuation.

As you can see these stocks had an average of 27.75 hedge funds with bullish positions and the average amount invested in these stocks was $1.7 billion. That figure was $22.2 billion in AGN’s case. Amgen, Inc. (NASDAQ:AMGN) is the most popular stock in this table. On the other hand PetroChina Company Limited (ADR) (NYSE:PTR) is the least popular one with only 8 bullish hedge fund positions. Compared to these stocks Allergan, Inc. (NYSE:AGN) is decisively more popular among hedge funds. Considering that hedge funds are fond of this stock in relation to its market cap peers, it may be a good idea to analyze it in detail and potentially include it in your portfolio.