Salix: Invert or Acquire?


On September 23, the Wall Street Journal reported that Allergan (AGN) is in talks to buy Salix Pharmaceuticals (SLXP).  Coincidentally, the Obama administration announced tough new regulations, effective immediately, to deter tax inversion transactions.  In our piece on Salix at the end of July, we discussed both the possibility that Salix would be acquired as well as the pending inversion transaction that Salix announced with Cosmo Technologies in Italy.  Let’s discuss each issue individually and also how they relate.

The Salix takeout thesis revolves around the potential for a larger pharmaceutical company with an established primary care sales force to sell Salix’ main drug Xifaxan in the expanded indication of irritable bowel syndrome (IBS), for which Salix expects to receive approval in the coming months.  Allergan has no current gastrointestinal (GI) business, so it appears that a Salix deal would act primarily as a defensive measure against Valeant’s pursuit of Allergan (while, to be fair, adding a strong growth business), rather than generate significant tax or operational synergies.  In today’s headlines, Irish-domiciled Actavis (ACT) is rumored to be in talks with Salix as well.  Given Actavis’ strong position in the GI space, we see a better strategic fit and more synergy potential in an ACT-SLXP deal. 

The proposed inversion transaction between Salix and Cosmo would likely be abandoned if Salix were acquired, but would also be endangered under the new government regulations.  Earlier this year, pharmaceutical companies asked about inversions typically replied that they were considering all possibilities to improve their tax positions.  Recently, though, the tone has shifted dramatically.  At an investor conference we attended earlier this month, the standard reply to the inevitable tax question had changed to “we’ll only consider a transaction if it makes strategic sense and any tax benefits would be secondary.” 

Perhaps shareholder backlash over deals that were not immediately accretive (Salix-Cosmo) or strategically inconsistent (Auxilium’s proposed inversion deal with Canadian-domiciled QLT added ophthalmology to the existing urology portfolio) is responsible for the change in tone.  Shareholders are likely also uncomfortable that much of the benefit of these deals only would kick in several years down the line, assuming the management teams could find attractive acquisitions at that time.  One unintended consequence of recent inversion deal announcements is that the U.S. “inverters” have become more vulnerable to potential acquirers themselves.  See the recent Endo bid for Auxilium and the Salix rumors as evidence.  In any case, we still believe Salix is a highly attractive asset and will generate interest from numerous potential acquirers at levels meaningfully higher than it is trading today. 

Convertible View

Both of Salix’s outstanding convertibles are essentially equity substitutes thanks to the stock’s outstanding performance in recent years.  For the record, we prefer the “lower-priced” 1.50%, with a Hillside Overall Convertible Rating of 55 (79 Growth/8 Safety), to the soon-to-mature 2.75%, with a HOCS array of 51/73/4.  But all that really matters, of course, is the stock.