Cephalon Inc., the mid-sized specialty pharma company under siege from a hostile buyer, has found a white knight. Just two weeks before a May 12 deadline for its shareholders to tender their shares for or against a takeover bid by Valeant Pharmaceuticals International Inc., it has accepted a $6.8 billion cash offer from Teva Pharmaceutical Industries Ltd., the companies announced on May 2.

Teva's winning pitch appeared to be in stark contrast to that of Valeant, the loser in this deal('Valeant Makes Hostile $5.7B Bid For Cephalon,' 'The Pink Sheet' DAILY, March 29, 2011).

Cephalon will "transform Teva's branded business, as it will help us deliver on our strategic goal of creating a diversified, multi-faceted company," President and CEO Shlomo Yanai said on a same-day call with analysts. "It allows us to further pursue our shared goals of delivering new innovative therapies to patients." The Israeli firm sees "tremendous value" in Cephalon's "pipeline, people and portfolio," William Marth, president and CEO of Teva Americas, said in an interview. [Editor's note: This story was republished May 3 due to a technical glitch impairing delivery of the original May 2 version.]

Valeant CEO J. Michael Pearson, on the other hand, initiated an unsolicited offer for Cephalon on March 29 by pointing to Cephalon's "deteriorating set of assets, earnings, and cash flows due to the upcoming risk of patent cliffs and generic competition for their products." Cephalon's board rejected that overture, but Pearson moved to replace it with his own nominees, who would seem more receptive to his ambitions. The deadline for shareholders to vote on Valeant's slate would have been May 12, but immediately after Teva and Cephalon announced their deal, Valeant withdrew its consent solicitation, congratulating Teva for a "very full offer," and noting that Valeant, too, will benefit because it holds more than a million shares of Cephalon stock.

The suitors were closer than meets the eye in terms of valuing their prey, however.Teva's offer of $81.50 is a 39% premium to Cephalon's stock price of $58.75 on March 29, the last closing price before Valeant's unsolicited bid. While Valeant's offer of $5.7 billion, or $73 a share, was lower than Teva's, it left open a door to raise the amount, depending on findings from its due diligence review. Wall Street analysts almost uniformly expected Valeant ultimately to pay $77 to $81 a share - an amount that they considered fair and still affordable for Valeant, and indeed, Cephalon's stock jumped to $75.44 a share almost immediately following disclosure of the formal bid.

But the bidders differed significantly in both style and philosophy. Pearson would have dismantled Cephalon's R&D infrastructure, shut down most of its partnerships and development work, and perhaps sold off the entire oncology business, noting that the field is too competitive and swamped by Big Pharma to conform with Valeant's operating model (Also see "Valeant CEO Outlines Takeover Rationale, As Cephalon Stays Mum" - Pink Sheet, 30 March, 2011.).

That move would have been dramatic in any circumstances but was particularly jarring to Cephalon management, analysts said, coming so soon after the death in November 2010 of Cephalon's long-time president and CEO, Frank Baldino Jr. Baldino, who co-founded the company in the early 1980s, was the architect of its efforts to diversfiy beyond its key asset, the sleep disorder drug Provigil (modafinil) and to gradually move the company away from its complete dependence on in licensing late-stage CNS assets to heavier involvement in R&D in fields such as pain and oncology.

Broadening Teva's Commercial Opportunities

In part, the style discrepancies stem from the companies' differences in strategy. Valeant's general strategy has been to build a diversified global business by acquiring niche, overlooked commercially available or near-commercial assets in select therapeutic areas.

On the other hand, Teva, a much larger and older company, has repeatedly stated its desire to better balance its mix of branded and generics businesses, in part by doing a mid-sized deal with a specialty pharma company - an ambition that has analysts in a perpetual guessing game. The company had held talks with Cephalon over the years, as it has with other specialty pharmas, but stepped into action only after Valeant's bid became known, said Marth. As such, it has done "extensive due diligence" on Cephalon's pipeline.

Executives were quick to emphasize that once they close the deal - likely in the third quarter - the combined company will have a sizable branded portfolio with approximately $7 billion in sales and a robust pipeline of more than 30 late-stage compounds. "Teva and Cephalon's product lines are very complementary," said Yanai, who noted that while there would be cost synergies, there would also be considerable growth opportunities, stemming from both Cephalon's commercial business and, longer term, its pipeline.

"For example, by combining the CNS and respiratory product portfolios we are significantly strengthening our position and extending our foothold in these areas," he said. "In addition, we will add Cephalon's pain management and oncology business areas, in which Teva presently has no commercial franchise."

Valeant had projected about $300 million in annual cost savings from cutting Cephalon's infrastructure, a number that analysts called conservative. Teva executives said it is far too early to be specific about their organizational plans for Cephalon, but they expect cost synergies of as much as $500 million a year by year three after the deal. They said they have not yet determined whether to retain Cephalon's top executives, except to note that the company's deal-making aims for "best in breed," which involves melding the best processes and employees of both companies.

Few companies have been as disciplined in their integration implementation as Teva, said Marth, adding, "Companies talk about best of breed and it always sounds nice until you get down to doing it."

Marth explained that Teva practiced "best-in-breed" in integrating its last large deal, the 2010 acquisition of German generics company ratiopharm, by retaining much of ratiopharm's back office operations. Those were combined with Teva's "front-end" high quality sales and marketing to create a new unit in Western Europe.

While not the primary focus of the acquisition, one Cephalon asset that both Valeant and Teva appear to like is Mepha, the Swiss-based generics business, which Cephalon bought in early 2010 (Also see "Cephalon Buys Swiss Generics Firm Mepha, Talking Up Diversification" - Pink Sheet, 1 February, 2010.). With $400 million in annual sales, Mepha gives Teva a presence it currently doesn't have in Switzerland, as well as strengthening positions in the Middle East, Eastern Europe, and other parts of the world, said Marth. Ironically, Mepha was previously owned by Merckle family of Germany, which also sold ratiopharm to Teva.

R&D Pipeline Valuation

Teva executives also went out of their way to praise the value of Cephalon's R&D pipeline, which Valeant had uniformly disparaged. That pipeline includes Cinquil (reslizumab), an anti-IL6 antibodyin Phase III for eosinophilic asthma, Lupuzor (forigerimod), a CD4-T cell modulator against systemic lupus erythematosus, in Phase II, and a PARP inhibitor, CEP-9722, for non-small cell lung cancer, among others.

Here, too, however, the huge discrepancy between Valeant's and Teva's approaches may have been more philosophical than financial. Valeant had placed zero financial value on that early-stage pipeline and it's not clear how much of a role it plays in Teva's overall valuation of the company. One way to assess the pipeline's worth in financial terms is to note that Cephalon spent more than $1 billion on licensing and M&A deals to build it, pointed out David Maris, an analyst with CLSA - although much of that money would be payable through earn-outs, over time, rather than upfronts. He argues that the company would be worth close to $81 a share even without the pipeline, calling the R&D work important to Teva's strategic growth, but not so risky that it jeopardizes the deal's success if it disappoints.

Perhaps more important from a valuation perspective, therefore, is Cephalon's in-house R&D expertise and its current product line-up, which includes the cancer drug Treanda, the pain medications Actiq and Fentora, as well as the sleep disorder franchise Provigil and its next-generation version, Nuvigil. Provigil, which contributed more than $1 billion in revenues to the firm's total 2010 revenues of $2.8 billion, goes off patent in 2012, however, and converting the market to the longer-protected Nuvigil is taking more time than expected. Moreover, Nuvigil, which had roughly $400 million in 2010 sales, faces a patent challenge of its own, a situation which Teva, ironically, more than almost any other company, is equipped to understand, Marth pointed out.

The transaction, therefore, supports Teva's oft-stated goal of growing the branded business from $4.6 billion in 2010 to more than $9 billion in 2015. On a pro forma basis, the combined company would have had 2010 revenues of $18.9 billion. With Cephalon, the branded business would have contributed about 36% of Teva's 2010 revenues on a pro forma basis, versus 28% on a stand-alone basis. The deal is accretive immediately and allows Teva to hold more than $1 billion in cash, with "significant balance sheet" flexibility, said Chief Financial Officer Eyal Desheh.

That balance will be critical to Teva's ability to weather some of the challenges it is facing in upcoming years. In addition to patent fights over its key branded product, the blockbuster multiple sclerosis drug Copaxone (glatiramer), its generics business - like other generics businesses - will confront headwinds as the number of large drugs expected to go off patent in 2013 and 2014 falls off. Many of Cephalon's pipeline assets could start to contribute to the company's revenues by that time, pointed out Maris.

Teva's efforts to diversify its branded business' dependence on Copaxone have, until now, met mixed success. Its Parkinson's disease drug Azilect (rasagiline), with $318 million in 2010 sales, is a modest success, as is its $875 million respiratory franchise. It has an oral MS drug in late-stage development, laquinimod, but released lukewarm Phase III data on that drug last month, even as it is likely to enter a market with intensifying competition (Also see "Biogen Idec's BG-12 Results Up The Ante In The Oral MS Market" - Pink Sheet, 21 April, 2011.)

- Wendy Diller (w.diller@elsevier.com)

In Cephalon, Teva Will Get An Expanded Innovative R&D And Branded Portfolio

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