Perrigo announced that it will acquire Elan in an $8.6 billion stock and cash deal, or $6.7 billion excluding Elan’s nearly $2 billion in cash on the balance sheet. Because about 60% of the offer is funded in Perrigo stock, analyst’s new Perrigo valuation will partially dictate the fair value estimate for Elan shares. This deal has little effect on Perrigo’s operational assets or competitive advantages, so we don’t foresee a change in the narrow economic moat rating for the firm.
Although Elan owns attractive royalty payment streams and has some (modest) pipeline assets, Perrigo’s primary incentive is to utilize Elan’s Irish domicile to lower the company’s tax rate. This acquisition follows a familiar strategy used by other specialty pharmaceutical companies, including Valeant VRX and Actavis ACT , to lower tax liabilities through tax restructuring deals. Following the transaction, Perrigo estimates its tax rate will move to the high teens, and analysts estimate the majority of the $150 million in annual cost synergies will stem primarily from tax benefits.
Analysts expect that Perrigo may eventually divest the royalty streams it will receive from Elan. These royalties stem from Tysabri, the intravenous multiple sclerosis drug now owned by Biogen Idec BIIB . Although Tysabri faces growing competition from new oral MS drugs, the drug has a long patent life and little risk of generic competition thanks to manufacturing complexity and safety issues.
Elan also has a Phase II drug in development for bipolar disease and Alzheimer’s disease, and data in 2014 will determine whether Perrigo will be able to partner or divest this business at a profit. However, Morningstar analysts had only assumed a 20% probability of the drug’s approval in their Elan valuation, and we do not see this as a significant part of Elan’s value to Perrigo. As a generic pharmaceutical manufacturer, we doubt Perrigo will utilize Elan’s assets as a launching pad for future biotech drug development.
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