The GlaxoSmithKline-Allergan Deal Worst-Case Scenario

Last Updated Mar 25, 2009 2:43 PM EDT

Allergan's stock has risen on an item from outlining acquisition discussions with GlaxoSmithKline. Allergan surged $5.41, or 13 percent, to $48.58, per Bloomberg, on the news.

As usual, at BNET we ask: before the money gets spent, what's the worst-case scenario?

The first thing to note is that GSK has less than half the cash it needs to create "GlaxoGan" without resorting to debt. Allergan's market cap is somewhere near $14 billion and rising. As DealReporter notes:

In the 4Q, GSK reported cash and cash equivalents at GBP 5.6bn (USD 8.2bn), while net debt at year-end increased significantly to GBP 10bn (USD 14.6bn). The spokesperson pointed out that net debt increased by GBP 4.1bn (USD 6bn) primarily due to share repurchases, further acquisition of businesses and a significant strengthening of the foreign currencies ...
So to complete this buy GSK will have to become even more indebted, with the consequent interest expenses that will bring for the combined company.

What riches will Allergan bring GSK in return for that burden? The case for the company usually begins by pointing out that it's cash-based, meaning that because its vanity portfolio isn't reimbursed by government health agencies its customers are all paying cash-on-the-barrel for their Botox and Juvederm treatments. This means the company doesn't have to worry about formulary or regulatory changes. And you can make an argument that by giving Allergan reps GSK's Alli to talk about, it extends the vanity franchise.

But much of Allergan's vanity portfolio plateaued or went into decline in Q4 2008. As these products are subject to the discretionary spending of the rich, their growth is capped, particularly in times like these. There is some growth in the eyecare franchise and the Lumigan eyelash extender launch, but overall Allergan itself is forecasting flat sales for 2009.

So GSK would essentially be indebting a new company with a giant aesthetics/eyecare footprint that won't grow until 2010 at the earliest. Bloomberg:

"Allergan is having more earnings pressure than I have ever seen them face, and they are having to cut spending just to have any growth," said Corey Davis, an analyst with Natixis Bleichroeder in New York, in a telephone interview. "Any buyer for Allergan would be chomping at the bit these days."
Would the combined company be any more efficient? Possibly not. GSK, following a disastrous Q4, currently gets only $2.53 in revenue for every dollar it spends on sales, marketing and admin. Allergan gets $2.44. Those numbers are at the low end of the large-pharma efficiency scale. Allergan has an excuse for its inefficiency: there's no automatic reimbursement for many of its products so its job really is about selling and capturing those discretionary dollars; it simply has to work harder to make a sale than GSK does with a reminbursed product. What's GSK's excuse? It doesn't have one -- suggesting that the cuts need to come from GSK and not Allergan for this deal to function. And if that's the case, why buy Allergan if the efficiencies to be made are all at your own firm?

But it gets worse for GSK. Later this year Allergan rival Medicis will launch a competitor to Botox, Allergan's flagship product. That competitor, Reloxin, will put downward price pressure on Allergan, leading either to lower revenues or higher sales expenses.

Note that Allergan is already cranking up the negative pr on Reloxin. I love this part of the DealReporter story where the Allergan rep hints that switching from Botox to Reloxin might somehow be dangerous:

An Allergan spokesperson pointed out her concerns that there is going to be certain risks of misinformation and misunderstanding about interchangeability of botulinum toxicities.

"Botulinum toxic therapies are biologics, they are non-interchangeable, so I would assume any manufacturer in this arena is going to provide proper education to physicians to make sure that there is no jeopardizing of patient outcomes and patient satisfaction," she said.

And then there's all the weird stuff that comes with Allergan. In its pipeline is this device:
Allergan invested in BAROnova, Inc.'s Series B financing to further advance the development of BAROnova's new technology designed to meet an unmet need in obesity intervention. BAROnova's non-surgical, non-pharmacologic TransPyloric Shuttle (TPS) weight-loss technology uses a revolutionary mechanical approach that helps the patient's stomach to fill up more quickly and to stay full longer, triggering the body's natural intake-reduction processes.
Would GSK even know what to do with such a thing?