Pershing Square and Valeant's Allergan Deal a Watershed for Activism

Updated with ValueAct comments, share prices and additional detail throughout.

NEW YORK (TheStreet) -- Pershing Square Capital Management may be re-writing the rules of activist investing after teaming up with Valeant Pharmaceuticals (VRX) on a takeover bid for Allergan (AGN). Valeant will offer Allergan $48.30 a share in cash and 0.83 of its shares in the bid, which values Allergan at a roughly 10% premium to its closing share price on Monday. 

The takeover effort is the first that counts an activist hedge fund investor as a crucial piece and it raises the prospect of similar marriages between activist investors and deal-seeking corporations looking to press an unsolicited merger. 

Valeant Pharmaceuticals and Pershing Square disclosed on Monday that they had struck a deal to acquire over $4 billion worth of Allergan's stock, or approximately 9.7% of the company's outstanding shares, as part of an unsolicited effort to merge the two pharma industry giants. On Tuesday, Valeant released details of its bid, including estimates of $2.7 billion in annual operating synergies in the event of a merger and the prospect of a 20-cent dividend.

While Allergan is most well known for its Botox treatments, Valeant Pharmaceuticals has emerged as one of the fastest growing generic drug manufacturers in the world. 

That prospective merger between Valeant and Allergan will contain a cash component of $15.5 billion with the rest of the transaction financed with stock. Such a merger would be among the largest pharmaceutical deals in recent memory and values Allergan at over $45 billion. Valeant and Allergan both closed Monday trading with a market capitalization of around $42 billion.

Barclays and Royal Bank of Canada have agreed to financing commitments to cover the cash portion of a deal.

"The combination of Valeant and Allergan represents the most strategic and value-creating transaction I have ever analyzed," Bill Ackman, head of Pershing Square, said in a statement on Tuesday. Ackman said Pershing would elect to take all-stock in a transaction as part of a long-term investment.

"This proposal represents an undeniable opportunity to create extraordinary value for both Allergan and Valeant shareholders by establishing an unrivaled platform with leading positions in ophthalmology, dermatology, aesthetics, dental and the emerging markets," Michael Pearson, CEO of Valeant, said in a statement.

A New Type of Mega Deal

A possible merger between Valeant and Allergan, on its face, isn't surprising. Valeant has indicated that after a string of acquisitions, the company was again on the prowl for a large deal. The inclusion of Pershing Square and a set of contingencies that tie both parties together, however, may break new ground in activist investing.

A source familiar with the deal said it was Valeant Pharmaceuticals that reached out to Pershing Square about a bid for Allergan in February.

Because Valeant reached out to Pershing, that source said there were no insider trading issues in building an Allergan stake because no fiduciary duty was breached. ValueAct Capital Management, a large investor in Valeant Pharmaceuticals shares with two seats on the company's board of directors, is supportive of Monday's developments.

Jeffrey Ubben, head of ValueAct, said in an interview with TheStreet at the IMN Active-Passive Investor Conference that Ackman chose to partner with Valeant Pharmaceuticals, but that the company was behind the decision to target Allergan. "We picked the target, he picked us," Ubben said of Pershing's role in Tuesday's offer, which has been studied for almost a year.

Ubben indicated that ValueAct's Mason Morfit may soon step off Valeant's board in order to focus on his recent appointment to Microsoft's (MSFT) board. Valeant may continue its acquisitive ways even after a prospective Allergan merger, Ubben said. He characterized Pershing's role as very helpful to those efforts.

The Foundation of Pershing and Valeant's Deal

Pershing is putting up most of the money for the 9.7% Allergan stake, its largest-ever single stock investment. However, the hedge fund didn't need to collect outside funding. Instead, Pershing redeployed proceeds garnered by the recent takeover of whiskey giant Beam (BEAM) and a sale of its General Growth Properties (GGP) shares.

The structure that Valeant and Pershing agreed on is complicated, but the salient points are that Pershing is taking most of the risk in the $4 billion Allergan stake and the fund could become one of Valeant's top long-term shareholders were a merger with Allergan ever consummated.

Pershing and Valeant created a vehicle, called PS Fund 1, in which Valeant contributed $75.9 million to acquire Allergan stock. Funds managed by Pershing Square are responsible for the remaining investment, however, Valeant will have a right to 15% of the net profits of the Pershing funds if a third party emerges as an acquirer of Allergan.

For its part, Pershing has committed to vote in favor of Valeant's merger proposal. If a deal does emerge, Pershing has committed to buying $400 million of Valeant shares at a 15% discount to the market price at that time. Were that transaction to be completed, Pershing will be required to hold Valeant shares worth at least $1.5 billion for at least 12 months.

On Tuesday, Valeant said its cash-and-stock bid would lead to a high single-digit tax rate for the combined company, in addition to synergies nearing $3 billion, according to Morgan Stanley estimates.

Overall, Valeant forecast that a merger could generate 25% to 30% earnings per share accretion in the first year after a deal is completed. Additionally, compound EPS growth is forecast in the 15% to 20% range. Valeant also forecast at least $300 million in annual R&D spending for late-stage pharmaceutical projects.

Allergan shares were rising more than 22% to $164.69 on Tuesday. Valeant Pharmaceuticals rose nearly 10% in afternoon trading on Tuesday, indicating investors believe forecasts of synergy and EPS growth are credible.

-- Written by Antoine Gara in New York.

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