Wednesday, February 16, 2011

Sanofi-Aventis to Buy Genzyme for More Than $ 20 Billion

The good news, at the very least, is Sanofi-Aventis (SNY) shareholders no longer have to worry about the price going even higher.

Sanofi-Aventis is acquiring Genzyme (GENZ) for $74 a share, or roughly $20 billion plus a contingent value right.

Sanofi-Aventis to buy Genzyme

Each shareholder will also get a contingent value right if certain targets are met for certain treatments. I happen to think even the initial offer of $ 18.5 billion was too high.

At the agreed price, Genzyme is selling for nearly 40x this years earnings which, of course, looks expensive.

At the projected forward earnings the deal looks much more reasonable at 20x. If that kind of earning power is there with steady growth to follow then the price paid becomes quite a bit less unreasonable.

Yet, in the context of Sanofi's significant free cash flow and very low P/E multiple, the argument for the deal looks weak to me from a shareholder return perspective. I understand that Sanofi-Aventis needs growth but the price paid for growth relative to what the company's own stock can be repurchased at matters.

At today's prices, Sanofi's stock is there for the taking at ~7.5x earnings*.

From this past weekend's Barron's article on Sanofi-Aventis. So what's the CEO Chris Viehbacher's objective?

RX: Bust Up Big Pharma

"It's to get back to a P/E of the S&P 500...".

Later in the article, Viehbacher had this to say about buybacks...

In an argument rarely made by CEOs, Viehbacher says that if there is an investor perception that a company has a declining profit base...then buybacks aren't effective. Only if there is a more positive view are buybacks valuable. By this reasoning, companies should buy back higher P/E stocks, not lower ones.

The article makes the point that buying back their own stock at 7x earnings instead of buying Genzyme at 20x probably makes more sense. At least some investors would prefer it.

The question is: does a CEO utilize every lever available to create shareholder value or instead focus on growing the empire in the guise of creating shareholder value?

Sometimes buying another company makes sense. If your business has a 30 P/E and great business comes along at a low multiple you buy it.

With a 30x multiple, in most cases buying your own stock isn't the greatest option unless there's a reasonable probability of strong growth (growth, that is, w/high return on capital) for years to come. Clearly, Sanofi stand alone doesn't have favorable growth prospects but its low P/E presents an opportunity.

Now, I realize the best argument for the Genzyme deal is that Sanofi is, in fact, buying an asset with lots of growth in front of it. If that's the case, Sanofi's move may not be a disaster and could even work out okay. Still, on a risk/reward basis I'd certainly vote for buying back that cheap stock.

When companies purchase their own stock, they often find it easy to get $2 of present value for $1. Corporate acquisition programs almost never do as well and, in a discouragingly large number of cases, fail to get anything close to $1 of value for each $1 expended." - Warren Buffett in the 1984 Berkshire Hathaway (BRKaShareholder Letter

By making repurchases when a company's market value is well below its business value, management clearly demonstrates that it is given to actions that enhance the wealth of shareholders, rather than to actions that expand management's domain but that do nothing for (or even harm) shareholders. - Warren Buffett in the 1984 Berkshire Hathaway Shareholder Letter

At 7.5x earnings, buying the stock at these prices provides a solid margin of safety while avoiding all the risks that are inherently part of any acquisition.

Here's a related post on Sanofi-Aventis from last year.

Sanofi-Aventis: How Not to Spend $ 18.5 Billion

This older Barron's article points out Sanofi's CEO blasted conference call participants about buybacks last year and said:

"I personally don't believe that buybacks add any shareholder value."

The article provided a quote from one big investor who was critical of drug-company CEOs:

"For these types, buybacks are a pejorative, a 'going out of business strategy' equated with no growth or ambition. Of course, the ambition to grow value per share instead of all the other stuff seems to escape many of them. I wonder how it's possible that so many well-educated people can be so ignorant of some pretty basic math."

With that view of buybacks I wouldn't expect a change in approach at Sanofi-Aventis anytime soon. While this may turn out to be a decent deal, it doesn't make the buyback lever any less important for Sanofi. If the stock stays cheap, it makes sense to take some of the free cash flow produced in the coming years to buy some of that stock.

So Sanofi's CEO says he wants "to get back to a P/E of the S&P 500".

Of course, that's what any CEO should want over the long haul but in the short to intermediate term, not necessarily.

I say be careful what you wish for, and, just in case the P/E adjusts upward sooner than later use some of the free cash flow to buy that stock on the cheap while you can.

While the price remains below intrinsic value (as Buffett says: "$ 2 of present value for a $ 1"), it gives a competent capital allocator another way of increasing returns for long-term shareholders.

You never know when the window to buy shares below intrinsic value will close.

Adam

Long position in BRKb and SNY

* Of course, one of the reasons for that low P/E multiple may be concern that the CEO has a track record of overpaying or will overpay for assets in the future.
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