Tomahawk, WI 8/01/2013 (Basicsmedia) – Perrigo Company (NYSE:PRGO) announced that it will acquire Elan ELN in an $8.6 billion stock and cash deal, or $6.7 billion excluding Elan’s nearly $2 billion in cash on the balance sheet.

Industry Analysis

With nearly 80% of sales in the U.S., international expansion could also bolster Perrigo’s growth, but analyst think the structure of these markets hinder this opportunity. In the U.S., a consolidated base of customers drives the adoption of store-brand products. WalMart WMT, for example, comprises approximately 20% of Perrigo’s revenue. However, Perrigo’s expertise, including shelf space management, unique packaging requirements, and retail distribution, doesn’t easily translate to the fragmented customer base in most international markets, in our view. Without consolidated retail chains pushing private labels in developed OTC markets, most fragmented global markets require generic drug manufactures to rely on branding tactics to reach consumers—an area relatively unfamiliar to Perrigo. This is the primary reason behind Teva TEVA and Procter & Gamble’s PG joint venture in global OTC products, which combines each company’s expertise in manufacturing and marketing, respectively. Perrigo has initiated licensing agreements for its infant nutrition products in China, but analyst imagine building direct operations in international markets will remain a slow process.

Regulatory Hurdles

As one of the three largest generic drug manufacturers in the world (based on volume), Perrigo controls about 70% of the store-brand OTC drug market. It also earns incrementally higher profits over competitors thanks to its ability to allocate fixed costs over a large volume of products. The company’s large-scale operations have enabled it to become firmly engrained in customer supply chains, such as that of Wal-Mart WMT, that depend on Perrigo’s reliable, large-volume manufacturing. Additionally, larger generic manufacturers like Teva TEVA partner with Perrigo on OTC launches of former prescription drugs in order to leverage Perrigo’s store marketing expertise and distribution network.

Perrigo also owns active pharmaceutical ingredient manufacturing operations, which provide it with reliable and cheaper raw materials. As a result, Perrigo has cut costs from its operating structure.

Lastly, heavy regulation by the Food and Drug Administration serves to insulate Perrigo from an onslaught of competitors.


According to Morningstar statistics, Perrigo’s prescription drug segment, including the recent Paddock Labs acquisition which places segment sales at nearly 17% of total revenue, should boost gross margin to approximately 36% in 2015. Gross margin expansion, modest operating leverage, and faster growth of higher margin segments should result in an operating margin near 19.5% by 2016, which equates to low double-digit earnings growth over the same period. While analyst think current levels of profitability in the prescription drug segment will be difficult to sustain over the long-term, a recovery in profitability of the nutritionals segment combined with a greater contribution from both of these segments to the overall business should enhance consolidated profitability. Their forecast results in a five-year average return on capital at 14%.

Potential Risk Factors

Wal-Mart alone accounts for almost 20% of Perrigo’s revenue. Although Perrigo is undoubtedly firmly embedded in Wal-Mart’s supply chain, a shift to another supplier would have disastrous consequences for Perrigo. Wal-Mart would be hard pressed to find a comparable low cost and reliable supplier, but Perrigo’s recent FDA warning letter could make Wal-Mart, and other large chain stores, look to potential competitors.


Analyst are placing both companies under review but expect the tax benefit from the deal will moderately boost the fair value estimate for Perrigo. Because about 60% of the offer is funded in Perrigo stock, the new Perrigo valuation will partially dictate fair value estimate for Elan shares. This deal has little effect on Perrigo’s operational assets or competitive advantages. Although Elan owns attractive royalty payment streams and has some (modest) pipeline assets, Perrigo’s primary incentive is to utilize Elan’s Irish domicile to lower the company’s tax rate. This acquisition follows a strategy adapted by other specialty pharmaceutical companies, including Actavis ACT and Valeant VRX, to help lower tax liabilities through tax restructuring deals. Following the transaction, Perrigo estimates its tax rate will move to the high teens, and analyst estimate the majority of the $150 million in annual cost synergies will stem primarily from tax benefits.

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