The Actavis-Forest deal, which is all but certain to close mid-year, reflects long-standing industry trends and competitive pressures, and aggressive, increasingly sophisticated management.
The new Actavis, after a series of large purchases, will have a hybrid business model, which builds on the industry’s learnings over the past decade of how best to integrate and manage an operation that embraces geographic and product diversity.
With the specialty pharma sector in play, deals seem to be driven largely by financial rather than strategic considerations, but the dynamics are nuanced, with interest in brands that help buyers achieve scale in select therapeutic areas.
Forest’s commercial strength was a draw for Actavis, whose leaders see primary care as ripe for a re-think and a way of broadening provider interest in its specialist brands.

The deal between Allergan PLC and Forest Laboratories Inc., which is likely to close mid-year, is indicative of many trends in biopharma, but one stands out: generics companies and branded specialty pharmas, long considered difficult to run under one roof, are converging into hybrid models.

While companies have sought for years to combine generics and branded innovative businesses, they have had mixed success at best; the business dynamics and corporate cultures were just too different. Actavis’ efforts could succeed better than most, however. That’s in part because the marketplace is changing and in part because its leaders, having learnt from past experiences, appear better equipped to handle complexities of integrating disparate businesses, with different margins, time lines, and commercial needs.

In addition, they see the deal as an opportunity to re-think primary care and use it to drive further uptake of Actavis’ specialty drugs. In the US, this means reaching primary care doctors, who prescribe many of the specialty drugs that Actavis sells. Overseas, it means one sales force that sells brands, branded generics, and OTC products.

Under the deal, announced on February 18, Actavis will pay $25 billion in cash and stock to Forest shareholders, giving them a 35% stake in the merged company. [See Deal] The $89.48 per share price represents a premium of about 25% over Forest's closing price on February 14. The cash portion is $26.04, or slightly more than a third of each share, and the rest will be paid in Actavis stock.

The combined company will generate more than $15 billion in revenues in 2015, and boast a broad portfolio of branded and generic drugs, which it can present to an increasingly consolidated customer base. If the deal goes through – and investor bets are that it will – Actavis will be the third largest generics company on a global basis. The merged company will have blockbuster franchises, involving both generics as well as brands, in central nervous system [CNS] disorders, gastroenterology, and women’s health. It would have annual free cash flow of $4 billion, a large international sales force of more than 3,700 reps, and an R&D budget of roughly $1 billion.

Notably for a company that has worked relentlessly for years to diversify beyond its base US generics business, the mix of revenues will be about equally split between generics and branded drugs. About 47% of the revenues will come from the North American specialty business, up from 30% pre-deal, whereas North American generics will account for 27%, and 15% of revenues will come from international business. Another 10% will come from the company’s distribution business, ANDA.

And while the new Actavis won’t have “blockbuster” brands, it will have blockbuster franchises, consisting of a mix of smaller innovative drugs, such as Rapaflo (silodosin), Lo Loestrin (norethindrone acetate), and Crinone (progesterone gel), as well as generics and over-the-counter medications, from Actavis. From Forest, it will have Namenda (memantine HCI), Bystolic (nebivolol), and Viibryd (vilazodone) as key offerings. (See Exhibit1.)

Exhibit 1

Forest’s Top Brands*

Forest	Indication	2013 Sales ($ mm)
Namenda/Namenda XR	Mild-to-moderate Alzheimer’s Disease	1,596
Bystolic	Hypertension	514
Viibryd	Major depressive disorder	191
Carafate	Duodenal ulcers	145**
Zenpep	Pancreatic enzyme for cystic fibrosis	143**
Linzess	Irritable bowel syndrome	119.5

*Actavis’ 2013 pro forma revenues from its specialty pharma business (including Warner Chilcott) were $720 million, but it does not break out sales by brand publically.

**Twelve months ending December 31, 2013 for Forest.

**Carafate and Zenpep came from Aptalis Holdings Inc., and figures are full year ending September 30, 2013.

Company reports

That breadth will be increasingly important to customers, many of which are consolidating and expanding geographically, executives say. On the wholesaler side, Cardinal Health Inc. and the pharmacy chain CVS Health Corp., McKesson Corp. and Celesio AG, and Walgreen Co., Alliance Boots GMBH, and AmerisourceBergen Corp. have all announced tie-ups within the last year; the latter two extend US wholesalers’ reach into international territories. [See Deal] (See [A#14131210007]and[A#14131024001].) Ex-US, having one parent may be especially beneficial, since many markets are already a blend of categories: generics, branded generics, OTC drugs, and innovative brands.

Analysts are predicting much more M&A activity is in store for the sector, as many forces are at work, including the need to diversify products lines, attractiveness of squeezing out synergies from enlarged operations, and better market positions from which to negotiate with distributors and health care payors, both of which are also consolidating.

The Actavis deal would be by far the largest recent acquisition in specialty pharma, but it isn’t the only one that occurred within the past six months; Endo International PLC, Jazz Pharmaceuticals PLC, and Valeant Pharmaceuticals International Inc. are also in the midst of deals.

Spec Pharma In Transition

Endo Health Solutions is buying Paladin Labs Inc. for $1.6 billion. [See Deal]
Jazz Pharmaceuticals bought Gentium SPA, an Italian biotech, for $887 million in December 2013. [See Deal]
Valeant Pharmaceuticals, fresh off the $8.7 billion acquisition of ophthalmic specialist Bausch & Lomb Inc. in May 2013, did a tuck-in deal in February 2014, paying more than $400 million for PreCision Dermatology Inc., which sells a mix of branded and generic drugs. [See Deal][See Deal]
Forest bought Aptalis Holdings Inc., a specialty pharma focusing on GI and cystic fibrosis, for $2.9 billion in January 2014. [See Deal]]

SOURCE: Strategic Transactions

Those that haven’t bought are prowling. On Mylan NV’s year-end earnings call on February 27, company CEO Heather Bresch said explicitly, in response to repeated analyst questioning, “We’re not standing still … We're looking at anything that would be strategic and complement us and be accretive. And I would say, as I mentioned earlier, we see several interesting things out there that would accomplish this.” (See [A#14140227003].)

Valuations are reasonable, especially relative to major pharmaceutical companies, and “multiple expansion across the group has been fairly modest,” Barclay’s analyst Douglas Tsao wrote in an extensive March 7 note on the sector. “There’s a rich landscape of assets,” from which to choose, despite the recent activity, and, critically, he pointed out, a cadre of experienced executive teams that know how to capitalize on financial as well as commercial strategic opportunities.

“I think as you think about the future of health care, particularly in the United States, we believe that over time, being able to offer customers a variety of products in both branded and generics will be something that will give us an advantage over many of our competitors, if managed in the right way,” said Brent Saunders, CEO and chairman of Forest, who will sit on the board of Actavis once the deal closes. The solid balance sheet, supported by cash flow from generics, will allow the company to “do future M&A off a very strong, stable base of products,” he added in a call with analysts on the day of the announcement.

Those dynamics aside, the deals’ success or failure will come down to execution, a fact acknowledged by Actavis and Forest Labs. “We’ve got a lot of integration work, we’ve got to capture the value of this transaction, but I believe we have the people in place on both sides of the organizations that can do that,” Saunders said.

M&A Dynamics

In their path to this deal, both companies faced relentless competition in their key markets and changing customer dynamics. In addition to responding to distributor consolidation, US generics makers also have scrambled to take the edge off the cyclical nature of their business, exacerbated by reliance on episodic, inconsistent big hits gained through successful exploitation of legal quirks, notably Paragraph IV challenges. The typical solution has been to diversify into niche, complex-to-develop drugs and ultimately into branded specialty pharmaceuticals. Actavis has been most aggressive recently, but Mylan and Teva Pharmaceutical Industries Ltd. among others are also pursuing various iterations of similar strategies, driven by the same concerns.

On the generics front, Teva in particular has paved the way, partly out of necessity, given its origins in tiny Israel and partly bolstered by profits from its hit, multiple sclerosis drug Copaxone (glatiramer acetate). Over the years, it acquired several companies in transactions that were considered enormous at the time, including its 2008 $9 billion takeover of Barr Pharmaceuticals Inc., which ironically employed the current Actavis CEO Paul Bisaro as president and chief operating officer. [See Deal] It built a hybrid business model that balanced both its generics and branded businesses.

But in the past few years, Teva has run into difficulties after two expensive, controversial, and ultimately unwieldy acquisitions, of the German generics company ratiopharm Group in 2010, and of the US specialty pharma company Cephalon Inc. in 2011. [See Deal][See Deal] (See Also see "Teva Swoops In To Snatch Cephalon For $6.7 Billion " - In Vivo, 1 May, 2011..) These moves triggered a series of leadership changes. Whether Actavis can avoid making some of Teva’s missteps remains to be seen.

One differentiator, which could be significant, is Actavis’ diversified specialty pharma portfolio. Despite efforts over the years, Teva’s branded business has continued to depend heavily on Copaxone, which faces a patent expiration, possibly as soon as May of this year. (See Also see "Copaxone’s Tombstone? 2014 Could Be Year Generic Launches, Momenta Says" - Pink Sheet, 17 February, 2014..) Actavis, on the other hand, has multiple innovative branded drugs, albeit none remotely approaching Copaxone in size.

Another point of departure from Teva: the Israeli company, in recent years, made heavy investments in key Western European markets, augmented by its ratiopharm deal, with the aim of protecting and building its leadership position in the largest countries.

Actavis, in contrast, has decided to steer clear of that part of the world; it is in the process of selling its commercial operations and assets in seven Western European markets to the Indian firm Aurobindo Pharma Ltd. Its determination to get out of non-core markets was underscored by the deal terms: a $40 million purchase price for a business with nearly $400 million in sales. [See Deal] Instead, the company’s focus ex-US will be “high growth markets such as Central Europe, Eastern Europe, Russia, Southeast Asia, and the like,” Bisaro told investors on the February 18 call.

For Forest, the end comes as the company struggles through a multi-year patent expiration of a set of blockbuster drugs, which bolstered its growth for decades. Forest executives foresaw the patent cliff, of course, but despite aggressive business development, they have been unable to deliver on enough promising innovative new drugs to offset the freefall in revenues and profits. (See Also see "Many New Products For Forest, But Not Enough To Fill The Lexapro Gap" - Pink Sheet, 23 April, 2013..) To top off the firm’s challenges, its founder and former CEO, Howard Solomon, did not have an adequate succession plan or a sharp enough business strategy to satisfied investors. An investor backlash, led by activist Carl Icahn, ultimately toppled Solomon and brought in Saunders in October 2013. (See Also see "Forest’s Board Grows, As Icahn Gains Second Director’s Seat" - Pink Sheet, 11 June, 2013..)

Actavis Moves Up

Watson Pharmaceutical’s seemingly rapid-fire transformation from a US-focused generics company to what is now Actavis, a global hybrid specialty pharma with a balanced focus on innovative branded drugs and generics, has been a decade or more in the making. “In just five years, the company has changed completely,” Sigurdur Oli Olafsson, president of Actavis Pharma, told analysts.

After a slow start under previous management, it moved into high gear following Bisaro’s arrival in 2007. In 2009, the company embarked on its first major overseas deal, the $1.8 billion purchase of privately owned Arrow Group APS, which gave the company a commercial presence in more than 20 international markets and the biopharmaceutical development organization Eden Biodesign in Liverpool, UK. [See Deal] (See Also see "Watson Acquires Arrow Group And Expands Its Global Footprint" - Pink Sheet, 17 June, 2009..)

In 2012, Watson bought the Swiss-based generics firm Actavis for about $5.6 billion and changed its name to the latter. That deal expanded the company’s global reach significantly, allowing it to attribute 40% of the combined revenues to geographies outside the US – up from 16% for legacy Watson. [See Deal] (See [A#14130125003].) (See sidebar, “Actavis’ Transformative Dealmaking.”)

[Sidebar#2014800045]

The purchase of Warner Chilcott PLC in 2013 for $8.5 billion addressed some of the US-based group’s difficulties in organically building its branded business, especially its women’s health segment, and brought Actavis the prescription overactive bladder drug Enablex (darifenacin), the GI franchise Asacol/Delzicol (mesalamine), and a pipeline full of oral contraceptive products. [See Deal] These complemented Actavis’ nonprescription emergency contraceptive Next Choice (levonorgestrel) and are expected to boost its prospects in the US women’s health care business.

That merger also allowed Actavis to move its corporate headquarters to Dublin to take advantage of a more favorable tax bracket; in an earlier presentation to investors on January 31, Bisaro noted that the company has been able to cut its tax rate almost in half over the past four years, largely through the Actavis and Warner Chilcott purchases.

Tax rate wasn’t a major concern in the Forest deal, but in general it is an important competitive advantage for specialty pharma companies; as the sector continues to consolidate and be more efficiently run, disciplined companies pounce on the vulnerable, pointed out Sven Borho, a managing partner at OrbiMed, which holds Actavis as a core investment and has a smaller position in Forest. (See [A#00140303013].)

The deal also let Actavis simplify its global structure, so that it now operates under three distinct units that company executives say will better combine the branded and generics businesses. The firm’s North American generics business ranks second in sales to Teva and includes a generic version of the pain patch Lidoderm (lidocaine) and the antidepressant Cymbalta (duloxetine), both of which launched in 2013, the former with exclusivity that runs through March 15, 2014.

Forest’s Primary Care Reach Will Bolster Actavis’ Brands

For Forest, the considerations were different but equally complex. This deal was announced only days after the Aptalis deal closed, adding branded gastrointestinal and cystic fibrosis franchises to the buyer’s therapeutic mix. (See [A#14140108007].)

The combined company will generate roughly $1 billion in branded GI sales. Although Forest also is relatively new to the space, it has a promising drug, Linzess (linaclotide) for irritable bowel syndrome, in the midst of a high-profile launch. The drug is partnered in the US with its innovator, Ironwood Pharmaceuticals Inc.; sales were $118.8 million in the US in 2013. [See Deal] Forest’s older franchise in cardiovascular disease is dominated by Bystolic, a mature beta blocker. (See Also see "Linzess Continues On Strong Launch Trajectory, Says Ironwood/Forest" - Pink Sheet, 23 July, 2013..)

Forest also brings solid franchises in respiratory disease, infectious disease, and, in particular, its core strength in CNS. When Saunders took over the top slot at Forest in late 2013, he began making deals that played to those strengths – particularly building up areas that Forest already had a stake in, allowing its sales force to approach physicians with a bag of drugs instead of just one product. Several small deals have helped fill gaps from loss of exclusivities of Celexa (citalopram) and Lexapro (escitalopram), and Saunders further added to the CNS portfolio by Forest’s $240 million purchase of the atypical antipsychotic Saphris (asenapine) from Merck & Co. Inc. in December 2013. [See Deal]

That deal aimed to capitalize on Forest’s powerful CNS sales force. Under Merck’s umbrella, Saphris was underperforming, a result, Seamus Fernandez of Leerink Swann says, of Merck’s primary care approach to marketing it. It will likely benefit, therefore, from Forest’s and now Actavis’ specialty CNS sales force, which can nearly double Merck’s reach.

At the other end of the spectrum, Actavis’ branded drugs have largely been sold to narrow groups of specialists, a choice the company made to focus resources. But executives hope to use Forest’s finesse in the primary care world to boost many of those drugs, including the urinary incontinence therapy Rapaflo, Zydena (udenafil) for erectile dysfunction, and oral contraceptives. Indeed, Actavis is betting that the primary care field, often shunned by Big Pharma, is ripe for a re-think. “Primary care with the ACA is going to become more important,” Bisaro told investors at a Barclay’s meeting on March 11. “Primary care physicians are going to be the ones who write first-line therapies.” (See sidebar, “Forest As An Aggressive In-Licensor.”)

[Sidebar#2014800046]

Forest’s marketing prowess can help in other ways. To stem the anticipated loss of revenue from its biggest drug, Namenda, going off patent in April 2015, Forest says it will implement a “hard switch” to the long-acting formulation, Namenda XR. That means it will stop production of the original drug as of August 2014. This kind of plan can blunt the impact of generic competition, when it eventually begins, by pressuring patients well in advance of a generic entry to move from a mature drug to a newer, improved version of it. The bet is that providers and patients will balk at returning to the older formulation, even if a cheaper generic is available, complicating payors’ decision making on coverage.

But such a tough strategy risks alienating constituents, particularly payors. Actavis executives said that the aggressive Namenda switch strategy was an important consideration for them, given the franchise’s $1.4 billion in revenues. They have said that they are impressed with the prep work Forest is putting in.

At an investor conference sponsored by Citi on February 25, Olafsson pointed to lessons Actavis learned from Warner Chilcott’s efforts in 2013 to implement hard switches with the GI drugs Asacol and Delzicol and also the oral contraceptives Loestrin and Minastrin. The company did not work closely enough with managed care and pharmacy benefit managers to ensure their acceptance of Delzicol, which launched in early 2013, and scripts declined, although they have now stabilized, he said.

“When we came to the Namenda XR switch, this was a key due diligence item for us for sure. We needed to understand this fully. And on the monitoring of the PMBs and the managed care, they [Forest] are way ahead of the curve,” he said, noting that they were “getting signed contracts in January on the XR formulation.” Moreover, the company has time, given the patent expiration is in mid-2015. And the once-a-day formulation for Alzheimer’s is attractive for nursing homes and caretakers. This is a declining asset, we understand that,” but “we got very comfortable around the strategy,” he said.

Execution Key

Analysts and investors have generally welcomed the Actavis/Forest merger plan. “Forest and Actavis fit well given GI overlap and broadening of the therapeutic footprint,” said Randall Stanicky of RBC Capital Markets. Jason Gerberry of Leerink said, “The deal valuation seems fair given the massive operational synergies that will be captured, and strategically it makes sense for Forest in terms of leveraging existing brands which longer term could translate to revenue synergies.”

Wall Street and the industry have speculated about whether possible rival bids could emerge, but as time marches on that looks less likely. Some initially believed that Valeant, which has signaled its intentions to grow hugely via M&A, might step in. But Valeant has not made a move, at least publically, and that talk seems to have died. (See Also see "Deals Of The Week: Keeping Score – Valeant Wants Actavis, Which Covets Warner Chilcott …" - Pink Sheet, 20 May, 2013..) Actavis also reportedly spurned an offer from Mylan in May 2013.

Furthermore, the deal has a breakup fee of about 3.5% of the equity value of each company, or roughly $1 billion, which could be a deterrent to other suitors. The rise in Forest’s stock since the deal was announced would also be a deterrent, as would the friendly nature of the negotiations. As part of the deal, following the closing, three members of Forest’s board, including Saunders, will take seats on the Actavis board.

The combined groups’ pipeline will comprise six brand products that have been filed recently or will be filed in the next few months, 10 products in Phase III, 10 products in Phase II, and what Olafsson referred to as “very interesting” preclinical assets.

The question is whether deals that seek to integrate such disparate businesses and extract cross synergies from them are manageable in the long term. Actavis has come together rapidly, built on a string of increasingly ambitious deals. Its executives argue that it is adept at integration, combining, for example, its commercial operations in the US and Europe with those of Warner Chilcott within 90 days of the deal closing.

The integration of Actavis into Watson was “incredibly complex” and “probably the biggest one we’ve ever done,” Bisaro told investors at the Barclay’s meeting. But it is complete and once those two deals were done, Actavis executives began casting about for the next opportunity. The Forest opportunity came together in mid-January, at the JP Morgan Healthcare Conference in San Francisco, where Bisaro, Olafsson, and Saunders met for dinner to discuss its potential.

Nor will the Forest deal disrupt the orderly integration of Aptalis within Actavis. “We closed that transaction … two weeks ago and we have announced $125 million in synergies there. We believe that we will be mostly complete with that synergy capture before the close of this transaction,” Saunders told analysts on February 18.

Nor are partnerships expected to suffer. Forest’s business model is primarily based on partnerships. Saunders stressed that the merger deal with Actavis won’t impact on Forest Labs’ change-of-control provisions with partners, and that the companies notified partners prior to the merger announcement.

The latest merger plan envisions about $1 billion in annual pre-tax operational and tax synergies over the first three years of combined operations. Some analysts believe the impact of Forest’s important partnerships will limit the scope of further synergies within the combined group.

“Given that Forest’s pre-existing partnerships are predicated on maintaining a strong presence in primary care, we question the extent to which Actavis can further scale back the cost structure beyond the guided cost synergies,” said RBC’s Stanicky.

That is, until the company’s next deal. The hard work of integrating lies ahead, but the company’s increasing global footprint will need bulk. In response to a moderator’s question about priorities, Bisaro told the Wall Street crowd Actavis would likely look for a commercial deal in South America. Going forward, he continued, “We'll be looking at licensing assets for the world as opposed to just North America or South America. It will be a global acquisition.”

Sten Stovall contributed to this article.

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