Back in January, I said that “elephant season” had opened for pharma companies, after the announcement that Bristol Myers Squib (BMY) was buying Celgene. By that, I meant that we could expect more big mergers and acquisitions this year, a prediction that came true this morning with the announcement that AbbVie (ABBV) is finalizing a deal to buy Allergan (AGN).
A move of some kind by AbbVie is not unexpected, given that the maker of the blockbuster drug Humira has come under fire recently for a perceived failure to protect itself sufficiently from the effects of intense competition to that therapy, and the looming expiration of its patent. As that criticism has intensified, ABBV has plummeted, losing around forty percent from the high in early 2018.
As you can also see from the chart above, this morning’s news hasn’t helped either. At the time of writing, the stock is down nearly sixteen percent from yesterday’s close, taking it to a new two-year low. Given that price action, AbbVie’s management must feel that they just can’t win. They have been punished for doing nothing and now are being punished for doing something, but in the long-term, this still looks like a decent move.
Let’s start with the basic facts. The deal is worth around $63 billion, making it the seventh largest deal in pharma history, and represents a price of about $188 per share of Allergan, paid part in cash and part in stock. That is a big premium to yesterday’s closing price of $129.57, and as a result, AGN is flying this morning.
The size of that premium has led to the initial conclusion from most analysts that this is a great deal for Allergan’s stockholders, and, by extension, a bad one for AbbVie. That is the most obvious way to look at it, but if we take a step back and consider some history, it isn’t necessarily true.
This isn’t the first time Allergan has been targeted for acquisition. Back in 2015, Pfizer (PFE) announced a deal to buy them for a whopping $160 billion, or around $169 billion in today’s dollars. That deal was canceled after the rules around tax inversion, a way of companies shifting their tax burden overseas, were changed. That advantage at the time accounted for some of that price but even so, the $63 billion price tag doesn’t look too bad in that context.
The main thrust of that piece I wrote in January was that whatever the nature and details of big pharma deals in the current environment, there were advantages beyond just the natural synergies of any merger or acquisition. The industry is facing some serious pressure on pricing, and a plethora of small companies with one or two targeted therapies has changed the competitive landscape. Those two things exaggerate the advantages of size in pharma right now—a fact that the market seems to be ignoring. A big, combined company would be better placed to fight pricing regulations, have access to more comprehensive R&D, and would have the cash flow and sheer size to expand their pipeline by buyouts of smaller companies in the future.
In other words, there is value to a big pharma deal that, while not immediately apparent, will become evident over time, and this is no exception.
It wouldn’t surprise me if we saw a bit of a bounce back in ABBV as today wears on, but even so, I would still not advocate rushing out and buying it yet. Over the next few days, analysts will look at this deal in the way they have been trained to, and that is unlikely to result in much positivity. They will assess the price paid and the immediate impact on revenue, and there is a good chance that with each negative release on that basis ABBV will drop a little more.
Before too long though, investors will consider the advantages above, the improved position of the new company relative to their competition, and, most of all, the value of its dividend yield in a static or even falling interest-rate environment. That won’t take long, and when it happens and ABBV will find a low. My best guess right now is that the low will come at around $60, but the trade should be based on price action rather than any particular level, with a couple of positive days in a row prompting a partial buy, and a view to average in several such events.
There is, of course, no guarantee that this will prove to be a good deal, but with all the bad possibilities getting priced in over the next few days there will be an opportunity in ABBV for those who take a slightly longer view.