Allergan Stock Buyback? Try M&A Instead

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(Bloomberg Gadfly) -- During Allergan's third-quarter earnings call this week, CEO Brent Saunders told shareholders the best thing the company can do with its cash right now is buy back its own stock.

The shareholder response: Are you sure? 

Allergan shares tumbled to their lowest point in more than two years Thursday the day after the company reported earnings that missed analyst expectations and cut 2016 revenue guidance, even as it beefed up its buyback program by $5 billion and announced a dividend. 

As it attempts to rebrand itself as a more conventional pharma firm, Allergan's recent deals have largely been risky moonshots that will pay off years from now, if at all.

This perception was not aided by the revelation on Wednesday that a drug the company acquired in September with its purchase of Vitae Pharmaceuticals disappointed in a Phase 2 trial. Allergan hinted it's interested in deals that pay off more quickly, but claimed it has found no target yet more attractive than its own shares. It should look a little harder.   

One source of urgency: Allergan's older assets appear to be declining more rapidly than expected -- particularly Alzheimer's drug Namenda, sales of which fell 32 percent year over-year in the quarter, due partly to price concessions. The company's efforts to switch patients to an extended-release version of Namenda from an earlier version now facing generic competition is not working as well as hoped.

As a result, Allergan cut $220 million from the midpoint of its 2016 revenue guidance, the second cut this year. It's not the best look for a company whose shares are already down 40 percent for the year and likely won't raise hopes about Allergan's top-line potential in 2017.  

After a years-long spurt of mega-deals, Allergan is having trouble convincing the market it will grow consistently without more deals. It does have newer, still-growing products on the market, such as the schizophrenia medicine Vraylar and chin-fat-reducing drug Kybella. 

But two older products, Botox and dry-eye drug Restasis, will be Allergan's biggest revenue drivers for some time to come. Analysts expect these drugs to account for nearly 30 percent of sales in 2018. The company is confident in Botox's growth potential, but it missed sales expectations in the third quarter. Restasis, meanwhile, faces aggressive competition from a recently approved Shire medicine.

Allergan hasn't been sitting quietly. It has done six deals since the $40 billion sale of its generics business to Teva closed in August. But it has focused on smaller, "stepping-stone" deals, mostly for earlier-stage assets. Trouble is, those stepping stones can be a bit shaky, often expensive, and too far apart. 

Vitae, an acquisition that looks shakier after its Phase 2 trial stumble, came at a 152 percent premium. Both of its lead-drug candidates are very far from market. Allergan also bought two companies with drugs intended to treat the liver disease NASH in one day. The first, Tobira Therapeutics, came at a record 500 percent premium in up-front cash alone. The final-phase trial for Tobira's lead drug isn't planned to begin until the middle of 2017. The second, Akarna, has not tested its drug in humans yet. 

Given Allergan's short track record of drug development, investors are understandably less than enthusiastic about such deals, and about the company's 70 mid- to-late-stage research programs.

An acquisition that adds more than a distant shot on goal would offer needed reassurance and top-line growth. It's time to do some homework.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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