Perrigo Company (PRGO), Elan Corporation, plc (ADR) (ELN): This Merger Adds Value Multiple Ways

2013 is turning out to be a stellar year for Mergers and Acquisitions. There have been a number of M&A deals in healthcare and technology sectors. Technology sectors might be in the news more often, but it’s the healthcare sector which has the highest number of M&As. During the current year, there have already been 426 confirmed deals. There were 203 M&As in the first quarter which increased to 223 in the second quarter.

Long term care and Pharmaceutical industries have led the pack with the highest number of M&As. The total worth of these second quarter M&As are $52.6 billion, up 252% from $14.9 billion in the first quarter. This increase in M&A activity is the direct result of a large number of drug approvals by the FDA and the patent cliff. Healthcare giants are facing generic threat due to expiring patents which are forcing them to invest in promising acquisitions. However, sometimes companies have a unique reason to acquire another company has nothing to do with patents or promising candidates. The recently concluded Perrigo Company (NYSE:PRGO)’s acquisition of Elan Corporation, plc (ADR) (NYSE:ELN) is example of M&A for tax gains.

The Deal

A number M&As have taken places during the last few months, but none more intriguing than the acquisition of Elan Corporation, plc (ADR) (NYSE:ELN) by Perrigo Company (NYSE:PRGO). Elan is an Irish biotechnology company which is engaged in the clinical stage development of ELDN005 for neuropsychiatric indications. On the other hand, Perrigo is a primarily an OTC and generic prescription manufacturer. It also manufactures and distributes infant formulas, nutritional product, and APIs (Active Pharmaceutical Ingredients).

The deal has been values Elan Corporation, plc (ADR) (NYSE:ELN) at $8.6 billion. Perrigo Company (NYSE:PRGO) will pay $6.25 per share in cash and the rest in stock at $10.25. The company is funding the deal with bridge financing from Barclays and HSBC. Among other benefits, this deal will also give Perrigo rights to Tysabri, a multiple sclerosis drug with $1.5 billion in annual sales.

Tax Savings

The acquisition will give Perrigo Company (NYSE:PRGO) control over Elan Corporation, plc (ADR) (NYSE:ELN)’s marketed products Tysabr and pipeline candidate ELND005. Despite the attractiveness of this portfolio, the real reason behind the acquisition is none other than tax savings.

U.S tax laws govern the tax payments of Perrigo Company (NYSE:PRGO), which demands a tax rate as high as 35%. On the other hand, corporate taxes are around 12.5% in Ireland. This deal will lower the effective tax rate from 30s to high teens. The company pays around $200 million in annual interest expense. If we assume that it will effectively lower tax expense by 40%, the impact on the bottom line will be approximately $80 million or $0.85 per share. Using industry average P/E of 38x, this should result in a $32 upside on Perrigo. Adding this to pre-acquisition valuations, we can get a target price of $166. This is a simplified calculation to show the crude upside effect of the acquisition and doesn’t account for any business risks due to this acquisition.

Fundamentals

Perrigo’s has appreciated 262% in the last five years and 45% in the last 2 years. The superb revenue growth has driven this valuation improvement. The revenues have grown by an average 18% in the last 5 years and at least by 14% every year. It has also beaten Street estimates in the last 4 out of 5 quarters.