This year could see a major healthcare M&A transaction as Merck (NYSE:MRK), Johnson & Johnson (NYSE:JNJ) and Pfizer (NYSE:PFE), are all rumored to be vying along with other healthcare companies like Sanofi, to acquire private equity firm Warburg Pincus’ large eye-care business Bausch & Lomb (B&L). Abbott Labs (NYSE:ABT) is mulling to throw to bid too since it has appointed a big investment bank to advise the company on the deal. 
Many of these cash rich companies are are looking at inorganic routes to fend off losses from patent cliffs or a weak drug pipeline. While there are a number of healthcare companies in the fray to acquire the company, we believe Merck and Abbott Labs could emerge as one of the most serious contenders. However, a $10 billion price tag put up by Warburg, could be too steep for many of the potential suitors.
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What B&L Brings To The Table?
B&L’s core businesses revolve around vision care products (contact lenses, lens care products etc) and ophthalmic surgical devices and instruments. In addition, it has a number of generics and branded drugs mainly for eyes that include steroid eye drops Lotemax and Besivance to treat bacterial infections. In March 2012, B&L acquired eye-drug company ISTA for $500 million, bringing in the latter’s current products including well known drop for cataract surgery patients, Bromday. The deal also added several pipeline drugs to its own, which currently has several promising drugs including a drug to treat dry eye disease.
Vision care and pharmaceuticals, each account for about 40% of B&L’s total revenues, whereas the rest 20% comes from surgical devices and instruments. Market wise, about 40% of total revenues comes from North America, whereas Europe constitutes for 33% and other regions bring in the rest. 
The Serious Contenders
Pfizer has been increasing its focus on its core pharmaceutical business and recently sold its nutritional business. Pfizer is also divesting its animal health business through an IPO. The rationale is that pharmaceuticals offer better profit margins and the divestment will leave more cash to repay debt, buyback stock and invest in its research and development programs. While B&L has some promising drugs in its portfolio, the majority of its revenues still comes from vision-care devices and related products. Therefore, we believe Pfizer might not be interested in buying the whole company, and Warburg Pincus, which plans to sell B&L intact to avoid potential increase in tax burden, wouldn’t agree otherwise. 
JNJ, which has been grappling with various recall issues in its OTC and medical devices businesses, along with patent expiries in pharma business, seems like a logical buyer. Its management has, at many instances, signaled to expand its medical devices business through inorganic routes. Further, long ago there were rumors of JNJ taking interest in the lens care market. But, issue is with the JNJ’s significant presence in contact lens business. JNJ commands more than 40% market share in the U.S. whereas B&L controls about 10%.  Market wise also, the deal won’t help JNJ much since B&L gets a significant chunk of its revenues from the developed markets, and we expect JNJ to rather spend its money on acquisitions in rapidly growing Chinese market. (Read Johnson & Johnson’s CEO Looks To Bolster Cardiology Devices Segment Through Acquisitions and Johnson & Johnson Mulls Acquisition of Baby Product Manufacturer in China).
Abbott Labs, through its is subsidiary Abbott Medical Optics, already has a limited presence in vision-care business. However, the business has been seeing dwindling sales.  Abbott Labs had earlier unsuccessfully tried to buy B&L in 2007, but lost to Warburg Pincus.  By acquiring B&L now, it could get ready access to its already established medical devices products and boost its presence in the market. While Abbott Labs wouldn’t want to keep the branded pharma business post its recent split from its separated proprietary research company AbbVie. But AbbVie is significantly dependent on Humira and a relatively weak pipeline continues to haunt it (Read Abbott Labs Snapshot As AbbVie Begins Trading). AbbVie could benefit from B&L’s current drugs to reduce dependence on Humira, while strengthening its pipeline.
In addition to Abbott, Merck, which has been facing a decline in revenues post Singuliar patent expiry and couple of recent setbacks in its pipeline, could also take a serious look at the opportunity. While the drug maker may not have experience in B&L’s core businesses, it has shown its willingness to expand its own consumer healthcare franchise, in stark contrast with its counterpart Pfizer.  Merck’s huge $17 billion in cash and cash equivalents at the end of Q3 also puts it in comfortable position. 
But, A $10 Billion Price Tag Is Not So Cheap
B&L had around $2.5 billion in revenues with about earnings before interest, taxes, depreciation, and amortization (EBITDA) of $400 million in 2007.  With an estimated 6% improvement in EBITDA margins since then  and an expected $800 million of EBITDA in 2013 , estimated revenues for 2013 would be close to $3.5 billion. Thus, a $10 billion price tag would be more than 2.5 times of its expected 2013 revenues, or about 12 times of its 2013 EBITDA. The big question is if these healthcare companies would be ready to shell out that much premium for a company whose overall growth may be in tandem, with the expected market growth of mid-single digit (market expected to jump by 17% to $35 billion by 2015). .Notes:
- Abbott, J&J, Sanofi Said to Show Bausch & Lomb Interest, Reuters, Jan 04, 2013 [↩] [↩] [↩] [↩] [↩]
- Contact Lenses 2011, Contact Lens Spectrum, Feb 1 2012 [↩]
- Abbott Labs Q3 10-Q, SEC [↩] [↩]
- Warburg Said to Hire Goldman Sachs to Sell Bausch & Lomb, Bloomberg, Dec 12 2012 [↩]
- Merck CEO Says ‘Worth Thinking About’ Bausch & Lomb Deal, Bloomberg, Jan 09 2013 [↩]
- Merck Q3 10-Q, SEC [↩]
- Bausch Shifts Contact-Lens Focus, Wall Street Journal, April 25 2012 [↩]