Actavis Buys Forest Labs: How Should Shareholders Proceed?

Forest Laboratories, Inc. (FRX, $92.42, up $21.03 midday)

Actavis PLC (ACT, $205.84, up $13.96 midday)

 

“Actavis Plc (ACT), the world’s second-largest generic-drug maker by market value, agreed to buy Forest Laboratories Inc. (FRX) for about $25 billion in a deal that will transform it into a developer of brand-name drugs,” reports Bloomberg.

Forest Labs shareholders will receive $26.04 cash, and .3306 shares of ACT stock valued at $89.48 per share for each share of FRX owned.  Actavis will finance $7.3 billion at 4.25% for five years, and issue approximately 90 million shares of stock, to fund the buyout.

Actavis PLC is a global, broad-based pharmaceutical company.  It recently completed the acquisition of Warner Chilcott PLC.  The company is based in Dublin, and operates in New Jersey.

Forest Laboratories, Inc. develops, manufactures and markets treatments for dementia, hypertension, irritable bowel syndrome, cardio-pulmonary disease, and depression.  Forest’s main product Namenda will go off-patent in January 2015.

Actavis expects the combined company to benefit from $800-$900 million in annual cost savings for several years, and to also incur a lower income tax rate.  These savings total about $1 billion per year, and don’t include additional gains from revenue synergies.  Morgan Stanley expects Actavis to gain a 15% EPS accretion from the acquisition in 2015 & ‘16.

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What Should Forest Labs Shareholders Do?

Forest Labs operates on a March fiscal year.  Looking forward, the 2015 PE is 24.9; quite expensive in light of the recent six-year PE range of 7-19.  FRX shareholders should consider themselves very fortunate to have the opportunity to take their money off the table at around $90 per share.

Unless shareholders have a strong sense that a higher, competing bid will emerge, Forest Labs shareholders should sell their shares now, and here’s why:

• The stock is trading above the acquisition value, which means if shareholders wait for the acquisition to consummate, they will have less capital than if they sell today.

• Shareholders’ capital will likely stagnate between now and the acquisition date.  Shareholders who sell FRX and reinvest their capital elsewhere have a current opportunity for their capital to continue to grow.

• The deal could fall through, if Actavis’ financing efforts fail, or if regulatory approval is denied.

• A broad stock market correction could harm the value of these stocks, and harm the acquisition itself.

• Shareholders are notoriously horrible at keeping track of their post-merger cost bases — please don’t take offense — and their tax-preparers are oftentimes woefully poor at this task as well.  If this sounds like you, and you own your FRX shares in a taxable account, make a clean break from the stock.  You can always purchase ACT shares on the open market if you’re in love with that stock, thereby eliminating the complicated tax basis.

Goodfellow LLC Rating:  Sell, Public.  (02-18-14)

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What Should Actavis Shareholders Do?

Prior to the takeover announcement, Wall Street expected Actavis’ earnings per share (EPS) to grow 38% and 12% in 2014 & ’15 (December year-end).  The 2014 price-earnings ratio (PE) is 15.9, in a ten-year range of 10-39.

Projected earnings growth is very attractive, and the PE is surprisingly low.  However, the long-term debt ratio is high at 61%, and the company’s financial position will weaken further with the expense of the FRX acquisition.  FRX has no long-term debt, so that’s a plus.

The stock has risen about 140% in the last twelve months.  Shareholders should hold Actavis stock, and use stop-loss orders to protect their gains.  It is unreasonable to expect stocks like this to go up forever.  If the market sours on Actavis, or if a broad market correction comes along, the stock could fall back to support levels of $120 from last summer.

Goodfellow LLC Rating:  Hold, Growth, Public.  (02-18-14)

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Happy investing!

Crista Huff

President

Goodfellow LLC

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