(The following alert was sent to Action Alerts PLUS subscribers Wednesday, May 11 at 11:50 a.m. ET. Check out Action Alerts PLUS for yourself here.)
On Tuesday morning, Allergan (AGN) posted solid first-quarter results, beating consensus on the bottom line and achieving strong year-over-year top-line growth, meeting its goals of sustained double-digit growt in its branded (non-generic) pharma business over the medium term.
After digging deeper into the results and combing through management's conference call commentary, we wanted to circle back to subscribers to review what we found to be the biggest takeaways from what was a catalyst-driven quarter.
First and foremost, this quarter helped ease the market's lingering skepticism around the completion and sale of Allergan's $40.5 billion generics business to Teva Pharmaceuticals (TEVA). On the call, management was steadfast in its belief that the deal will close (likely in June) and both sides have worked meticulously with regulators to ensure the deal receives approval. Rob Stewart, COO of Allergan, specifically noted on the call that Allergan is "operationally ready to close once we receive the anti-trust clearance. (The company) has regulatory approvals in all countries, with exception of the U.S., but both teams are working diligently to complete that process."
Teva management also assured investors on its Monday conference call that they fully expect the deal to close in June, indicating that it has already found buyers for more than $1 billion in the business in order to alleviate any regulatory concerns.
Once the Teva deal closes, Allergan will be on the receiving end of a $36 billion windfall in net proceeds ($32 billion in cash and $4 billion in equity). Given its commitment to maintaining an investment-grade rating, management intends to use the proceeds to pay down $8 billion in debt, helping to delever the balance sheet and reduce annual interest expenses by $125 million.
Second, the company intends to voraciously repurchase its shares, announcing that its board had approved a $10 billion buyback program, with $4 to $5 billion coming in the 4-6 months following the close of the Teva deal and the remaining $5 to $6 billion of the program executed opportunistically. At current levels, the $10 billion authorization would reduce AGN's share count by roughly 10% and every $1 billion in share repurchases could increase annual EPS by more than $0.20.
Interestingly, CFO Tessa Hilado also noted that a dividend is an option for the future in order to maximize shareholder value should the company find itself with excess capital. The buyback and potential dividend should help provide a floor on shares while giving management ample optionality to optimize the use of their cash (if shares become expensive, capital deployment will shift towards more value-creating activities, such as tuck-in acquisitions). Management would prioritize tuck-in deals that can bolster any or all of Allergan's seven therapeutic areas of focus (eye care, central nervous system, aesthetics, urology, anti-infective, gastrointestinal and women's health).
It is important to recognize that Allergan does not need deals to grow. In fact, each of these seven therapeutic areas remains strong in its current form, with all but two growing sales at a double-digit clip. The two exceptions -- aesthetics and gastro -- are poised to benefit from impending new product launches: Viberzi for IBS in gastrointestinal and Kybella for treatment of the double-chin in aesthetics.
That last key point we wanted to highlight for subscribers is Allergan's strategy to remain focused on volume rather than price-based growth. Despite the comparisons to Valeant (VRX), which we find utterly unsubstantiated, as AGN's growth has been driven by product differentiation, demand, and volume (all byproducts of major investments in research and development). Any notable price increases are tied directly to demand and investments -- Allergan is developing treatments in areas with huge unmet needs -- rather than the unjustified, egregious price-gauging tactics employed by the likes of Valeant (VRX:NYAW). Price and volume are roughly equal contributors to growth in Allergan's U.S. business, with price increases averaging in the mid-single digits. Most importantly, sales across Allergan's top dozen products are disproportionately driven by volume growth (70%) rather than price (30%).
Bottom line: Allergan's earnings release and subsequent call was exactly the soft catalyst we anticipated. The company hit all the major points of investor concern -- the Teva deal, continued branded growth, capital deployment and pricing dynamics -- and the market rewarded them as shares surged over 5% throughout the day and continue to climb higher in today's session (shares are now up roughly 13% for the week). All said, we remind that the closing of the Teva deal still remains the major catalyst that can propel AGN from the cloud of smoke that has caused investors to ignore the company's strong fundamentals.
While we do recognize that volatility may hit shares at some point between now and the end of June (or until there is concrete approval of the deal), we reiterate that once the overhang has passed we expect the streamlined branded business, powerful buyback program and acquisition optionality to push shares higher.