Investors said that even an ultimately positive takeover would crush Allergan's A3/A+ investment-grade credit rating, and quickly jumped to market to sell off its paper.
The 2023s plummeted to US$84.58 in the secondary market, where they were quoted at 225bp bid/175bp offer over Treasuries - sharply off US$94.53 and an 80/70 bid/ask on Monday.
The company's outstanding 2.8% 2023 bonds have no change of control of language, investors said, leaving the outstanding notes open to the potential of being structurally subordinated to new acquisition debt, and a rapid tumble into junk-bond status.
"Investors are piling out of these bonds because they are looking at a situation that would lead to a downgrade of Allergan from the single-A category by the agencies to a triple-B rating in optimistic scenarios," Julie Stralow, credit analyst at Morningstar, told IFR.
Ackman's Pershing Square Capital Management, which currently holds 9.7% of Allergan, has teamed up with Canada's Valeant Pharmaceuticals International to mount the takeover bid.
"Never mind what the deal structure might look like going forward or even that it could ultimately be positive for Allergan," one bond investor said.
"You are sitting on a single A credit that could go down to single B or double B, and whenever Ackman is involved there will be headline risk."
A takeover would be another notch in the belt for Valeant, which has made a series of high-profile acquisitions in recent years, including taking over US giant Bausch & Lomb.
According to Barclays research, Valeant is aiming to become one of the world's top five pharma companies by the end of 2016.
"We expect it to be a significant participant in M&A activity in the sector for the foreseeable future," the bank's analysts said in a report earlier this month.
Valeant is said to be proposing to swap each Allergan share for US$48.3 in cash and 0.83 Valeant shares. It says it has committed financing from Barclays and Royal Bank of Canada for about US$15.5bn.
The deal values Allergan at around US$152.89 a share, though the actual share price has soared to US$164.25 since the unsolicited takeover bid became public knowledge.
Valeant said it would take out the US$15.5bn financing through "secured bonds, unsecured bonds and bank debt [at an] expected interest rate of around 5.5% on new debt."
At current levels the Allergan 2023s yield around 4.6% in the secondary market, according to data from MarketAxess.
Pershing Square has elected to take only stock in the offering.
Valeant's cash bond spreads remained firm on the news, given that the combined company is expected to have a higher rating than its current B1/B.
It said in its filing that the combined entity would have US$28bn of net debt at closing and an expected pro forma leverage of around 3.0 times.
Valeant said it expected the combined company would have an investment-grade rating "over time".
It estimates a merger would reap cost synergies of US$2.7bn and that the combined entity would have a tax rate in the high single digits, because of its Canadian domicile, rather than the significantly higher US tax rate Allergan now has. (Reporting By Danielle Robinson)