Never let it be said that Valeant (NYSE: VRX) management is shy about doing deals. With a roster of past deals including Biovail, Cephalon, OraPharma, and Medicis, Valeant claims that better than 80% of its deals have attained the 20% internal return target it uses to evaluate potential transactions. If rumors out Friday prove true, Valeant is about to bag its biggest target yet in what would be a particularly bold move.
Multiple sources have reported (or repeated) rumors that Bausch + Lomb‘s private equity owners Warburg Pincus are near a deal to sell the eye care giant to Valeant in a deal worth close to $9 billion. That Bausch & Lomb is on the block is well known – Warburg Pincus hired Goldman Sachs back in December of 2012 to assist them, and reportedly approached companies including Sanofi (NYSE:SNY), GlaxoSmithKline (NYSE:GSK), and Abbott (NYSE:ABT) without getting any takers on the then-reported price tag of $10 billion. At that point, Warburg Pincus reportedly began considering an IPO of Bausch & Lomb to cash out of a company it originally acquired for $4.5 billion.
Taxes Will Help, But Can Valeant Drive The Synergies?
Valeant is a bold and experienced acquirer, and $9 billion is not unreasonable for a business that reportedly generated around $3 billion in revenue last year. The question I have, though, is how much Valeant can really do to make Bausch & Lomb bigger and better.
If the $3 billion revenue figure I’ve seen mentioned is in fact accurate, Bausch & Lomb was a bit of an underachiever relative to the eye care businesses of companies like Novartis (NYSE: NVS), Abbott, Sanofi, and Johnson & Johnson (NYSE:JNJ). Along similar lines, the company appeared to fail to take real advantage of Cooper Cos. (NYSE:COO) issues in the silicone hydrogel market, and has the #4 position in the contact lens business (with about 10% share).
It may be the case, then, that B&L can benefit from a more aggressive management team that is better at extracting value from R&D and marketing efforts. Along similar lines, though, I do wonder what sort of synergies Valeant can expect. Private equity groups are fairly notorious for running very tight ships (some times too tight), and it may be the case that Warburg Pincus under-invested in B&L to the detriment of product development and marketing support.
Valeant does have at least one ace in the hole with respect to generating deal value, and that is its privileged tax status. The how’s and why’s get a little convoluted and confusing for those not well-versed in tax law, but by virtue of being headquartered in Canada, having the IP domiciled in Bermuda, and products commercialized out of Ireland (along with the use of various transfer price agreements), Valeant has an effective tax rate in the single digits. When you pay an effective tax rate of 5% and your rivals (and rival bidders) have to pay 25%, 30%, or more, it’s not hard to see where Valeant can wring value from this deal that others cannot.
Still, It’s A Curious Move
Even with Valeant’s advantageous tax structure, the eye care business is a challenging one in many respects. Fortunately for all of us, there aren’t all that many eye diseases, but that means it’s just not as large of a market as other major drug targets like oncology, metabolic health, or even dermatology (an area of focus for Valeant). While the lack of public pure-plays makes gathering data challenging, the eye care market has generally been growing at a mid-single digit rate, and many of the players in the space (including Allergan (NYSE:AGN) and Cooper) have been doing deals outside of eye care to improve their growth prospects.
Then again, none of this is news to Valeant. Investors may recall that Bausch & Lomb actually beat out Valeant to acquire ISTA Pharmaceuticals back in 2012. Suffice it to say, then, I think that Valeant has done its due diligence on the eye care sector and is comfortable with the growth prospects of branded, generic, and OTC ophthalmology drugs.
I will also be very interested to see if Valeant keeps all of the B&L business – assuming, of course, that they do the deal. Keeping the drug business, which has relatively solid market positions in categories like allergies, anti-infectives, glaucoma, and pain/surgery, seems like a no-brainer. What the company does with the contact lens and device/tools business is more interesting. Valeant has reportedly sniffed around some device-related businesses in the past, but this would be an aggressive move into new markets for the company.
Bausch & Lomb has a well-regarded instruments (Storz) and surgical tools line, and I don’t imagine Valeant would struggle to sell it (perhaps to Cooper or Abbott). Likewise, the recent renewal of interest in OTC healthcare on the part of many Big Pharma players could spur interest in the contact lens business if Valeant decided that it didn’t want a customer-facing business like this. Still, in the final analysis, I’d say the odds favor Valeant being bold and keeping Bausch & Lomb together as it currently is.
The Bottom Line
If the Valeant-Bausch & Lomb rumors prove true, it’s an interesting move for the med-tech sector. At a minimum, I would think it would raise the hopes and expectations of companies like Endo Health Solutions (Nasdaq: ENDP) (another drug-device hybrid reportedly up for sale) and perhaps give a company like Roche (Nasdaq: RHHBY) more confidence in holding out for a reasonable bid for its glucose monitoring business (though eye care has not seen the same reimbursement pressures). The deal would also restore the notion that three times sales is a good benchmark for large med-tech businesses, a multiple that certainly slipped during the past few years of low industry growth.
Disclosure – the author owns shares of Roche.
Stephen Simpson CFA is a former sell-side and buy-side analyst who focuses most of his professional attention on financial and investment writing. In addition to a decade of work as an analyst, Mr. Simpson has worked as a wet-bench biomedical researcher and a consultant in the med-tech industry, as well as writing on a freelance basis for over 10 years. He can be reached via email at firstname.lastname@example.org.