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Can Cephalon, a Company in Mourning, Fend Off the Hostile Borg at Valeant?

In Valeant (VRX)'s hostile bid for Cephalon (CEPH), Valeant CEO J. Michael Pearson has come on with all the subtlety of the Borg from Star Trek: "You will be assimilated! Resistance is futile!"

The psychological drama is all the more fraught because Cephalon's founder and CEO, Frank Baldino Jr., died in December last year after taking leave in August, leaving his life's work in the hands of the team who helped him build it. That left Cephalon uniquely vulnerable: CEPH declined to $58.75 before Valeant's $73/share, $5.7 billion offer, and now new CEO J. Kevin Buchi must defend his company even as his troops mourn the loss of their spiritual leader. (Adding to the weirdness is that both CEOs use "J." initials in front of the names they actually use.)

Valeant doesn't care about any of that, of course. It digested Biovail last year and ate PharmaSwiss on March 11. Now, Pearson has announced that he wants to buy, strip and destroy Cephalon, too:

While we may not be the natural owner for many of these assets, we believe that there are many other biotech and pharmaceutical companies that might be interested in partnering with us on these assets.
He doesn't have much patience, either:
If we have a chance to look at the books, there might be a little more on the table, but not substantial [extra money]. If the shareholders don't like it, we'll move on. We will not hang around for months.
You can see why he's so bullish. Valeant's stock rose on the news (acquirers' stock usually falls in this scenario) of its attempt to swallow Cephalon using a secret letter from Goldman Sachs. VRX has been on a tear since 2008, rising from $7.39 to $53.96 today.

Cephalon adopted a poison-pill in its defense. If Valeant acquires more than 20 percent of Cephalon then everyone except Valeant gets the right to buy extra shares at half price or a free extra share -- a provision that would dilute Valeant's stake, rendering it profitless.

In the pipeline
Those are the tactics. The substance behind the bid is the value of Cephalon's product portfolio and its pipeline. The company claims Valeant's bid undervalues at least five potential blockbusters poised to launch through 2016:

This is where there may be potential bad news for Cephalon. One of those "blockbusters" is merely the addition of FDA approval to promote Nuvigil for depression. Nuvigil, a sleep disorder drug, is already on the market and has not replaced the revenues of Provigil, its similar predecessor. Provigil loses patent protection in 2012 at which point its revenues -- and those of Nuvigil -- will face an onslaught of cheap generic competition. Cephalon admits its revenues may collapse in its annual report:

We expect that PROVIGIL sales will erode beginning in April 2012 and beyond, and it is possible that NUVIGIL sales will also be affected by PROVIGIL generic competition.
Provigil is 38 percent of sales, Nuvigil is only 7 percent. There are dozens of competing depression drugs already on the market, many of them cheap generics too. What are the chances that an extra depression approval for Nuvigil will vault its sales to the level of Provigil's?

Given that, Cephalon's shareholders might well be asking themselves whether they want to wait around until 2014 and 2016, when the rest of Cephalon's new launches kick in, or whether they should take the 20 percent premium Valeant is offering right now. That may be an argument that Cephalon ultimately loses.

In that case, Valeant's instructions to Cephalon's board of directors will feel remarkably similar to those of the Borg: "Lower your shields and surrender your ships. We will add your biological and technological distinctiveness to our own."


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