Shares of Forest Laboratories, Inc. (FRX), a Zacks Rank #1 (Strong Buy) stock, soared 27.52% on news that the company will be acquired by Actavis plc (ACT). The companies have signed a definitive agreement under which Actavis will acquire Forest Labs for a cash and equity transaction valued at about $25 billion or $89.48 per share.

Each Forest Labs share will be entitled to a cash payment of $26.04 and 0.3306 Actavis shares. The offer price represents a 25% premium to Forest Labs’ closing price on Feb 14. Once the deal closes in mid-2014, Forest Labs’ shareholders will own 35% of the new company.

Why Forest Labs?

Forest Labs has well-established franchises in the central nervous system (CNS), cardiovascular and respiratory markets, as well as R&D programs that address a wide range of health conditions. Well-known products include Namenda (Alzheimer’s disease) and Bystolic (hypertension). Forest Labs also has a wide range of new products in its portfolio.

Earlier this month, Forest Labs acquired U.S. based privately-held Aptalis for $2.9 billion with the intention of strengthening its position in the gastrointestinal market in the U.S. and Canada and the cystic fibrosis market in Europe.

Although Forest Labs is currently facing generic competition for Lexapro (depression) and will face generic competition for Namenda IR, the company has been taking steps to combat the impact of genericization. Forest Labs has a deep pipeline and was successful in gaining approval for several new products.

Moreover, a new CEO, Brenton L. Saunders, was appointed last year and he announced several initiatives to streamline operations and cut down costs. Saunders was at the helm of Bausch + Lomb when the company was acquired by Valeant Pharmaceuticals (VRX).

Actavis, which was previously known for its strong presence in the generics market, is looking to strengthen its branded product portfolio. Initially known as Watson Pharmaceuticals, Inc., the company changed its name to Actavis following the Oct 2012 acquisition of Actavis Group. Then last year, the company acquired Warner Chilcott plc which helped boost its branded products portfolio and provided it with the tax advantages that go with an Irish domicile.

Now with the Forest Labs acquisition, Actavis expects the combined company to have a $2 billion CNS franchise, a $1 billion gastroenterology franchise, a $1 billion women's health franchise, a $500 million cardiovascular franchise and urology and dermatology/established brand franchises approaching annual sales of $500 million each.

Actavis’ current CEO will continue to lead the combined company. Meanwhile, Saunders will be joining the Board.

Deal to Be Accretive

Actavis expects the acquisition to drive double-digit accretion to earnings in 2015 and 2016. More than $4 billion of free cash flow will be generated in 2015 which will allow the company to de-lever its balance sheet rapidly.

Operating and tax synergies of about $1 billion will be realized following three years of close. This does not include any manufacturing or revenue synergies. Actavis intends to invest more than $1 billion every year on developing branded, generic and biosimilar products.

Our Take

Actavis has been on an acquisition spree over the past few quarters having successfully completed two big deals. The decision to acquire Forest Labs is in line with the company’s strategy of building its branded product portfolio. With a fewer number of blockbuster products slated to lose patent protection in the coming years, quite a few generic companies have been focusing on strengthening their branded products offerings.

The Forest Labs acquisition will push up Actavis’ branded products revenues to 50% of total combined revenues from the current level of 30% of the standalone company’s revenues. The acquisition will lead to the creation of a specialty company with sales of more than $15 billion per year, a diversified portfolio and a presence in different geographical areas.

The Forest Labs acquisition will also bring about significant synergies and boost earnings and revenues. However, the looming Namenda patent expiry in 2015 remains a matter of concern.

Actavis currently carries a Zacks Rank #2 (Buy). Shares were up 5% on the acquisition news. Another well-ranked stock in the health care sector is Auxilium Pharmaceuticals (AUXL), which carries a Zacks Rank #1.

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