The Pfizer-Allergan Deal Worst-Case Scenario

Last Updated Dec 5, 2008 4:31 PM EST

Jim KramerCNBC Mad Money host Jim Cramer suggested recently that Pfizer ought to acquire Allergan, maker of Botox and Juvederm. Cramer is usually not worth listening to but this idea has some merit: A tie-up of the two companies has advantages for both. However, mergers don't always go as planned, so it's worth bearing in mind what could go wrong if Pfizer CEO Jeff Kindler is tempted out of M&A hibernation and into the deal marketplace.

First, Let's look at the advantages of "Pfizergan." Pfizer is under pressure to do something about its declining revenue stream, caused by the expiration of its Lipitor patent. It has a massive amount of cash on hand, and stocks' of rival companies are cheap right now. There are plenty of battered shareholders who would accept a premium on their shares from Pfizer.

Allergan gives Pfizer some potential new growth avenues. Its Lumigan/Latisse new drug application, in which the glaucoma drug is being repurposed as a cosmetic eyelash lengthener, has not developed any bad news in the time it has been sitting with the FDA. Due to the recession, Allergan's discretionary business will weaken in short term but strengthen in long term. Americans don't like getting old and Allergan sells products that "fix" that.

Allergan is also well within Pfizer's price range. Unlike a putative acquisition of Bristol-Myers Squibb or Bayer, it would not require heavy use of the credit markets. Allergan is holding $1 billion in cash, has $2.1 billion in current assets and is on course for a $3.7 billion-plus year in revenues. This analysis seems persuasive:

Pfizer has $26 billion in its coffers, which is more than double what the company would need to buy Allergan. In return, on top of Allergan's fabulous brands, Pfizer would inherit a 14% long-term growth yet. That easily beats the 1% growth rate Pfizer has now.
The other part of the Cramer logic is that Johnson & Johnson just bought Mentor, a tiny competitor to Allergan, so the latter now needs a giant corporate network of its own to keep pace. Again from CNBC:
Investors looking to trade such a buy might do well if the J&J purchase of Mentor is any guide. Mentor fetched a price equal to just under 20 times earning. If Allergan earned the same, then AGN jumps to $54 a share. And even if a deal doesn't happen, there's potential for some heavy cost-cutting here, research firm Cowen & Co. said, which would offset any recession-related loss in sales at Allergan.
Lastly, an unscientific survey of Allergan reps suggests that the staff there would not be opposed, as they were in the Roche-Genentech bid:
Allergan's image always surrounds around botox. That has been an image they can never shed. A buyout like this would offer some credibility with the organized customer.
So that's the case in favor. What could go wrong? First, one of the very worst reasons for doing something is because someone else (i.e. J&J) just did it too. Allergan isn't all bread and roses. A closer look at its Q3 earnings shows the company is actually cashflow negative for the first nine months of this year.

Second, Allergan estimates peak sales of $500 million for Lumigan if it gets its new FDA app. The eyelash drug, which is currently used for treating glaucoma, is currently estimated to do maybe $430 million in sales. So that "growth" is just $70 million a year (Lumigan is already being used off-label all over the place; the new app could be relatively incremental.)

Investors underestimate the vanity of the monied American female at their peril, but if there's one thing women definitely don't want to give up, it's their eye-color. BNET readers already know this drug has some scary side effects, including changing your eye color permanently, which will retard sales.

As for competing on price, J&J has a long way to go and a lot of money to spend before it can ramp that Mentor network up and really start threatening Allergan or its main rival, Medicis. In a three-way fight, price will be a determining factor as fewer rich women want "work" done in the recession, and derm-docs seek to maintain their margins by looking for cheaper quality product.

But it's not all just about price. This is a relationships business too. Many docs are in practices that do a range of cosmetic procedures, and the three companies are bound to come on with deals linking discounts on one brand to purchases of another.

Allergan and Medicis both have long and deep histories in this business that J&J and new reps from "Pfizergan" will take years to replicate. Merger disruption risks annoying major customers. This is an industry in which, for instance, Medicis CEO Jonah Shacknai calls every single one of his doctor customers on their birthdays. Can you see Kindler doing that? Of course not.

Bottom line: This is one merger where the worst-case scenario isn't that bad. There are more advantages for ailing Pfizer than there are for growing Allergan, but Big Blue has one possible advantage on its side. Check this post from an Allergan employee on Cafe Pharma:

Stock options are under water all let the buyout happen