Can This Pharma Go From Good to Great?

By Markets Fool.com

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Actavis PLC's stock just keeps climbing. Over the past two years, the share price has jumped by an astounding 230%.

Even before its recent acquisition of Allergan , which, at $66 billion, was the biggest healthcare deal in six years, the generic-drug company has transformed itself from a small fish in a crowded pond into amajor pharmaceutical contender. Looking back almost five years, when Actavis was called Watson Pharmaceuticals, the company has streaked up more than 625%.With that kind of stellar performance, a lot of people would consider Actavis already a "great" company, and due for a breather.

Those people might be forgetting about the company's brash CEO, Brent Saunders, whom Forbes recently called "the hottest executive in the global pharmaceutical business." Saunders has always been impatient to do more.

In fact, to hear Saunders tell it, he rescued Allergan from a hostile takeover by rival pharmaceutical company Valeant Pharmaceuticals , and activist investor William Ackman, for only one reason: He intends to use the megamerger as a springboard to create a revolutionary new kind of drug company.

Big pharma vs. growth pharma
The acquisition of Allergan will put Actavis in the ranks of big pharma, by making it the world's 10th-biggest drug firm. When the merger is complete, the new company will have 30,000 employees and revenues in excess of $23 billion anticipated in 2015, according to the company. But Saunders claims he's not after bragging rights to big-pharma status. "Size was never a goal and doesn't remain a goal," he said.

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That doesn't sound like a typical CEO speaking. So what's the goal?

Actavis has a different dynamic -- "a commitment to managing for growth," according to Saunders. He's even coined a new phrase to describe it -- "growth pharma." It's not just a clever phrase; Saunders has made it clear he doesn't plan to fit the mold of big pharma. Instead, he plans to break it.

Big, hairy, audacious goal
One of the major criteria for making the leap from good to great -- direct from Jim Collins and Jerry I. Porras' bookBuilt to Last: Successful Habits of Visionary Companies -- is having a BHAG, or big hairy audacious goal.

Saunders not only has a BHAG; he has one in spades. For his new company, which will take the name of Allergan, he's set a goal to "generate organic revenue growth at a compound annual growth rate of at least 10% for the foreseeable future."

Among the growth kings in tech, such as Apple, Fortinet, or even Aruba Networks, that kind of growth wouldn't raise an eyebrow. But it's a high mark for a drug firm of the new company's size. The patent cliff has taken such a hammer to big pharma that even the best run tend to max out at a few percentage points of overall annual revenue growth.

BHAG drivers
Is Saunders speaking out of his oversized hat with that kind of goal? Let's look at how Actavis/Allergan intends to reach its BHAG.

  • Cut bureaucracy to the bone. Big pharma is known for having a slow-moving, lumbering style of organization. By contrast, Saunders is aiming for a nimble, fast-paced environment. He said, "We don't plan to have committees; instead, we will foster a culture of individual decision making and accountability." The new company's corporate structure will be flat, with only seven layers from the CEO to the front line.
  • Improve branded sales force efficiency. Actavis' sales force, focused on primary doctors, will be used to generate more revenue from Allergan drugs such as Botox, which have been traditionally marketed to specialists.
  • Power its way into biosimilars. Actavis has a strong industry partnership with Amgen for developing biosimilars, including copycat versions of Herceptin, Avastin, Rituxan, and Erbitux. The first biosimilar from the pipeline should launch in 2017.
  • Keep expanding into higher-barrier markets of ophthalmology and cosmetics. Dry-eye treatment Restasis is a flagship drug for Allergan, but Botox is the company's key growth driver. Analysts see $3 billion in sales for Botox by 2017, as new indications get approved. The drug's medical side is responsible for more than half its sales. It's expanding faster as well -- medical sales for Botox grew 17% last year, compared with 8% for its cosmetic side. The growth should continue, since Allergan has applied for patents for more than 90 new uses for the neurotoxin.
  • Take advantage of an estimated $1.8 billion in cost synergies from Allergan and another $1 billion from an earlier Forest deal. Actavis acquired Forest Laboratories in February 2014. The cost-cutting synergies should help the new company sustain its high profitability, while expanding the breadth of its portfolio.

While the BHAG looks doable, with the kind of share price gain Actavis has seen, it's only fair to ask whether the stock is overpriced. Morningstar's current fair value estimate for Actavis is $330. Shares currently trade at a market forward P/E of 16.79, which is below the market average and looks reasonable considering its growth before the merger -- 45.97% in sales or revenue growth in 2014. In fact, given Actavis' growth, profitability, and diversification, that should probably justify a higher multiple for Actavis than for most of its pharmaceutical peers.

Actavis has a global footprint, with R&D, sales, and manufacturing plantsin 60 countries, including this facilityin Iceland.It reincorporated in Ireland in 2013 to reduceits tax rate.

Any big, hairy headwinds?
Integration is always a concern with a large acquisition, and Allergan is a name-brand, R&D-driven business, while Actavis is a legacy generics business. But while these companies are dissimilar, we're in a new era, one in which the big divide between generic and branded companies is blurring.

In addition, Allergan is Saunders' third acquisition since he moved to the helm of Actavis. In fact, Saunders has completed more than $99 billion worth of deals in his career, dating back to his days as CEO of Bausch & Lomb. I'm no fan of companies that buy themselves a future, but Saunders has this down to a science. His track record shows he is one of the few CEOs who can consistently make big acquisitions work out great for investors.

I do have one major concern, however. A large determinant of success for this acquisition is the eventual launch of key assets in Allergan's mid-stage pipeline, such as its anti-VEGF DARPin for age-related macular degeneration. Just this one drug could post $2.7 billion in U.S. sales. Actavis' own pipeline is lean, and it needs Allergan's forthcoming drugs, as well as continued expanded indications for Botox, to come through. Otherwise, Actavis' growth prospects will diminish.

To make that less likely, Saunders has promised to keep the R&D spend at around $1.7 billion a year for the combined company, while cutting out low-value targets.

Is the new Actavis/Allergan likely to become an enduring great company? I wouldn't be surprised if that happened. This company has proved it can work its formula successfully again and again. In fact, I have only one real problem with this audacious company, its gung-ho CEO, and its top-performing stock. I jumped in for the ride 12 months ago, and I only wish I'd had the smarts to get aboard sooner.

The article Can This Pharma Go From Good to Great? originally appeared on Fool.com.

Cheryl Swanson owns shares of Actavis and Apple. The Motley Fool recommends Apple and Valeant Pharmaceuticals. The Motley Fool owns shares of Apple and Valeant Pharmaceuticals. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.