Endo Pharma (NASDAQ:ENDP) acquired privately held generic drug maker Qualitest Pharma today for approximately $1.2 billion in cash, which closely follows a smaller acquisition of Penwest Pharma last month for $144 million. ENDP projects that its generic drug division will grow by at least 15% over the next two years and expects the Qualitest deal to add $400 million in revenue and 40 cents per share in adjusting earnings per year.
Lannett Company (AMEX:LCI) presents a relatively unknown, small / micro-cap value play in the generic drug industry that represents a potential takeover candidate for ENDP or others in the industry with a current market cap of $107 million, an enterprise value (EV) of $95.5 million, a trailing price/earnings (P/E) ratio of 14.4X, a price/sales ratio (PSR) of 0.8X, an EV / EBITDA ratio of 5.2X, and a price / book ratio (PBR) of 1.2X.
Lannett has posted revenue growth of 164% since fiscal year 2005 (FY-05) through FY-09, expanding the top-line from $45 million to $119 million. The Company has been in business since 1942 and acquired Cody Labs in 2006, which is one of only seven US companies with a license to import opiate raw materials used in the production of narcotic / controlled substance pain relievers such as morphine and provides LCI with a vertically integrated business model within the niche pain management segment of the generic drug industry that is expected to lower manufacturing costs and expand profit margins.
Key products for LCI include digoxin (87.9% market share) (Lanoxin, Digitek) (heart failure treatment) and levothyroxine (27.4% market share) (Synthroid, Levoxyl) (thyroid hormone replacement therapy), which have relatively few competitors within the generic drug industry as compared to other categories which may have more than 10 companies producing the same compound. It should also be noted that these two drugs are also subject to periodic shortages in the market, which I have experienced first-hand in my former life as a retail pharmacist. In addition, both of these drugs treat medical conditions in which it is crucial for patients to avoid missed doses.
Because of Endo Pharma's focus on pain management, LCI represents a potential takeover target given its vertically integrated business model in the narcotic / controlled drug pain management business with the Cody Labs acquisition and pending FDA decision for morphine sulfate oral solution. I have calculated a $7.70 fair value for LCI based on the enterprise value (EV) to (earnings before interest, taxes, depreciation, and amortization) EBITDA ratio for Endo's acquisition of PPCO. In addition, ENDP paid approximately 3X sales for Qualitest, while LCI trades at a meager 0.8X sales on a trailing 12-month basis.
Looking ahead, LCI is expanding its facilities (including facilities acquired with Cody Labs) and has provided guidance for product submission in 2011 for two Paragraph IV patent challenges. Updates from Lannett's recent SEC 10-K annual filing include...
- ended 6/30/10 with $21.9M in cash / equivalents, $2.9M in long-term debt, $19.1M inventories, and 25.2M shares of common stock outstanding (as of 9/17/10)
- fiscal year 2010 (FY10) (ended 6/30/10) revenue of $125.2M and $7.8M in net income, equivalent to earnings per share (EPS) of $0.31 on fully diluted basis
- derived approx. 69% of FY10 sales from distributed products manufactured by Jerome Stevens Pharmaceutical or JSP, including levothyroxine (41% of sales) and digoxin (17% of sales)
- recent FDA action requiring formal approval for products such as morphine that were marketed prior to FDA approval process (pre-1962) (GRASE or grandfathered products)...resulted in LCI halting production and removing its morphine sulfate oral solution from the market on 7/24/10...currently has $2M in morphine inventory that can be used if FDA approval received as expected by early 2011...morphine oral solution projected to account for 5-8% of future annual sales
In addition, the fundamentals for the global generic drug industry point to continued growth, including those outlined below (click here for the HavRx Global Generic Drug Index)...
- approximately 70% of all prescriptions in the U.S. are filled with generic drugs;
- IMS Health estimates $135 billion in branded drug sales (including $90 billion in U.S.) will face generic competition / patent expiration over next five years (including blockbusters such as Lipitor and Plavix);
- IMS Health estimates $42 billion in global generic drug sales in 2011, representing growth from an expected $28 billion in global sales in 2009 and $17 billion in 2008; and
- IMS Health estimates that the generic drug industry is growing at 7.8%, which is a faster pace than the worldwide market for pharmaceuticals.
Disclosure: Author is long LCI