By Jake King
Endo Health Solutions (ENDP) re-established financial guidance Thursday night, re-affirming 2012's prior outlook and, as expected, guiding expectations lower for revenue and EPS in 2013. This news will be viewed as a key clearing event for the stock as few believed the company's prior guidance, and analysts and investors have been waiting for the company to set expectations in a realistic, if not conservative, manner. With the company reducing its prior 2013 EPS outlook from a range of $5.20 to $5.40 (the Street was at $5.08) to a new range of $4.40 to $4.70, the market is likely to finally breathe a sigh of relief that earnings expectations are now beatable, not set up to disappoint. That shift from "estimates are too high" to "estimates are too low" should open the floodgates for investors waiting on the sidelines to jump into the story.
In addition to lowered expectations positioning the next several quarters for earnings upside, there are several potential catalysts that should drive ENDP shares higher to a more respectable valuation. We list those catalysts below, with the most important one being the upcoming appointment of a new, capable specialty pharmaceutical CEO in the next couple of months. Nevertheless, despite the lowered guidance, ENDP trades at just 5.7x the midpoint of the new 2013 EPS guidance range, which compares very favorably to the Specialty Pharmaceutical P/E multiple average of approximately 8x. Assuming ENDP can trade at a 20% discount to the average P/E multiple of the group, the shares would be valued at $29.12 (using the midpoint of 2013 guidance). As a result, we see strong upside to ENDP shares given its discounted price, potential upside to earnings estimates, and catalysts that can move the stock higher.
Conservatism built into the outlook, cushion to beat. Most importantly, the new guidance takes significant pressure off of expectations for Opana ER to grow, with the company now factoring in a 20% reduction in sales, year over year, for the pain drug. Opana ER disappointments in the last several quarters have been the most visible reason that ENDP shares have been unable to perform, and now the new guidance positions this key product for potential positive surprise. Investors were a bit taken aback to see the company reduce revenue growth guidance for its generic drug business (Qualitest). However, the takeaway from private conversations with management is that this business is still very strong, with demand outweighing the company's ability to supply product.
Even though it will continue to expand manufacturing capacity, the company brought down guidance from "double-digit" revenue growth to "low double-digit" revenue growth likely to make numbers that much more conservative. Lastly, the company also mentioned that its medical device business (AMS) will now grow in the low single-digit range (from the mid-single digits), also for conservative reasons. With these changes, the revenue line for 2013 is now expected to be in the $2.8 billion to $2.95 billion range (vs. the prior Street estimate of $3.06 billion). While this is lower than many were modeling, the revision was also expected and now provides the company ample cushion across all of its business units to perform.
Stock moving events expected. First and foremost, ENDP is actively searching for a new CEO, and odds are that an executive coming out of Valeant Pharmaceuticals (VRX) could take the reins. This would be big news for the company, as VRX has been one of the most successful Specialty Pharmaceutical stories in the industry, with the stock up 300% in three years largely on an asset acquisition strategy. In addition to seeing a proven leader take over the helm, this kind of news could lead to speculation that VRX could in fact consolidate ENDP at some point, as it has successfully done with other specialty pharmaceutical assets. We would bet that pieces of ENDP could be sold off first, giving investors several value creating events along the way to an ultimate sale of the company.
In addition to the anticipated leadership change and potential for the company to beat earnings estimates, we could also see more movement on the abuse-resistant opioid front, in which the anticipated generic Opana ER could be removed from the market by FDA later this year. Despite that this generic will not be directly substitutable for the company's branded Opana ER, we still believe that if this drug is removed from the market, ENDP shares will rise significantly. The move by the U.S. government to limit or remove abusable opioids in favor of abuse-resistant products (like the company's Opana ER brand) could offer multiple regulatory events in the next several months.
- First, the Citizen's Petition (CP) filed by ENDP will need to be addressed by the FDA either by Feb. 13 (the 150-day anniversary from filing) or, for sure, by May 13 (the 270-day anniversary from filing), both of which are dates mandated by federal statutes. A response by FDA that it agrees with ENDP that the abusable version is unsafe means that the generic will be removed from the market.
- Second, FDA is also expected to act on its own in the next few weeks in terms of providing industry guidance for increasing the scrutiny on abusable opioids and promoting abuse-resistant products. This guidance could include further quota restrictions by the DEA on abusable pain killers.
- Finally, there was another CP filed by drug maker Purdue Frederick, also petitioning the FDA that abusable generics for its Oxycontin product should be removed from the market. A response from FDA is also expected in the near-term on this issue, and a favorable decision for Purdue would be read as a favorable decision for ENDP. As a result, there are many chances to win on the regulatory front for ENDP shareholders in 1H 2013.
Story remains the same -- shareholder value creation expected via turnaround, break up, or sale of the company. Our prior thesis remains intact (see original article here), and with the bad news out of the way, investors that want to make sure all the shoes have dropped can now begin to build positions in ENDP. Importantly, the company's board of directors appears to be listening to top shareholders, and we believe the business will start performing, otherwise further activist activity may take place. After all, it didn't take long for the company to end the current CEO's contract when guidance from ENDP's Analyst Day did more damage than good by overpromising. We certainly expect to see the new CEO, once named, move to create value quickly. Given that ENDP is essentially a combination of three businesses, each of which are undervalued relative to peers, there are a number of strategic levers to pull if the company as a whole does not get to a better valuation.
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