A bold plan to combine Germany's Ratiopharm and Iceland's Actavis, two of the world's biggest generic drugmakers, could cure a multi billion-euro debt headache for Deutsche Bank, Actavis's main creditor.

Actavis is vying with Pfizer and Israel's Teva Pharmaceutical Industries in the €3 billion auction of Ratiopharm, which is being sold by the family of late German billionaire Adolf Merckle to repay creditors, sources familiar with the situation say.

If Actavis triumphs, this rare example of restructuring-via-dealmaking would make it less likely that Deutsche will suffer a big loss on its largest block of risky loans held over from pre-credit crisis days.

Deutsche has held most of Actavis's debt since it financed the firm's 2007 leveraged buyout (LBO) by Icelandic tycoon Bjorgolfur Thor Bjorgolfsson in a deal that was valued at €4.74 billion including debt, according to Thomson Reuters data.

Compared with the fight between Citigroup and private equity firm Terra Firma over music firm EMI , whose buyout Citi bankrolled, Deutsche's Actavis issue has attracted little publicity. But the people familiar with the matter say Deutsche, Actavis, its majority owner, other lenders and London law firms Linklaters and Clifford Chance have spent months in talks, after a sale of Actavis fell through last year.

It is unclear whether Bjorgolfsson's stake will be diluted as part of a debt-for-equity swap, as in a typical restructuring. In January Icelandic media claimed Deutsche was taking control of Actavis. But Bjorgolfsson denied any change of control was underway or planned.

Tycoon
Allying Ratiopharm's strength in Germany with Actavis' breadth in emerging markets would create a more valuable joint firm, bolstered by cross-selling and cost savings.

The combination could enjoy about €300 million of annual synergies, people familiar with the matter say - an amount roughly equivalent to Ratiopharm's total earnings before interest, tax, depreciation and amortisation (Ebitda) last year. Credit Suisse estimates a merged Ratiopharm-Actavis would be the world's third-largest copycat drug maker by sales.

Since the buyout, Actavis's debt has ballooned, since a chunk of it is in bull-market instruments known as "payment in kind," or PIK, loans, which grow in size instead of paying interest.

In late 2007, Deutsche tried to syndicate the debt, according to a Dow Jones report, offering 3 billion of senior, second-lien and mezzanine debt, and €1 billion of "preferred" PIK loans paying more than 20%. But growing turmoil in the credit markets meant the deal never went ahead.

Then, last April, a sale of Actavis itself was abandoned, after people familiar with the matter said it had failed to attract enough interest from bidders. That was despite initial hopes it could fetch up to €7.5 billion, or 15 times expected recurring Ebitda of about €500 million. After that, some of the people say, Actavis drafted in management consultants to help it cut costs and improve operational efficiency.

Some of the people said Actavis also owes money to three Icelandic banks, all of which have been restructured after the country's financial crisis.

Some of its debt is held by the now state-owned Landsbanki and the bankrupt investment bank Straumur, which both had ties to the Bjorgolfsson family. Glitnir Bank, which is being wound up after part of it was reborn as Islandsbanki, also has a smaller, indirect exposure to Actavis.

Alternatives
With the restructuring talks shrouded in secrecy, it is unclear how exactly a Ratiopharm takeover will be financed - since it may require hundreds of millions of euros in fresh equity from another investor.

People familiar with the matter have previously said Nordic private equity firm EQT was working with Actavis, but the duo did not ultimately bid together. And if Teva, the world's biggest generic drugmaker, or Pfizer, the world's biggest pharmaceutical firm, win Ratiopharm instead, attention could turn to other potential merger partners for Actavis.

Germany's Stada, for example, said last March that a tie-up between it and Actavis would make more sense than Stada buying Ratiopharm, but its finances precluded a merger. Since then, though, Stada's shares have risen about 150%.

Deutsche, which stresses it values loans conservatively, said it would not comment on individual credit exposures. In a Feb. 4 presentation, Chief Financial Officer Stefan Krause said the bank had €7 billion of leveraged finance loans, and a further €12 billion of similar loans that had been reclassified from its trading book to its loan book, suggesting they will not be sold imminently.

Across its entire "higher risk bucket," which also includes commercial real estate, the bank made €274 million of provisions for credit losses in the fourth quarter.

Actavis and Ratiopharm declined to comment. Novator, Bjorgolfsson's investment vehicle which owns most of Actavis, also declined to comment. Representatives of Landsbanki and Straumur and Glitnir Bank declined to comment.