Pershing Square Capital Management, L.P.
888 Seventh Avenue, 42nd Floor
New York, NY 10019
May 5, 2014
Mr. Michael R. Gallagher
Lead Independent Director
2525 Dupont Drive
Irvine, CA 92612
Dear Mr. Gallagher,
As Allergan's largest shareholder with 9.7% of the common stock, we look forward to working with you and the rest of the board to maximize value for all Allergan shareholders. In light of news reports that state that Allergan has begun to approach alternative business combination partners, we had some thoughts to share on the Valeant transaction and how Allergan could best maximize shareholder value.
The Valeant Proposal Is Substantially Superior to the Standalone Alternative
It is evident based on the market's response to the Valeant proposal that it is substantially superior to Allergan's value as a standalone company. The Valeant offer represents a significant premium to Allergan's unaffected stock price of $116.63 on April 10th, the day before Pershing Square began its rapid accumulation program. Conservatively valued at Valeant's current stock price, the offer represents a 38% premium to Allergan's unaffected stock price.
While a 38% premium is certainly substantial, we believe that valuing the transaction using Valeant's current stock price significantly undervalues the proposal. Valeant's stock price has appreciated only 8% since the transaction was announced, despite Valeant's forecast that the transaction would be 25%-30% accretive to Pro-Forma Cash 2014 EPS, offers $2.7 billion of identified cost synergies, and potential significant revenue synergies. As I am sure that you recognize, Valeant's current stock price reflects a substantial discount to where it will likely trade if the transaction closes. In our view, this discount arises from the market's uncertainty as to whether Valeant will be successful in merging with Allergan, a further discount for the potential time to transaction completion, and due to technical factors, as risk arbitrageurs short Valeant and buy Allergan to "set up" their trades.
We believe the correct methodology for valuing the Valeant proposal is to add the $48.30 in cash from the transaction to the pro forma value of 0.83 shares of Valeant stock, based on its estimated trading value beginning at the time the transaction closes, and considered over the long term.
Even if Allergan were able to identify a transaction that offers a higher cash value than the estimated value of the Valeant proposal at the time of transaction closure, we do not believe such a cash transaction would be necessarily superior to Valeant's stock and cash offer, as many shareholders would likely prefer to continue to participate in the value creation of the combined enterprise through ownership of Valeant common stock.
Many from the Wall Street equity research community use a similar methodology in calculating the transaction's value. For instance, on April 28th, J.P. Morgan published an equity research report that values the transaction using J.P. Morgan's forecast of the per-share value of the combined company. J.P. Morgan assumes that the combined company would trade at 14 times J.P. Morgan's estimate of 2016 cash EPS, which implies that the combined company is worth $192 per share, and that the Valeant transaction proposal is worth $208 per share. This value, $208 per share, is a 78% premium to Allergan's $116 unaffected stock price, and a 61% premium to the average analyst price target on April 10th.
A $208 per share offer implies $28bn of value creation above Allergan's unaffected, April 10th valuation. We believe the probability that Allergan can create this much incremental value as a standalone company is remote.
Our Recommendation as to How to Maximize Value for Allergan Shareholders
We understand that Allergan, consistent with its fiduciary duty, has approached alternative potential business combination partners, but it has not contacted Valeant or otherwise engaged in discussions with Valeant despite Mike Pearson's public statements suggesting that Valeant may be willing to improve its proposal if Allergan management and its board were to initiate discussions shortly.
We believe it is in the best interest of Allergan shareholders that it begin discussions with Valeant in the very near future. Today, Allergan is in a good position to negotiate with Valeant. This may not always be the case. The strength of Allergan's negotiating position comes, in part, from the potential that the board may negotiate a more valuable transaction with a large global pharmaceutical company. The list of global pharmaceutical companies with the financial capacity to buy Allergan, however, is limited, and even more limited when factors such as strategic fit and antitrust risk are considered.
As a result, it is risky for Allergan to rely on the potential for it to negotiate a transaction with a global pharmaceutical company that is superior to the transaction proposed by Valeant. Unless Allergan were to identify such a transaction in the very near future, the odds of such a deal are likely to decrease over time, and the market and Valeant will likely learn of the lack of interest from alternative companies. In our experience, shareholders of potential acquirers will pressure management to dispel acquisition rumors. As each rumor is dispelled, the board's negotiating leverage with Valeant will decline. Already some of the rumored suitors have publicly declared their lack of interest in a transaction with Allergan.
Valeant management has publicly acknowledged it understands this dynamic, and has even suggested it would consider reducing its offer if Allergan does not engage and no alternative suitor emerges. As a result, we believe the board should begin negotiations with Valeant immediately. The decision to negotiate now is not a decision to sell the company and, therefore, would not prejudice the exercise of the board's fiduciary duties.
Tax Inversion Transactions
There have been a number of press reports that suggest that Allergan is looking to acquire a foreign company and domicile the combined company in the jurisdiction of the target or in another low-tax jurisdiction. We are skeptical that such a "tax-inversion" would be superior to the Valeant transaction. We believe a business combination with any of the likely tax-inversion companies would lack the strategic rationale of combining with Valeant, for none of these likely companies has a meaningful presence in
ophthalmology, aesthetics, or dermatology. These companies would, therefore, lack the revenue and cost synergies of the Valeant transaction.
Furthermore, a "tax-inversion" combination would likely require Allergan to pay a premium to the inversion company's shareholders as compensation for the tax benefits Allergan would receive from the transaction. This dynamic is the opposite of and highly inferior to the Valeant proposal, in which Allergan shareholders are receiving, not paying, a premium.
There have also been press reports that suggest that Allergan is looking for potential transactions which would deter Valeant's interest in Allergan. We would strongly oppose a transaction with another company which did not offer superior shareholder value to the Valeant transaction. We caution that we would view any "lock up," break-up fee or other deal protection arrangements that Allergan puts into place between itself and another party interested in a business combination as value destructive. We would strongly caution Allergan from entering into any of these kinds of arrangements prior to a full engagement with Valeant regarding its proposal and a determination that the alternative proposal is clearly superior and likely to be supported by a majority of the Allergan shareholders.
As Allergan's largest shareholder, we are supportive of Allergan making the best possible deal with Valeant or identifying a superior transaction with another company. Given the short list of potential acquirers and Valeant's willingness to negotiate quickly, we believe Allergan can explore its strategic alternatives and determine a course of action within a matter of weeks. A quick timeline will also benefit the performance and retention of Allergan employees, who are no doubt distracted by recent events.
We would like to be helpful to the board throughout this process. I am available anytime by phone for discussions with you or other directors.
William A. Ackman