The merger announcement that Valeant Pharmaceuticals (VRX) would combine with troubled Canadian biotech firm Biovail (BVF) was one of largest of the past several months. The new company will retain the Valeant name, but will be controlled by Biovail shareholders, 50.5% to 49.5%.
Since Valeant will be the name of the new company, let’s take a look at what it brings to the table.
Valeant is a medium-sized drug manufacturer that specializes in medicines that treat ailments of the skin and brain. This is a great business. Over the past three years, healthcare spending has risen 4% annually, outpacing inflation and GDP growth.
In 2008, healthcare accounted for 16.2% of GDP at a time when 12.8% of Americans were over 65. By 2030, 19% of the population is expected to be over 65, which means demand will grow. Many changes lie ahead for drug makers in this environment under the new rules recently passed by Congress, and they include provisions that will help give more Americans access to treatments that might previously been out of their reach.
VRX’s product roster includes many drugs that target older people. One of its top performers is Kinerase, promoted by actress Courtney Cox since 2005, which is a plant-derived treatment that makes skin smoother, younger and healthier.
The company also produces medicine for acne, which is suffered by 85% of Americans. Its gel is the only FDA-approved combination of antibiotic and topical treatment. Its popularity has grown as teens have discovered they face less dryness and skin irritation compared to competitive products. Valeant also sells hundreds of so-called orphan drugs that only treat rare conditions, yet remain profitable without government price controls.
The company was founded in 1960 as ICN Pharmaceuticals. Based out of Aliso Viejo, California, its first major product was ribavirin, an anti-viral drug for Hepatitis C that also had some success against influenza. Until 2002, the company was unfortunately better known for lawsuits against ex-CEO Milan Panic, as well as insider trading scandals. Shareholders ultimately forced Panic out, and the company restructured. It emerged as Valeant with new leadership and direction.
Over the past three years, Valeant has shot up 400% on triple digit earnings growth engineered by new chief executive Michael Pearson. He migrated as a pharmaceutical consultant from McKinsey in 2008. With 2009 sales of $830.5 million, it is small for a drug company and yet still devotes a lot of money to research. Valeant has often partnered with pharmaceutical giant GlaxoSmithKline (GSK) to bring its best-selling drug through clinical trials and then to market.
Recently, VRX’s growth has been fueled by a series of acquisitions in the Canadian, Australia, New Zealand, and Mexican markets. Nearly half its revenue now comes from brand name generics sold abroad.
VRX’s newest potential blockbuster is Retigabine, an epilepsy drug that opens potassium channels in the brain to stop seizures. This is a different mechanism than traditional anticonvulsants which slow down neurons in the brain. As epilepsy affects more than three million Americans, analysts say Retigabine has shown promising clinical test results and ought to propel Valeant’s growth rates over the next few years.
In its dermatology pipeline, Valeant has an acne drug that can be swallowed rather than applied as a cream; an anti-fungal drug that cures scalp infections for which there is no FDA-approved drug; and a specialized sun screen for people with very sensitive skin.
Valeant’s primary risk at present is that Retigabine will not receive FDA approval. Three of its major patents have already expired or will do so in the next year, making generic competition another concern.
Volume in the stock has also been positive and steady over the past 10 days, indicating accumulation and the validation of its uptrend. Despite 39% earnings growth last quarter, analysts now expect growth to slow down to the 20% range until 2013. Shares trade at a slight premium to competitors, at 15x earnings, largely because of the promise of Retigabine. An earnings estimate of $3.73 and a PE of 15, yields a $56 price target, which is 22% higher than the current quote.
In the combination announced over the weekend, Valeant shareholders will receive 1.78 Biovail shares for each VRX share they own. They will also get a one-time special dividend of $16.77 just before the deal closes. The merger is one of the few that could actually work out. Shares just exceed their 1999 high, so it’s a buy on a return to test the breakout at around $51.