In an effort to increase its presence in skin care, Valeant Pharmaceuticals International (NYSE:VRX) just bought DS Healthcare Group's (NASDAQ:DSKX) closest competitor in aesthetic treatments, Obagi Medical Products (NASDAQ:OMPI). The deal was consummated at a solid 28% premium to Obagi's share price, or 2.9x revenue in 2011, supporting what investors are calling a new trend in pharmaceutical mergers where firms offering cosmetic solutions to rejuvenate skin are in strong demand.
Valeant wants Obagi's skin line to bolster its aesthetic franchise that currently consists of a botox and collagen substitute with wavering degrees of popularity; other products include variations of herpes topicals and acne treatments, along with solutions for teeth and eye care.
The pursuit of companies offering high-end skin products by FDA-weary, pipeline-depleted pharmaceutical firms is overall a smart idea. The US skin care market is estimated to be greater than $5 billion, with the bulk of cosmetic products available today attempting to mask the effects of aging instead of treating the underlying vitality of skin. Hence the flourishing business in non-invasive medical aesthetics that feature derma fillers, laser resurfacing and wrinkle reduction. More than 25,000 doctors specialize in dermatology and plastic surgery, with a growing number of general practitioners, internists and even OB/GYNs receiving board certifications to offer cosmetic services.
Revenue multiples awarded to innovative cosmetic companies are redefining themselves. Last November Allergan Inc. (NYSE:AGN) paid $350 million for privately-held SkinMedica at what was estimated to be 5x revenue although the only valuable product bought was prescription VANIQA cream to reduce facial hair in women. However, it fit nicely with Allergan's facial aesthetics products BOTOX Cosmetic, JUVEDERM and LATISSE.
Considering the Obagi deal at 2.9x, last September's Medicis Pharmaceuticals take-out for $2.6 billion at 3.6x revenue, and the SkinMedica acquisition, a valuation range between 3-5x sales emerges. The perception of product value appears to come into play - Valeant was willing to pay more for Medicis than Obagi because of the cosmetic filler Restylane and botox-like Dysport. Last year's purchase of DUSA Pharmaceuticals' tiny dermatology line by Sun Pharma Industries for 5.1x 2011 revenues makes sense when the novelty of the products are considered.
I believe DS Healthcare's value would fall at the high end - 5x sales, if not more based on the distinction of its products that are gaining attention and loyal usage. Obagi's ingredients for advanced skin care are not exceptional; marginally valuable offerings are vitamin C and 4% hydroquinone where both contribute to brighter skin that gives the illusion of deeper skin health. The "revolutionary skincare solutions" from Obagi's website feature its Hydrate moisturizer whose main ingredient is a foreign-grown seed pod sometimes used to stabilize food such as ice cream, along with a generous portion of shea and mango butter. ELASTIderm Eye Products' malonic acid as the active ingredient is nothing more than an alpha hydroxy acid also used in toothpaste. CLENZIderm M.D. Systems contains harsh 5% benzoyl peroxide and recently-introduced Blue Peel RADIANCE is made with trichloroacetic acid, the same compound used to remove genital warts and skin tags.
My research did not produce evidence that any of Obagi's ingredients act to improve collagen and elastin production, keratinocyte clearing, and melanocyte regulation, as claimed by the company.
Contrast this with DS Healthcare's skin line. Trioxil gel for acne substitutes skin-drying benzoyl peroxide with the progressive ingredient ICHTHYOL pale shale oil, whose anti-inflammatory effects were shown in scientific studies. Viterol.A for the reduction of wrinkles contains one of the hottest new peptides used in cosmetology, acetyl octapeptide-3, where the Journal of Cosmetic Science released data illustrating a decrease in wrinkle depth up to 30% within 30 days of treatment. Hydroviton, a skin cleanser for acne, contains azelaic acid whose clinical studies proved a significant suppression of the hormone 5 alpha-reductase for less facial surface oil. No other company offers aesthetic skin treatments with this kind of research backing.
Compare also DS Healthcare's sales growth, far more robust than Obagi's. Revenue categories for Obagi in 2012 gained a weak 6% overall while DS Healthcare showed a 77% and 55% increase in revenue for 2011 and 3Q12, respectively. Applying the high end of the range noted above, its market value using a revenue run rate based on the first three quarters of 2012 would be $4.80 per share, 66% over its current price.
Interestingly, my channel checks for DS Healthcare led to an enthusiastic report from a top distributor in the New York/ New Jersey territory who is thrilled to have its products to sell and volunteered a buy-out figure, from his long-time knowledge of the industry, of 8x revenues that would value the company at $7.60 per share using the 2012 revenue run rate.
Another hint that skin care companies should command high multiples - last week shares of Anacor Pharmaceuticals (NASDAQ:ANAC) rose over 60% after good results from a Phase II trial of an ointment for dermatitis, a widespread condition affecting about 20% of kids in the US, sure, but a commonplace drug fated to sell into a very crowded market.
Those of the population inclined to take care of their bodies remain active longer and want a face that denies their age. As long as the fascination with youth prevails, companies offering products in advanced cosmetology will be sought after. DS Healthcare's mission of providing unique aesthetic products supported by research plays well into this desire, and it should reap the benefit of existing and expanding multiples on valuation.