By Jonathan D. Rockoff, Dana Mattioli and Liz Hoffman 

Teva Pharmaceutical Industries Ltd. on Monday agreed to buy Allergan PLC's generics unit for $40.5 billion in cash and stock, in a deal that will vault the Israeli company into the top ranks of global drug makers.

Teva said Allergan would receive $33.75 billion in cash and Teva shares valued at $6.75 billion, giving it a 10% stake in Teva.

The deal, the latest in a wave of consolidation in the drug industry in recent years, combines Teva, the world's largest generic-drug company by sales, with the third-largest competitor in the market.

The acquisition will give Teva increased scale in the hotly competitive generic-drug market, and an opportunity to pursue further cost reductions that could help it cope with the end of a wave of big patent expirations.

"This transaction delivers on Teva's strategic objectives in both generics and specialty," Teva Chief Executive Erez Vigodman said.

Teva shares rose 14% in premarket trading, while Allergan added 10%.

In a separate statement, Teva said that as a result of the Allergan deal it would drop its bid for rival Mylan NV. Mylan, in its own press release, congratulated Teva, said its focus remains unchanged and reaffirmed its commitment to acquiring rival Perrigo Co. So far, Perrigo has rebuffed Mylan's takeover attempts.

Mylan shares fell 12% premarket, while Perrigo gained 4%.

Teva said it expected the acquisition of Allergan Generics to contribute $2.7 billion in earnings before interest, taxes, depreciation and amortization, or Ebitda, in 2016, excluding synergies. It expects to achieve cost synergies and tax savings of approximately $1.4 billion annually, largely achievable by the third anniversary of the closing of the transaction.

Teva said the transaction was unanimously approved by the boards of both companies and is expected to close in the first quarter of 2016.

Midsize companies such as Teva have largely driven the breakneck pace of consolidation in the drug industry in recent years--part of a broader boom in mergers and acquisitions--as they take advantage of cheap debt and in some cases low tax rates secured by relocating overseas, while drawing on the approval of investors who have driven their shares higher. Meanwhile, bigger, more-established rivals have largely been on the sidelines of major deal making.

Last year Teva, which had a market value of $60 billion before The Wall Street Journal reported Teva's talks with Allergan on Saturday, had $9.1 billion in generic-drug sales, according to EvaluatePharma, about 12% of the world market. The company said it already accounts for one in six drug prescriptions in the U.S. But much of its business is in no-name generic medicines sold at lower prices. Nearly half of Teva's $20.3 billion in sales last year were from the off-patent generic copies of drugs.

By adding Allergan's business, which reported $6.6 billion in sales last year, Teva would have revenue significantly greater than that of better-known, branded-drug companies such as Cialis maker Eli Lilly & Co., which reported $19.6 billion in sales last year.

The deal could give the combined company a market value exceeding that of Lilly, which stood at $94 billion on Friday.

For Allergan, the deal will allow the company to sharpen its focus on its branded pharmaceutical business and strengthen its financial position.

"We will have the potential to add scale in existing therapeutic areas, expand into new therapeutic areas and geographies and evaluate strategic transformational deals as we continue to build on our position as the most dynamic branded growth pharma company," Allergan CEO Brent Saunders said.

Dublin-based Allergan became one of the top 10 drug companies by sales this year when Actavis bought the maker of wrinkle treatment Botox for nearly $70 billion, and renamed itself.

Razak Musah Baba contributed to this article.

Write to Jonathan D. Rockoff at Jonathan.Rockoff@wsj.com, Dana Mattioli at dana.mattioli@wsj.com and Liz Hoffman at liz.hoffman@wsj.com

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