Why Valeant Splurged $1 Billion on Sprout... and Why It's Worth It

Last week,Valeant Pharmaceuticals (NYSE: VRX) said it reached an agreement to purchase privately-held Sprout Pharmaceuticals. The price is roughly $1 billion in cash, in addition to a share of future profits based on a set of milestones.

The reason for the buy is Sprout Pharmaceuticals' flagship product, flibanserin, which will be marketed in the U.S. as Addyi. The drug has been nicknamed "the female Viagra," alluding to the male erectile dysfunction treatment that's been a money-earner for Pfizer.

That nickname isn't quite accurate, as the drug works differently, and carries different risks than its masculine sort-of counterpart. Does that mean Valeant overpaid for its new asset?

Lifting libido, lifting profits?The timing of the buy was certainly auspicious... for Sprout, that is. The deal went down just after the Food and Drug Administration approved Addyi for the treatment of hypoactive sexual desire disorder, or HSDD, in premenopausal women. It's the first and only medication of its kind given the green light by the FDA. No doubt that commanded a premium.

But there's a catch. Addyi isn't Viagra, which activates enzymes in order to improve blood flow to the necessary place. Instead, Sprout's medication targets the brain's neurotransmitters to increase libido.

At the moment, that seems to be a dicier proposition than increasing blood flow. It apparently produces side effects in some patients that include unconsciousness and low blood pressure, particularly when taking the drug in conjunction with alcohol.

As a result, unlike Viagra, it will only be available from certified medical professionals and pharmacies. It'll also carry a black-box warning on the label regarding those side effects.

Some estimates have it that around 10% of all women are afflicted by sexual desire disorder.That's a huge potential market to draw from, particularly considering that Addyi will be the only pharmaceutical available for treatment.

And it's coming soon. Valeant expects Addyi to be available in the U.S. starting in the fourth quarter of this year. With the company's global reach, it also plans to sell it abroad.

Given the fact that the drug is not only new, but the first of its kind, it's hard to say just how much revenue it stands to bring in. At least one estimate put potential peak sales at around $100 million per year, meaning Valeant will need more than a decade to reach breakeven.

I think that's very conservative. The potentially massive patient base for the drug is clearly underserved, and will likely not be dissuaded by the potential side effects. Most of these effects are connected with alcohol consumption, and I'd speculate that most women diagnosed with HSDD will happily forego drinking in favor of more satisfying sex.

A strong drugA base price of $1 billion is far from cheap, even for a free-spending and acquisitive company like Valeant. But market-leading, impactful, and unique drugs don't hit the market every day -- particularly drugs that treat a condition millions of people struggle with.

In that light, I think buying Sprout was a good and opportunistic deal for Valeant. Yes, it's just a little pill, but it's packed with huge potential for its new owner.

The article Why Valeant Splurged $1 Billion on Sprout... and Why It's Worth It originally appeared on Fool.com.

Eric Volkman has no position in any stocks mentioned. The Motley Fool owns and recommends 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.

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