Watson adds Actavis and now needs to deliver
Confirmation of Watson Pharmaceuticals' takeover of Actavis has been well received, with shares of the US generics group up 7% in early trade, to $74.35. The move, costing an initial €4.25bn ($5.61bn), will make Watson a substantially bigger player on the global stage, transforming it into the third largest maker of copy cat medicines behind Teva and Novartis.
Like many generics companies Watson has grown swiftly through acquisition over the last few years, although Actavis is by far its biggest move to date. With expectations high and austerity measures pressuring many sections of the drugs market, the company now needs to demonstrate it can make the deal pay in the long term.
This year Watson has already bought the Australian OTC business of Strides Arcolab for $393m, having swallowed a Greek generics firm, Specifar, for $618m last year. Previous substantial moves included the $1.75bn purchase of the UK’s Arrow in 2009 and the $1.9bn takeover of US rival Andrx in 2006.
It was the move on Arrow that really made the difference for Watson. Having a valuable deal with Pfizer to launch the first authorised generic version of Lipitor and biosimilar capability, the private company had clear attractions (Watson fulfills overseas ambitions with $1.75bn Arrow move, June 17, 2009).
Watson's revenues are forecast to breach $5bn this year for the first time, but then largely stagnate over the next six years. Consensus data from EvaluatePharma show sales of $5.5bn by 2018. As such, new growth drivers were required.
Investors clearly hope the privately held Icelandic group is the solution; including today’s gains Watson shares have added almost a third in value since rumours of the bid emerged in March (Global growth would be goal of Watson-Actavis tie-up, March 22, 2012).
With a broad presence in emerging markets Actavis is a potentially valuable asset that should help grow sales and profits. The deal will boost earnings per share by 30% in 2013 and more thereafter, Watson projects. The group also confirmed much greater than expected cost savings from combining the two businesses; it reckons $300m annually should be stripped from costs within three years.
Funded with debt, this level of leveraging by a cash generative business holds no fears for investors in this low interest rate era.
Equity analysts responded enthusiastically today. UBS forecasts earnings could beat expectations in the future, and raised its share price target on the stock from $71 to $80. JP Morgan went even further, lifting its price target to $90, from $70 previously.
There are signs that the future will not necessarily all be plain sailing, however, highlighted by the fact that Watson structured the deal with a €250m future payment, contingent on Actavis hitting earnings projections this year. Uncertain growth prospects in the US and Europe mean Watson is only prepared to pay top dollar for a top dollar business, and rightfully so.
As analysts at Leerink Swann wrote today, pricing dynamics in Europe remain highly unpredictable, a region where the Actavis derives around half of its revenues. They also point out that following their own moves to scale up in Europe, both Teva and Mylan subsequently struggled to keep investors convinced that the deals were paying.
Watson needed to find new avenues for growth and Actavis should provide it. But the share price reaction reflects substantial expectations that now must be delivered.