Business

Valeant – Zoetis Chatter Dominates Wall Street

Valeant Pharmaceuticals may or may not be interested in buying Zoetis, but is Zoetis even interested in being acquired by Valeant? That is perhaps the key question as rumors about Valeant approaching Zoetis about a potential combination swirl around Wall Street. Today shares of both companies pulled back after CNBC reported that Valeant actually isn’t interested in acquiring Zoetis.

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Unsurprisingly, analysts from virtually every single firm are weighing in on the possibility that the two companies will decide to get together.

Is Ackman behind Valeant’s offer?

Naturally much of Wall Street is wondering whether Bill Ackman and his firm Pershing Square Capital Management has anything to do with Valeant making an offer for Zoetis. He worked with Valeant on its hostile bid for Allergan, which eventually failed when Actavis swooped in to save Allergan from Valeant.

In this case, Ackman has significant stakes in both Valeant and Zoetis, plus seats on Zoetis’ board. It’s certainly possible that a deal between Valeant and Zoetis would have his fingerprints all over it, but there’s no proof beyond pure speculations at this point.

Timing of a deal as expected?

The timing of the report that Valeant had approached Zoetis about a potential buyout is certainly apt. It has now been two years since Pfizer spun off Zoetis. The two-year mark is important because it made Zoetis able to be acquired without having to pay a hefty tax bill for it.

Interestingly, BMO Capital Markets analyst Alex Arfaei and his team think the timing of a potential deal between Valeant and Zoetis is a little odd. They noted in their report dated June 26 that Valeant is still in the process of “digesting” Salix. Also the leverage is “quite high.”  However, they say the timing suggests that Valeant is again being “opportunistic.”

The BMO team suggested that the offer from Valeant is probably around $60 per share with a 60/ 40 cash/ stock mix.

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However, they estimate that Zoetis is worth between $47 and $50 per share, so they think the animal vaccine maker’s shares could decline by between 15% and 20%.

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Valeant’s M&A strategy

Further, they think that even if Valeant did approach Zoetis about a deal that the drug maker is passing on it because it would have gone against its typical merger and acquisition strategy. They said the main source of value in the deal would have been Valeant’s lower tax rate and potential multiple expansion. The problem with this is that Valeant management said in the past that they don’t rely on their lower tax rate as the main driver for acquisitions.

Another reason a deal with Zoetis wouldn’t fit in with Valeant’s typical M&A strategy because the company usually looks for inefficient targets, but Zoetis has already gone a long way in trimming the fat. There may be no more room to make more cost cuts.

Is Zoetis a good match for Valeant?

So would a merger of Valeant and Zoetis be good for shareholders? Although most analysts don’t think there will be significant accretion or a large number of synergies from a combination of the two companies, most seem to think it will create value for shareholders.

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BMO analysts agree with JPMorgan analysts in believing that a combination would invite an expansion of multiples for the combined company. They also note that it would greatly improve the “durability” of Valeant’s business. Further, they doubt that Zoetis management would be able to create as much near term value for shareholders if they did not accept a buyout offer from Valeant. Because of the volatility in Zoetis shares today, the BMO team downgraded the stock to Market Perform.

Morgan Stanley analyst David Risinger and his team suggest that accretion could be possible in a merger, but only if deep cost cuts are made. They estimate 7% dilution next year even if the combined company is able to slash its selling, general, and administrative expenses and research and development costs by 25%.

The good and the bad about a merger

The Morgan Stanley team highlighted three potential positives for a deal and three potential negatives. On the plus side, it would give Valeant a 20%, market-leading global share of the animal health market. It could also enhance Valeant’s price to earnings multiple because Zoetis is a “high terminal value business.” And third, they say a deal could help de-lever Valeant’s balance sheet from higher than five times net debt/ EBITDA to under five times, depending on how the deal is structured.

On the negative side, they say investors might worry about the timing of payback on such a “high-priced asset” in a new business because any potential synergies would be very small. The Morgan Stanley analysts also said Zoetis’ closing stock price on Wednesday already included an “activist premium” and increased margin projections after restructuring. And third, they report that opportunities for Zoetis to reduce its tax rate are “far less than historical Valeant acquisitions.”

Let the bidding war begin

Analysts from Gabielli & Company think Valeant is just the first bidder to make an offer for Zoetis. They think Bayer would be a more likely buyer for Zoetis than Valeant. Bayer is the fifth-biggest animal health company. Other possible bidders include Allergan, GlaxoSmithKline and Johnson & Johnson, according to Gabielli.

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