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Elanco rattles investors with $7.6B buy of Bayer's animal health unit

Elanco Animal Health Inc. will become the No. 2 animal health company behind Zoetis Inc. with its $7.6 billion acquisition of Bayer AG's animal health business.

Evercore analyst Umer Raffat said investors are rattled by the deal, citing Bayer Animal Health's heavy reliance on a few key products and potential antitrust issues stemming from the combined company's portfolio overlap.

The Greenfield, Ind.-based company's stock was trading down about 8.8% to $27.18 as of 2:22 p.m. ET.

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But Elanco CEO Jeffrey Simmons said the "forward-thinking" Bayer deal, slated to close mid-2020, had to be executed now, especially in light of the evolving animal health industry's demand for new products and distribution channels.

"We don't have the luxury to wait and see," Simmons said on an Aug. 20 call with investors.

Another Evercore analyst said the acquisition could raise questions about whether Elanco can execute on its growth strategy as an independent company. Elanco spun off from Eli Lilly and Co. in 2018, completing the transaction in March.

Creating a contender

Elanco executives emphasized Bayer Animal Health's complementary pipeline, primarily in six main therapeutic categories: companion animal therapeutics, pet vaccines, pet parasiticides, food-producing animal pharmaceuticals, animal vaccines and animal nutritional health.

Simmons said the deal will result in a doubled companion animal business worldwide, with revenues from this segment accounting for 46% of the combined company. Elanco previously saw 37% of its revenue from this business, Simmons said. The two companies' parasiticide portfolios include topical and chewable formulations as well as prescription-only and over-the-counter products, the CEO said.

Bayer boasts the Advantage product family, which includes Advantix, Advantage Multi and Advocate. The company also launched Seresto, a parasiticide collar for cats and dogs, in 2012. The collar has since become the second-fastest-growing product in animal health, Simmons said. Seresto could potentially pull in over $2 billion, the chief executive added.

Elanco markets the following for use in dogs: Trifexis, which kills fleas and prevents heartworms; dewormer Interceptor Plus; and Credelio for flea and tick prevention

An analyst noted during the call that animal health competitor Zoetis will launch a new parasiticide product called Simparica Trio to provide triple protection for fleas, ticks and heartworm.

Simmons said Bayer's pipeline, details of which he did not disclose, will add eight key development projects to Elanco's lineup. This will create a combined company pipeline of more than 50 programs.

He also pointed to the importance of new distribution pathways that the Bayer deal opens up. One-third of U.S. pet owners do not see their veterinarians regularly, meaning that e-commerce channels like Chewy Inc. are essential, Simmons said. Bayer already has established relationships with e-commerce and physical retailers, which would have taken Elanco years to replicate, Simmons said. Bayer will further provide Elanco a pet market presence in China, he added.

Antitrust concerns

The very advantage of Bayer's overlapping pipeline could be an issue for the Federal Trade Commission. The agency has recently turned a critical eye on other pharma mergers' product overlaps.

During an Aug. 20 Evercore webinar, Raffat said Bayer's main over-the-counter channel versus Elanco's primary distribution via veterinary prescription is the "crux" of Elanco's argument, in addition to differing administration methods.

However, Raffat pointed out that several of Bayer's and Elanco's products have some of the same active ingredients. These include Elanco's Interceptor Plus and Bayer's flea protectant Droncit. The FTC will not necessarily push back on the deal even if their products overlap. Rather, the market share of a combined company's products could determine the outcome, Raffat noted.

Nevertheless, Raffat warned that Elanco's projections for the combined company bank on the acquisition of all of Bayer Animal Health's products. If the FTC requires any material divestiture, the EPS growth will be undone, Raffat said.

Doubts about Elanco-Bayer margins

According to Elanco, adjusted EPS will show growth in year one of the deal. In year two, the combined company will post high single- to low double-digit growth. Elanco expects a combined revenue of $4.7 billion and a revenue growth rate in the mid-single digits.

Moreover, Elanco noted a proven track record in M&A integration and the successful spinoff from former parent company Eli Lilly.

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Stifel analyst Jonathan Block said Zoetis, which posted 2018 sales of $5.8 billion, will remain "superior."

Raffat contested the projected revenue growth. The analyst said Bayer's animal health unit revenue would be more likely to grow at a low single-digit rate. This would be the result of the 1.8% sales declines in North America in the first six months of 2019 and intellectual property threats.

Very few of Elanco's and Bayer's products still have patent protection, while in Bayer's portfolio, only Advantage Multi still has protection through October 2020.

Additionally, Raffat said investors believe the deal distracts Elanco from its independent margin expansion goals — despite the company's assertion that the acquisition strengthens and accelerates its strategy.

"This is not a step back or step away from anything," CEO Simmons reiterated. "This is … necessary for long-term, sustainable value for our shareholders and putting Elanco in more of a leadership position as we combine these two great companies together, making the No. 2 animal health company."