Last year was the most active period for mergers and acquisitions (M&A) since before the economy collapsed in 2008, with total dollar transactions eclipsing $3.5 trillion.
And this year could be even bigger, considering that a KPMG survey estimates that 82% of U.S. companies will embark on at least one acquisition in 2015.
The news pushed VRX shares $25.49 higher than Friday’s close. But Salix shareholders are skeptical…
While Valeant has completed roughly 40 acquisitions since 2008, giving it a diversified portfolio of some 1,500 drugs in virtually every conceivable branch of medicine… these purchases cost shareholders a hefty price.
In spite of Valeant more than doubling its share count over the last five years to help fund its acquisitions, it’s issued a truckload of debt, as well (ouch).
The good news is, the company trimmed a total of $1 billion from its previous $16.3-billion debt load. But the bad news is, Valeant currently carries a speculative credit rating of Ba3 from Moody’s.
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Now, the all-cash deal for Salix Pharmaceuticals will be financed through a combination of additional debt and bonds, which will result in a net leverage ratio of about 5.6. Compare this to the company’s current debt-equity ratio of 3.04.
While the company is thoroughly committed to reducing its leverage ratio below 4 by the second half of 2016, in order to accomplish this, it will likely need to halt further acquisitions through 2017.
Slowly Moving Forward…
Now, Valeant expects Salix’s earnings to be accretive to its bottom line, accounting for 20% of Valeant’s EPS. But unfortunately, that won’t happen until 2016 and 2017.
Why so long?
Well, it turns out that Valeant is inheriting an inventory nightmare from Salix.
You see, back in November, Salix reported that many of its drugs had several times the company’s targeted inventory with wholesalers, some as high as nine months.
For Valeant to draw down the inventory level to two months, as announced, the company will realize little benefit to its bottom line in 2015.
Bottom line: Cantor Fitzgerald raised its price target for Valeant to $214 based on the Salix accretion assumptions made by Valeant. And I’m convinced that a $214 price still looks doable in light of VRX’s projected $500-million synergies that it expects post-merger, and despite the high levels of debt on Valeant’s books.
The company’s cash flows should be enough to handle all of its obligations through 2019. At that point, the company will likely need to refinance or use its available cash to retire the debt altogether.
The deal is expected to close in Q2 2015, and comes with a break-up fee of $356 million owed to Valeant should the deal not close by August 20, 2015.