Description
We believe that the Allergan AbbVie deal presents a straightforward merger arbitrage with minimal risks. We think the current spread of 7.9% is attractive and provides a 17% IRR. However, we recognize that this spread seems too attractive in a low rate world. We are posting to share our idea but to also get feedback. Please let us know where we are wrong.
Deal
AbbVie announced its plan to acquire Allergan for $120.30 in cash and 0.8660 shares on June 25, 2019. At the current prices, there is a 7.9% spread. Management expects the deal to close in early 2020. We will generate a 17% IRR (after fees, borrow costs, dividends) if the deal goes through.
Return
Gross spread of 7.9%
Annualized spread, assuming a 4/11/2019 close, of 17.3%
Assuming a 10% IRR cost of capital, the implied probability the deal goes through is 90% (assumes AbbVie and Allergan share prices return to pre-deal prices)
Timeline:
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Past:
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Deal Announced
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June 25,2019
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Allergan schedules shareholder meeting for 10/14
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September 10, 2019
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FTC Second Request
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September 27,2019
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Allergan Shareholders Approve Merger
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October 14, 2019
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Future:
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Expected Close
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Early 2020
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Risks
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Financing
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AbbVie entered into a $38B Bridge Credit Agreement. The credit agreement was pre-arranged and announced at the time of the acquisition.
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Legal Approvals
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U.S. Federal Trade Commission
European Commission, Brazil, Canada, China, Israel, Mexico, Japan, South Africa, South Korea, Turkey and the UK.
Irish Court Approvals
AbbVie expects some divestitures in overlapping products.
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Material Adverse Effect
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No undisclosed liabilities
No undisclosed investigations
Potentially more (difficult to understand legal document)
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Shareholder Approval
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Allergan shareholders have approved the transaction.
AbbVie shareholders do not get to vote on the transaction because less than 20% of shares will be issued (Allergan will own 17% of combined entity).
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Transaction Economics
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Humira is 60% of AbbVie sales and losses exclusivity in 2023. This deal diversifies Humira to less than 40% of sales.
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Break Fee
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AbbVie to pay 2% of equity deal value ($1.26B)
Allergan to pay 1% of equity deal value ($0.63B)
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Buyer Health
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Moody’s: Baa2, S&P: A-
Will be near 3x net debt/EBITDA after transaction.
Committed to remain Baa2/BBB or better
Plan to reduce debt by $15-18B within two years of closing
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Close Time
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Expected to close in early 2020.
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Management
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Both management teams support the deal. AbbVie’s CEO will continue as CEO and Allergan’s CEO will get a board seat. Prior to the acquisition announcement, Allergan was considering “all strategic options”.
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Consumer Advocacy
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On September 12, 2019, a coalition of Unions and Consumer Groups filed a letter with the FTC opposing the acquisition. The letter made three points:
The merger will continue a trend of consolidation and evidence shows that consumers are paying higher prices.
The merger will reduce competition in a few markets where the companies directly overlap.
The merger will exacerbate problems that already exist within the industry relations to rebate walls and patent abuses.
The deal spread was unaffected by this filing.
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The deal spread appears wide and has not changed. Therefore, the IRR has increased. The risks look minimal. Both companies support the deal, AbbVie has secured financing, and there is little precedent for regulators to block the deal. Additionally, AbbVie’s size makes it unlikely that it could become the target of an acquisition.
Nevertheless, the spread is wider than we would expect. The best-case scenario is the deal spread is attractive due to lack of merger arbitrage funds and the size of the acquirer and target. If the deal spread is wide for another reason, it is not obvious what that reason is.
Appendix
Past Pharma Mergers:
We reviewed 156 pharmaceutical mergers. This included all mergers within the last year 10 years within FactSet (ex. China) where the deal target was >$1B in MV. Regulators did not prevent any transactions from proceeding.
Share Price Drop:
AbbVie’s stock price dropped 16.25% from 78.45 to 65.70 on the day of the announcement. The stock price has since recovered to 74.80, down only 4.6% from the pre-deal price. Over that same period the S&P Pharma ETF (XPH) is down 1.6%. The CEO commented he did not think this reaction was unusual and cited first day reactions on Bristol-Celgene (-13.2%) and Takeda-Shire (-7.5%). He blamed the mechanical aspect of the merger arbs and noted the stock was up ~3% on Wednesday, Thursday and Friday following the deal after the management team had a chance to meet with investors. However, by Friday’s close the stock was still down 7.3%.
FTC Comments:
Historical Spreads
Shown below is the historical spread of AbbVie and Allergan. The lack of movement in the spread may indicate that there is no black swan event risk. However, the spread has not closed over the last four months. We worry that there is a risk we are missing. The Red Hat deal had a large spread but closed in a linear fashion.
Also shown below is the BMY – Celgene deal. This had a large initial spread but faced clear investor opposition. The frequent spread change clearly showed a “risky” merger arb with plenty to worry about. The theory is that the lack of activity in AbbVie – Allergan is indicative of simple path forward.
Short Interest:
AbbVie has short interest of 60.8m shares of 4% of shares outstanding. Allergan has short interest of 10.3m shares or 3.1% of shares outstanding. One area that is slightly concerning is short interest in Allergan has increased since the deal announcement.
Stamp Tax:
AbbVie may owe €572m Irish stamp duty. Previously mergers were able to get around the 1% stamp duty fee but a regulatory change that took effect Oct. 8th took measure to close that.
Catalyst
Deal close