Billionaire Activist Investors Are Fighting Over This Sector

StreetAuthority Network

Following the moves of billionaire investors can be a great strategy -- if you do it prudently. 

Many of the great money managers run concentrated portfolios, with the majority of their fund invested in a small number of stocks. That means these managers usually have a high degree of conviction when it comes to their picks. 

One such fund is activist hedge fund Third Point, which Daniel Loeb founded in 1995. His $14 billion flagship fund returned 25% last year, and its success over the past couple of years has been driven by major investments in Yahoo (Nasdaq: YHOO), AIG (NYSE: AIG) and Delphi Automotive (NYSE: DLPH).

During this year's first quarter, Loeb and Third Point bought 2.5 million shares of drugmaker Actavis (NYSE: ACT), making it the hedge fund's largest holding. 

Actavis develops and manufactures branded and generic drugs, with a focus on urology and women's health. Its generic drug portfolio should benefit from a shift toward cost-effective health care. 

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Actavis has been on an acquisition spree, which should help the company deliver an earnings growth rate in the high teens over the next few years. In less than two years, Actavis has already closed two acquisitions and is poised to wrap up another. 

Formerly known as Watson Pharmaceutical, Actavis changed its name after buying Actavis Group in 2012 for $5.25 billion. It completed its second major acquisition just a year later, when it bought up Warner Chilcott for $8.5 billion. 

Its next acquisition is likely to be its pending buyout of Forest Laboratories (NYSE: FRX). Forest is no small company, with a market cap of $25 billion. Carl Icahn -- a peer of Loeb's among billionaire activist investors -- owned just over 11% of Forest at the time of the buyout.

Another drugmaker that has been growing through acquisitions is Valeant Pharmaceuticals (NYSE: VRX), which also has a billionaire activist involved: Bill Ackman's Pershing Square Capital owns just under 10% of the company. There was previous speculation that Valeant and Actavis might merge -- and Valeant was also interested in buying Forest Labs -- but with Ackman's help, Valeant is now focused on a $50 billion acquisition of Allergan (NYSE: AGN)

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The Forest Labs deal should be a big step in building up Actavis' branded drug portfolio. It should also allow Actavis to add new revenue and pipeline products, including products in treating cardiovascular, central nervous system and gastrointestinal disorders. Analysts expect Forest Labs' earnings to hit $2 billion by 2020, compared with $165 million over the past 12 months.

Thanks to its acquisitions, Actavis is posed for strong earnings growth: Wall Street expects earnings to grow at an annualized rate of 19% over the next five years. That strong expected earnings growth is attractively priced, too, as Actavis' price/earnings-to-growth ratio (PEG) is a mere 0.8.

Actavis trades at a forward P/E ratio of 12.5 based on next year's earnings estimates. However, its historical average P/E is 25, and the industry average P/E multiple is 34. Once Actavis fully integrates its new acquisitions, its margins should move toward industry averages. Its gross margin came in at 47% for the past 12 months, compared with the industry average of 54%. As Actavis' margins move more in line with its peers, so should its valuation. 

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Risks to Consider: Hedge funds don't have to disclose their holdings until 45 days after the end of the quarter, which means a fund may have sold its position by the time of its SEC filing (though this seems unlikely in Loeb's case). Actavis has also grown through a robust acquisition strategy; one poorly executed acquisition could have a negative impact on growth expectations. 

Action to Take --> A forward P/E of 18 times 2015 earnings estimates of $16.61 a share gives a price target for ACT of $300 -- nearly 45% from current levels.

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