Warner Chilcott has uphill battle ahead in US market

Opinion: The US consortium of three private equity houses now in the throes of a due diligence procedure into Warner Chilcott, the women's healthcare group, will be starting with a strong base if they go ahead, with the suggested offer of £1.47 billion (€2.2 billion), or 800p per share.

Warner Chilcott, a Portadown-based group previously called Galen, is in a strong financial position. It has more than $200 million (€160 million), according to its results to June 30th, 2004.

That represents $1.38 per share (78p), or almost 10 per cent of the suggested offer price. Further, it has a healthy cash flow, the life blood for venture capitalists, generating an operating cash flow of $62.6 million in the third quarter to June 30th, 2004. This could be used to significantly reduce the cost of an acquisition.

Warner Chilcott is not Galen. Following the sale of its mainly UK pharmaceuticals services businesses to Dr Allen McClay, Galen's founder, and the purchase of Warner Chilcott in 2000 and other US firms, Galen has little resemblance to its former self. It is now essentially a US company, and this has undoubtedly attracted the latest takeover interest.

But as Warner Chilcott has warned: "There can be no certainty that an offer will actually be made."

The collapsed takeover talks with Barr Laboratories, another oral contraceptives company, may point to the uncertainties ahead. However, this latest suggested proposal is an all-cash deal. In contrast, Barr's was a share swap that was scuppered by the share movements.

This abandonment is thought to have disappointed Warner Chilcott's executive chairman, Dr John King, who, after 25 years with the company, wanted to cash in his 8 per cent shareholding. This latest deal could net him £118 million.

But regardless of what happens, it is clear that Warner Chilcott is now in play. And the appointment of Greenhill, the investment bank, to its team of advisers could imply that it wants to sound out other potential bidders to outflank the trio of Goldman Sachs, Blackstone and Texas Pacific.

The strategy of any successful venture-capital bidder is likely to include a relisting of the shares on the US markets (following a period under private control), where the ratings for such healthcare companies are much more attractive. It already has a listing on the Nasdaq for its American depository receipts (ADRs), and share listings on the Irish and London exchanges; it would be surprising if these were resurrected.

Ironically, Warner Chilcott wanted to go for a US listing last year, but institutional shareholders rebelled, and the proposal was dropped.

So who is in this trio? Goldman Sachs is well known. The Blackstone Group describes itself as a "leading global investment and advisory firm" and came to prominence in 2001 when it was appointed as Enron's principal financial adviser. It has ties with American International Group and Kissinger Associates/Henry Kissinger. It was recently runner-up in a bidding war for the UK Odeon cinemas and is also trying to build a private-nursing-homes business in the UK.

The inclusion of Texas Pacific, headed by Ryanair chairman David Bonderman, in the consortium, is a little surprising as it has gained a reputation for taking over companies others would rather avoid. It has, however, a very successful record.

Apart from a Ryanair restructuring in 1996, one of the highest recent profiles was the turnaround it engineered at UK pub chain Punch Taverns, making a profit of some $400 million as a result.

It is hard to see what venture capitalists can bring to Warner Chilcott. The key player in Warner Chilcott's rapid development has been chief executive Roger Boissoneault, who came into the group from the Warner Chilcott stable. He has been excluded from the present talks because he is seen as crucial to the further development of the group if a deal is concluded.

Since he joined the group, Warner Chilcott has divested itself of the lower-margin pharmaceutical services businesses, which should lead to increased group margins. And he acquired a number of brands in the US covering hormone replacement therapies, oral contraceptives and acne treatments. This year, it acquired a pharmaceutical manufacturing unit in Fajardo, Puerto Rico, which the company said would enable it to end its near-total dependence on third-party manufacturing.

The historic figures are impressive: turnover up from $134.4 million in 2000 to $432.3 million in 2003; and net assets up from $597.5 million to $1.12 billion.

There is no discernable trend in pre-tax profit because of exceptional and non-trading items but reflecting real growth, the adjusted earnings per share (eps) rose from 23.4 cents to 85.2 cents over that period.

The latest results show continued underlying growth. Revenue grew by 13 per cent; operating profit was much better at 46 per cent and eps was up 18 per cent to 19.7 cents. Mr Boissoneault has expressed confidence in continued growth.

Warner has, like others in its field, been beset with legal actions over patents and questions about the performance of some of its products, such as Sarafem, an anti-depressant. However, it has settled patent litigation with Barr and a court in the US has, since the end of its last results, upheld the validity of its patent on Sarafem.

With the uncertainties, is it any wonder that analysts have substantially differed on the right share value for Warner Chilcott, with the price ranging from £8-£12 depending on the assumptions used?

In the US, the group is facing stiff competition from larger groups. These direct quoted competitors include Johnson & Johnson (58 times bigger in terms of earnings before interest, tax, depreciation and amortisation, or EBITDA) Pfizer (46 times) and Wyeth (8.6 times). Warner Chilcott is important in some niche areas. Overall, it is a very small player but, surprisingly, it outclasses these biggies with fatter operating margins.

Texas Pacific has shown its mettle with Punch. With the starting base of oodles of cash, can it, if it decides to go ahead with its partners, transform Warner Chilcott into a significant US player?

Short-term, it and its partners, have the capabilities. But long-term - Punch's shares fell by 29 per cent after Texas offloaded its 22 per cent stake - is not their business.