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.
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.
Perrigo is a leader in private label OTC and plans to launch around 60 more products in 2013. The street expects Perrigo’s EPS to grow 11% in 2013 and 16% in 2014. This is excluding the positive tax impact on company’s EPS from the Elan Corporation, plc (ADR) (NYSE:ELN) acquisition.
OTC Growth
The U.S OTC industry has shown rapid growth in the last few years. The analysts are expecting the industry to grow to approximately $32 billion by the end of 2014. Perrigo is currently the leading private label manufacturer in the industry and is set to benefit from this growth in OTC. The company expects to target a $10 billion opportunity in OTC markets in the coming years.
The growing opportunity in this space has also attracted other key players. The Procter & Gamble Company (NYSE:PG) and Teva Pharmaceuticals have partnered to target the OTC industry. P&G is already a leader in FMCG and Teva is a leader in generic pharmaceuticals. This partnership is a threat to existing industry players and would positively affect the valuations of P&G. The company expects this new OTC JV, PGT Healthcare, to generate sales of $4 billion by the end of this decade. Although the exact share of each partner is not public, Teva has reported $257 million in revenues from 2Q2013. Assuming both players have an equal share would put The Procter & Gamble Company (NYSE:PG) annual share around $1 billion.
Buy or Sell
The market has reacted negatively to the acquisitions of Elan with shares sliding down almost 9% on announcement. One of the major reasons behind this decline is the inability of the market to understand the unique synergy between the two companies. This acquisition would significantly reduce Perrigo’s tax payments and give it a $0.85 per share advantage. The new tax benefit increases the target price to $166 and supports the buy thesis for Perrigo.
Mohsin Saeed has no position in any stocks mentioned. The Motley Fool recommends Procter & Gamble.
The article This Merger Adds Value Multiple Ways originally appeared on Fool.com and is written by Mohsin Saeed.
Mohsin is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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