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By Caroline Humer and Svea Herbst-Bayliss
NEW YORK/BOSTON, Aug 20 (Reuters) - A few months ago, an innovative partnership between Valeant Pharmaceuticals and billionaire investor William Ackman to buy Botox maker Allergan Inc looked like a blueprint for success. Now some Valeant shareholders who backed the deal at its start are questioning whether it will become reality.
A robust defense from California-based Allergan and Valeant's own weak second quarter financial performance have pressured Valeant stock, which is down 6 percent this year after doubling in 2013. Ackman, whose hedge fund Pershing Square Capital Management owns nearly 10 percent of Allergan, is digging in and told his own investors he is focused on getting a deal done. Valeant also remains committed.
Allergan's resistance -- the company has rejected Valeant's overtures and instead been looking for a partner while also trying to cut costs -- is an unexpected twist for Valeant, whose steady stream of drug industry acquisitions under Chief Executive Michael Pearson drew frequent investor praise.
Valeant's novel strategy to team up with Ackman and his hedge fund, also was lauded. One of Valeant's top shareholders, ValueAct Capital, called Valeant and Allergan a "perfect match" when the plan was announced in late April.
Now the value of Valeant's cash and stock-based offer has fallen $5 billion to $48 billion.
ValueAct is the first large shareholder to have expressed concerns about the deal publicly, telling Reuters last week that Canada-based Valeant doesn't need to buy Allergan and that it may do better by considering other acquisition targets if the battle drags out.
In Reuters interviews since then, five other large Valeant shareholders, most of whom support the deal, said that there were mounting doubts, ranging from concern a transaction wouldn't happen to worries that the pursuit of Allergan would drag out so long as to undermine the benefits.
"The dive in the stock price does make it difficult to pursue Allergan and others," said Valeant investor Gautam Dhingra, CEO of High Pointe Capital Management, which owned 18,600 shares as of June 30.
Dhingra said he still believes in Valeant's business model of acquiring companies and cutting research & development costs, although people are starting to challenge it. "Until now there has been no flaw in the model, nobody has questioned it," he said.
Another investor at a Canadian investment fund said that six months or a year of pursuing Allergan would not be too long, but that by early next year, he would like the deal to be moving forward. "If the opportunity cost is too much over time, we think there are other things that Valeant can do."
During the second quarter 57 fund firms exited Valeant stock completely and 148 funds cut their positions, according to data from the Securities and Exchange Commission.
Mutual fund giant Fidelity Investments cut its Valeant holdings by 38 percent while a number of hedge funds including Robert Citrone's Discovery Capital Management and Daniel Loeb's Third Point LLC as well as Adage Capital Management, sold out completely, according to the filings.
"The share price had gone up a lot and when things started to look a little more difficult, many investors were not ready to stick around and wait for that little extra percent they might make if and when the deal is consummated," one shareholder at a New York hedge fund said.
Erik Gordon, a professor of law and business at the University of Michigan, said that in April he saw a "transformational deal" between an activist investor and a company that wanted to buy another company. "Now with all of these complications cropping up, I'm not sure anymore," he said.
Still, 81 funds opened new positions and 191 added to their Valeant holdings in the quarter. Steven A. Cohen's family office Point72 Asset Management, the successor to hedge fund titan SAC Capital Advisors, added a new position as did Eminence Capital and Senator Investment Group, the filings show.
Ackman and Valeant both stressed their commitment to completing a deal. The partners are working to gather the support of owners of 25 percent of Allergan stock, the level needed to call a special meeting. Ackman holds 9.7 percent.
Proxy advisory firms have suggested investors vote for the meeting, at which Ackman and Valeant want to replace the bulk of Allergan's directors. They also want Allergan shareholders to vote for opening discussions on a deal. There is no vote on a deal yet, making it premature for proxy firms to issue any opinions.
Allergan has been fighting hard to keep Valeant at bay, from suing its pursuer to looking for its own potential acquisitions, which would complicate a Valeant deal.
Ackman and Valeant began working together in February.
Ackman used a corporate entity, funded by the hedge fund and Valeant, to amass an Allergan stake. Pershing Square in turn booked about $1 billion in profit as Allergan shares shot up on the deal announcement.
Allergan said the arrangement between Ackman and Valeant violated insider trading rules and sued. Valeant and Ackman deny those claims, with Ackman calling the lawsuit a tactic to delay a special shareholder meeting.
The Securities and Exchange Commission is asking questions about the proposed deal, a source familiar with the matter said last week, and Valeant disclosed earlier this month a new Internal Revenue Service audit of the its U.S. consolidated group for its 2011 and 2012 tax years.
A Valeant spokeswoman said that the company remains committed to both the deal and its promises of growth, and that it was confident in the legality of its actions with Ackman.
"Valeant also has a rich pipeline of other business development opportunities, and we are confident that we will continue to deliver strong results and grow in the high single digits," Valeant spokeswoman Laurie Little said in an emailed statement. (Additional reporting by Rod Nickel in Winnipeg, Manitoba; Editing by Michele Gershberg and Peter Henderson)