Look for Allergan Inc. to start looking different as the takeover battle for the Irvine-based drug maker grinds on.
Driving the change in the near term will be the latest defensive tactic for Allergan, which plans to shed costs, starting with roughly $50 million in the current quarter.
That’s likely to include shutdowns of some early-stage research programs at the company, which had $6.2 billion in sales last year. Nearly 20% of the company’s 11,400 jobs are tied to research and development, which also accounts for much of the staff of about 2,400 at its headquarters campus near John Wayne Airport.
Allergan Chief Executive David Pyott went public last week with plans to “take a deep look and see where we can do some trimming ourselves and raise the value we offer to our stockholders” as the company continues to fend off hostile advances from Quebec, Canada-based Valeant Pharmaceuticals International Inc. and Bill Ackman’s Pershing Square Capital Management LP in New York.
The goal of the cost cuts is to boost Allergan’s earnings prospects in an effort to send its share prices up, a trajectory that would hold the potential to put a deal out of Valeant’s reach.
A recent analyst report put some numbers against Pyott’s plans.
David Buck, a partner and director of New York-based Buckingham Research Group, said that “without any further enhancement, each $250 million cut in operating expenses would add [about] 60 cents” to the company’s adjusted earnings-per-share forecasts.
Earnings Per Share
Allergan’s current estimate on its 2014 full-year EPS is $5.64. Its EPS in the first quarter was $1.18 and is projected to be at least $1.41 for the quarter just ended. That leaves $3.05 for the next two quarters, and using rough, straight-line estimates would give third-quarter earnings of about $1.53 a share. The quarter-to-quarter difference—between the third and second quarters—would be 12 cents or so. That would equate to about $50 million in cost savings in the third quarter, based on Buck’s ratio of cost cuts to additional earnings.
The question is where Allergan will achieve the savings, said Shibani Malhotra, an analyst with Sterne Agee, in a recent report that reflected a conversation with Pyott.
Malhotra said that “some will suggest that [Allergan’s push for savings] validates Valeant’s point that the company was fat.”
She disagreed, noting a distinction between the two companies’ respective approaches to cost cutting.
Valeant has said that it would slash Allergan’s research and development budget—currently about $1 billion a year, or nearly 17% of sales—if it gets its way. It has taken a similar tack on a string of acquisitions in recent years under Chief Executive Michael Pearson, who has maintained a strategy of buying companies and cutting research operations, focusing mainly on sales and marketing of drugs.
Allergan has laid out plans to pare the proportion of R&D spending to about 14% of sales over the next few years, while management isn’t likely to “cut any investment that delivers a high return in [the] near term,” Malhotra wrote. “Most of these cost cuts will come from longer-term market development or early R&D projects. While in the past management chose to invest in these … longer-term projects, these will have to be cut or delayed in order to deliver higher near-term returns to shareholders.”
Major layoffs wouldn’t necessarily equate to savings in the immediate quarter since there are costs associated with letting employees go, although Wall Street would likely consider the moves as extraordinary expenses. Other options could be to place a hiring freeze and count on attrition.
Pyott has also made clear that Allergan could look for mergers and acquisitions opportunities to help fight off Valeant.
He said potential targets would be companies that are specialized and have complementary assets, as well as “great connectivity” with physicians and customer groups.
Malhotra said in her report that there’s been investor interest in a combination of Allergan and Actavis PLC, a Parsippany, N.J.-based specialty pharmaceutical company with a recent market value of about $38 billion.
“However, both management teams, while acknowledging the potential benefits of such a transaction, have been mostly non-committal,” Malhotra said.
The Business Journal in January reported on Pyott’s announcement that the company could spend $10 billion on potential buys this year, a target cited before Valeant surfaced as a bidder.
An acquisition, whether by cash or debt, would make Allergan’s balance sheet less appealing to Valeant, which had more than $17 billion in long-term debt at the end of the first quarter. That compared with $576 million in cash and cash equivalents.
Allergan at the same time had $2.1 billion in long-term debt and $2.8 billion in cash and cash equivalents.
There remains the possibility that the Valeant proposal would go through.
Valeant first made a cash-and-stock offer for Allergan in April at a value of about $47 billion. Since then, it has made separate and increased bids, the value of which currently hovers around the $51 billion mark based on the latest stock prices.
Allergan if acquired would be as good as gone from the Orange County business scene—where it’s the biggest publicly traded company based here and a longtime hub of the area’s vibrant clusters of drug companies and medial device makers.
Allergan has rebuffed Valeant’s offers so far and has gone to work to convince its shareholders that the company is better off on its own, and that it could be a long-term value driver for them as a stand-alone entity.
Shareholder Meeting
Ackman, in the meantime, has been pushing for a special shareholder meeting, where he intends to take a vote to oust six of Allergan’s nine directors. He would need 25% of shareholder support to hold the meeting and 50% approval at that point to remove directors, according to company bylaws.
“If Pershing is finding it difficult to get 25%, the actual vote to remove board members and getting to the 50% might prove more difficult,” said analyst David Maris, of BMO Capital Markets Corp. in New York.
That puts time in Allergan’s favor, Maris said, as “a newly elected slate [of board members] will likely have to wait until the next annual meeting” in May. “In the meantime, Allergan could pursue any number of options.”
