By Soyoung Kim and Tim McLaughlin
NEW YORK/BOSTON (Reuters) - Fidelity Investments, the largest shareholder in Actavis Plc (ACT.N), has increased its holdings in takeover-target Allergan (AGN.N) in recent months and would be supportive of a potential merger between the two drugmakers, according to people familiar with the matter.
The Boston-based investment firm, which collectively owned 3.88 million Allergan shares through several of its funds as of end-June, had added roughly 2 million shares by the end of August, according to Thomson Reuters data based on Fidelity's monthly filings.
The additions would likely make Fidelity the No.8 shareholder in Allergan, according to Thomson Reuters data, assuming there was no significant changing of hands in the company's top-10 shareholder base. Fidelity is currently Actavis' top shareholder with a 6.3 percent stake, according to Thomson Reuters data.
Fidelity would be open to taking Actavis' shares if the drugmaker comes up with a rival bid using its own stock as currency, the sources said, asking not to be named because they are not authorized to speak to the media. The fund managers also like Allergan's standalone business plan, the sources added.
Revelations of Fidelity's increased holdings in Allergan come days after Reuters reported that Actavis was planning to make a new approach to the Botox maker about a merger, potentially challenging Valeant Pharmaceuticals Inc's (VRX.TO) (VRX.N) unsolicited bid for Allergan.
Boosting its Allergan ownership also contrasts with Fidelity's recently reduced bets in Valeant. Two of Fidelity's top stock pickers unloaded most of their holdings in Valeant after the Canadian drugmaker in April unveiled its bid for Allergan, which has marked one of 2014's most contentious takeover battles.
Some Fidelity fund managers are reluctant to support Valeant's cash and stock proposal in part because they have questions about the value of Valeant's stock, according to the people familiar with the matter.
Allergan Chief Executive David Pyott has regularly cast doubts on the value and sustainability of Valeant stock, saying the rival's share performance has been driven by financial engineering and "unsustainable" price increases.
Allergan declined to comment. Representatives for Fidelity also declined to comment.
Several analysts said in research notes this week that Allergan shareholders would prefer a competitive offer from Actavis over Valeant's bid.
"Based on our discussions with investors, we believe fundamental investors who own Allergan... are inherently more comfortable with the Actavis business model than the Valeant model," BernsteinResearch analysts said in a Wednesday note.
"Exchanging Allergan shares for Actavis shares would not force many of them to sell, as they might with Valeant position."
Industry executives say Actavis would be a better cultural fit for Allergan because the companies' respective chief executives, Brent Saunders and David Pyott, believe in focusing on research and development, while Valeant CEO Mike Pearson is known for cost cutting.
To be sure, Valeant still has a powerful ally. Hedge fund manager William Ackman has amassed a 9.7 percent stake in Allergan to make him the company's largest shareholder, and has teamed up with Valeant to pursue a joint bid.
T.Rowe Price, the second-largest shareholder in Allergan with a stake of near 5.4 percent, is also Valeant's No.3 investor with a 4.9 percent stake, and would likely benefit from a combination between the two companies.
Ackman has secured investors who collectively own more than 35 percent of Allergan shares, including his position, to call for a special shareholder meeting on Dec. 18, at which he hopes to replace majority of the company's board.
The prospect of a bidding war, as well as Allergan's own improving performance, has driven its shares to all-time highs this week, with the stock trading at $187.55 on the New York Stock Exchange, well above Valeant's offer.
On Thursday, Allergan lifted its third-quarter profit estimate and said the updated forecast showed that Valeant's takeover offer undervalued the company.
Shares of Valeant have come under pressure, however, as doubts increase about whether its bid will succeed. The stock fell 2.8 percent to $122.35 on the New York Stock Exchange on Thursday, valuing its Allergan bid at $173.55 per share, or just below $52 billion.
(Reporting by Soyoung Kim in New York and Tim McLaughlin in Boston, additional reporting by Jessica Toonkel and Nadia Damouni; Editing by Alden Bentley)