Time to Cash In on Actavis

 | May 13, 2013 | 9:00 AM EDT
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Actavis (ACT), the largest generic drugmaker in the U.S., has seen its stock rise 351% since the end of 2008. That's more than triple the gain in the S&P 500.

I believe it's time to sell and take profits. Here are seven reasons.

First, no one ever went broke taking a profit.

Second, competition in generic drugs is fierce worldwide, with such competitors as Israel's Teva (TEVA) and India-based Dr. Reddy's Laboratories (RDY) -- not to mention homegrown competitor Mylan (MYL).

Third, Actavis is hot to trot when it comes to acquisitions. Last year, Watson Pharmaceuticals acquired the private Switzerland-based Actavis Group for about $5.5 billion and took its name. The integration of that large acquisition is still in progress, and Actavis is now on the hunt for Warner Chilcott (WRCX), a large Ireland-based maker of generics.

Pythons that swallow too many pigs sometimes wind up with bellyaches.

Fourth, partly as a result of its rapid expansion through acquisitions, Actavis has a lot of debt on its balance sheet. Debt as of December constituted 168% of stockholders' equity. Among U.S. companies with a market value of $1 billion or more, only 14% have that much debt.

Fifth, Activis pays no dividend. By comparison, Teva has a 3.3% yield, Merck (MRK) yields at 3.7% and Pfizer (PFE) offers a 3.3% payout.

My sixth point is only speculation. The pendulum has swinging for years in favor of generic drugmakers and against proprietary drugmakers. What if it swings back?

Unlikely though that may sound, I can see one possible catalyst. The big pharmaceutical giants may lobby Congress to change the rules to give them additional patent protection, citing the need for innovation and the lack of development of new blockbuster drugs in recent years. Given the sizable political contributions the biggest drugmakers can hand out -- and, in my opinion, some merit in their arguments -- they might prevail.

Seventh, and in my mind most telling, Actavis shares have climbed to a point at which valuations are comfortably high. The stock is priced at 45x earnings and 4.2x book value, or corporate net worth per share. In my opinion, Actavis deserves some premium over its competitors, but not at this high a level. Teva trades at less than 20x earnings, while Mylan is quoted at 15x.

The bigger pharmaceutical companies, by comparison, fetch modest multiples -- 13x for both Merck and Pfizer, and 15x for Eli Lilly (LLY).

John Dorfman is chairman of Thunderstorm Capital LLC, a money management firm in Boston. He can be reached at jdorfman@thunderstormcapital.com.

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