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Is Elan Corporation, plc (ADR) (ELN) Pushing Its Luck?

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Recently Elan Corporation, plc (ADR) (NYSE:ELN)‘s shareholders voted against management’s proposal to invest $1 billion in Theravance Inc (NASDAQ:THRX), a deal which a fellow Fool calculates to be ill conceived.  Shareholders also voted against the purchase of Austrian AOP Orphan Pharmaceuticals, as well as the sale of Alzheimer’s drug ELND005.  Conversely, shareholders did vote in favor of a $200 million share repurchase program, effectively thwarting Royalty Pharmaceutical‘s attempts to take over the company.

Elan Corporation, plc (ADR) (NYSE:ELN)

The rejected proposals seem appropriate for Elan Corporation, plc (ADR) (NYSE:ELN) shareholders, but should the offer from Royalty have been given more thought?  As of the updated June 7 deal Royalty was offering $6.7 billion, or $13 per share, plus an additional $2.50 per share if Elan’s Tysabri hits a sales target.  At $13.44 per share on that date the initial deal represents a loss for shareholders, but the sales incentive means shareholders would have received a 15% premium.  This was Royalty’s fourth offer, with the first dating back to mid-February when the stock was trading around $10.60.

Management continues to insist that its business is worth more than $15.50 per share, and has initiated a formal sale process to court other buyers.  What is behind Elan’s lofty self-valuation, and are there any suitors out there who agree?

Elan’s self-calculated valuation

Elan Corporation, plc (ADR) (NYSE:ELN)’s only marketed product is Multiple Sclerosis drug Tysabri. Tysabri brought in $1.6 billion in 2012, which Elan split with partner Biogen Idec Inc. (NASDAQ:BIIB).  Earlier this year Elan sold its portion of Tysabri to Biogen, in exchange for $3.25 billion in cash.  Elan used this cash to pay off its debt and institute a $1 billion share buyback program.  Moreover, the deal provides Elan with cost-free royalty revenue of 12% on Tysabri sales, rising to 18% or 25% for certain sales achievements.

In a report detailing Elan’s valuation and urging shareholders to reject Royalty’s takeover bid, Elan Corporation, plc (ADR) (NYSE:ELN) predicts Tysabri sales growth of 11%-16% compounded annually from 2012-2016, down from 19% compounded annual growth from 2008-2012.  Extrapolation puts Tysabri revenue at $484 million – $611 million in 2016.  At a forward price/sales multiple around 11, the stock is overvalued compared to industry benchmarks like Biogen Idec Inc. (NASDAQ:BIIB) (trailing P/S of 8.7), Gilead Sciences, Inc. (NASDAQ:GILD) (trailing P/S of 7.8), or Amgen, Inc. (NASDAQ:AMGN) (trailing P/S of 4.2).  The additional 15% premium offered by Royalty should therefore have been welcomed by investors.

What if Elan stays independent?

An alternative approach is to ask what happens if Royalty’s offer isn’t topped and Elan Corporation, plc (ADR) (NYSE:ELN) isn’t bought out; is the company’s current financial outlook favorable?  Continuing to extrapolate at the most generous proposed rate (16%) to 2020 brings cumulative revenue to around $5.25 billion.  Adding in the current $1.9 billion in cash gives $6.95 billion – still less than the $7.9 billion complete offer.  Elan claims this calculation doesn’t account for sales beyond 2020, but it also doesn’t account for operating costs or cash spent in the approved share buy back.

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