Allergan (AGN): Exit Early or Go for Broke?

Allergan, Inc. (NYSE:AGN), a large-cap growth stock in the biotechnology category, has been on the rise for almost two years.

Allergan185Allergan stock soared 121% in the past year, largely driven by a $66 billion acquisition bid from drug rival Actavis (NYSE:ACT). Since January 1, Allergan shares are up about 3% — outpacing the S&P 500 by about five percentage points.

Allergan announced earnings on Wednesday that blew past Wall Street’s expectations. For the fourth quarter of fiscal 2014, AGN reported adjusted earnings per share of $2.17, compared to $1.35 in the same period a year ago, for a whopping year-over-year increase of 60%. The consensus estimate called for Allergan to report EPS of $1.83.

Allergan reported $1.89 billion in revenue in the quarter, a record year-over-year increase of 17.2% on a constant currency basis. Because of the pending merger with Actavis, management did not provide guidance for fiscal year 2015.

Allergan Wednesday posted a stellar operating report, but it still raises the question: Should investors play it safe and pocket their gains now, or is it worth the risk to go long? This company’s diversified portfolio of blockbuster products indicates that the stock still has room for growth. But with AGN on the cusp of being absorbed by a larger entity, uncertainties remain.

Allergan’s growth has derived from organic development of new products, whereas its suitor Actavis has grown from mergers and acquisitions. The two companies would create a combined behemoth with annual revenue of about $23 billion. Investors averse to risk should pocket their gains now; those willing to shoulder uncertainty for future gains should consider hanging on for the ride.

Allergan has been reaping the benefits of its varied portfolio of products, spearheaded by Botox, Restasis and the Juvederm product line. Barriers to entry are high and the risk of competition from newcomers is low. AGN also enjoys favorable prospects from accelerating drug approvals, new product launches, and extended coverage for drug treatments under Obamacare.

AGN: Cash Rich and Resilient

Fledgling biotechs are known for showing exciting promise and then flaming out, either because they couldn’t get their drugs through the regulatory gauntlet or because they ran out of cash. However, Allergan boasts $4.2 billion in cash and short-term investments, not to mention a track record of relatively rapid U.S. Food and Drug Administration (FDA) approvals, making it one of the globe’s largest and most resilient biotech firms.

The FDA approved 39 drugs in 2012, followed by 27 in 2013 and 40 in 2014. The bulk of the multi-year spike in new drug approvals derives from advances in biologics, which are manufactured from a living organism to forge a matrix of molecules. Conventional drugs are usually created by mixing chemical compounds.

Allergan is in the forefront of developing patented biologic treatments, such as antibodies and vaccines. AGN also has entered the field of “biosimilars,” which are generic, less costly copies of biologics. The company is readying several new biosimilar drugs for market, to supplement its existing pipeline of products. Gene-based biologics are increasingly crucial for oncology treatments, but as they lose patent protection new opportunities are opening for cheaper biosimilars.

Allergan Stock: The Expectations Game

On March 10, both Allergan and Actavis will hold special meetings of shareholders to address Actavis’ impending acquisition of Allergan, a deal already supported by the management of both companies.

Actavis markets a diverse portfolio of branded and generic drugs. The Actavis/Allergan deal is expected to close by the end of the second quarter of 2015 and would create one of the top 10 global pharmaceutical companies by revenue. Now’s the time to evaluate whether you should stick with AGN and bet on the Actavis deal.

Actavis’ growth strategy has been predicated on mergers and acquisitions, which so far has paid off. The Ireland-based drug-maker’s revenue has grown from $5 billion in 2012 to an expected $12 billion for 2014. Allergan’s business model, on the other hand, has been more focused on organic growth and internal drug development.

The two companies complement each other. The larger Actavis would provide Allergan with even greater financial clout for research and development; Allergan would provide Actavis with well-known brands, such as Botox, that are gaining market share. Botox is a popular product for medical cosmetics, but it’s also increasingly applied as a therapeutic treatment, especially for combating macular degeneration.

However, in light of current market turbulence and the usual uncertainty that surrounds any acquisition bid, risk-averse investors might be better served elsewhere. If you want a similar but safer growth play on “Big Pharma,” consider Novartis AG (ADR) (NYSE:NVS), which I recommended in a story posted December 12. Investors will be able to reevaluate Actavis and Allergan after the March 10 meetings.

As of this writing, John Persinos did not hold a position in any of the aforementioned securities.

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