Akorn (AKRX) is a manufacturer of a range of pharmaceutical and related products, being founded back in 1971. The company has been relatively small until it embarked on an acquisition spree in recent years, sending the share price much higher.
The multi-year momentum run stopped in early 2015 as Akorn had to restate its financial numbers following this acquisition spree. The focus on better internal control, improved operating conditions and stronger balance sheet are reasons to be upbeat after the stock performance has been dismal.
Akorn, Back In 2011
I find it very informative to look at how a business evolved and which valuations have been attached to a business in the past. So lets go back 5 years back in time when the company started to growth aggressively through acquisitions.
In 2011, Akorn was divided in three segments. The company derived the majority of sales from ophthalmic as well as the hospital drugs & injections business. Besides these two businesses, Akorn operated a small contract service business at the time. These products were sold through the three largest distributors, being McKesson, Cardinal & AmerisourceBergen. These distributors were responsible for roughly two thirds of total sales, as many smaller drug manufacturers rely on these distributors to a great extent.
For the year of 2011, Akorn reported a 58% increase in sales towards $138 million. The increased scale allowed the company to become solidly profitable as operating profits totaled $33 million. The company was furthermore in a healthy financial state, operating with $84 million in cash and a $100 million in debt.
The 104 million shares outstanding ended the year trading at around $10 per share, for a market value of $1 billion. This was equivalent to roughly 7 times sales and 30 times operating profits. While these are certainly elevated valuation multiples, investors were rightfully attracted to the strong growth trajectory.
Growth Continues, Driven By Acquisitions
Akorn´s growth was aided by both product launches and acquisitions. The company spend $87 million to expand its business through dealmaking in 2011, followed by another $55 million in deal-related activity a year later.
The real M&A growth story started in 2013 when the company purchased Hi-Tech Pharma in a $640 million deal. This deal was executed to reinforce the company´s position for the generic ophthalmic market. With the purchase of Hi-Tech, Akorn was adding roughly $240 million in annualized sales, translating into a 2.7 times sales multiple.
This deal was followed by a much smaller $53 million purchase to acquire three products from Merck later that year. Dealmaking continued into 2014 when the company bought VersaPharm for $433 million, thereby expanding its multi-source prescription pharma business. VersaPharm added just $90-$100 million in annual sales, equivalent to a sales multiple of 4.5 times.
In total some $1.3 billion was spend to grow business in the period 2011-2014. As a result, the flattish net cash position of 2011 turned into a net debt load of $1 billion. Despite the increase in debt, investors were very pleased with the operational growth and dealmaking as shares rose from $10 at the end of 2011 towards $50 in early 2015. With 120 million diluted shares outstanding at the end of 2015, the enterprise valuation has increased from $1 billion in 2011 towards $7 billion at the start of 2015.
Equity investors were very pleased with the strategy of the company having five-folded their investments in just four year´s time.
Troubles Start In 2015
The first warning sign emerged in March of 2015 when the company was forced to delay a 10-K filing. The company cited that a delay in the financial information of the acquired VersaPharm business was to blame.
More bad news surfaced a few weeks later as the financial statements had to be adjusted following improper accounting of the Hi-Tech acquisition. This was followed by further revisions and the resignation of CFO Timothy Dick in the summer of last year. Ever since, the company struggled to meet deadlines to file 10-Ks, something which has put pressure on the stock price. By now the company has identified that sales and pre-tax earnings have been inflated to the tune of $35 million for the year of 2014. The related uncertainties and the public outcry regarding drug prices have certainly weighted on the shares during 2015.
Investors acted relived when the company announced Duane Portwood as the new CFO in the autumn of last year. The relief rally following the announcement of this former Home Depot veteran lasted shortly as pressure kept building on the stock. Shares eventually fell to a low of $17 just a few days ago, marking a two-thirds decline from the peak of early 2015.
As the company released relative solid preliminary results for 2015, and remains on track to meet its 10-K extended filing deadline, shares have bounced back towards the mid-twenties.
What Is The Current Situation?
After the shares have seen a 60% plunge to current levels in the low twenties, the equity value of the company has fallen towards $2.5 billion by now. Lack of dealmaking in 2015, as the company was busy with the restatement of earnings, has allowed for some deleveraging as well. In March of this year, when the company released its unaudited results for 2015, it reported a cash position of $226 million and $875 million in debt. This means that the >$1 billion debt load has been reduced towards $650 million, for an enterprise valuation of roughly $3.1 billion.
The company reported preliminary sales of $985 million for 2015, adjusted EBITDA of $455 million, and adjusted earnings of $1.93 per share. It should be said that the company incurred quite some one-time expenses related to the restatements of its financial numbers, as GAAP earnings are seen at $1.14 per share.
The good news is that the reduction in the net debt load, while adjusted EBITDA kept rising, has allowed for a sizable reduction in leverage. The leverage ratio has fallen to 1.6 times by the end of 2015, down from >2 times by the end of 2014. As Akorn is not likely to engage in significant dealmaking in 2016, the leverage ratio is anticipated to fall towards 1 times adjusted EBITDA by the end of 2016.
What About The Outlook?
After years of spectacular growth, it is clear that Akorn has hit the breaks in 2015. The focus on the restatement of the financial statements prevented it from dealmaking, and this has prevented the company from overleveraging itself, unlike some competitors.
CFO Portwood is happy that the restatement work for 2014 has been completed as he works hard to meet the 9 May deadline for the 2015 restatements. He and the rest of the management team seem confident that the deadlines can indeed be met.
Despite the lack of investments into the business in 2015, with capex being cut significantly and acquisitions coming to a standstill, Akorn expects revenues to increase by 8-10% in 2016. This would translate into sales of $1.06 to $1.08 billion, with adjusted EBITDA seen at $485 to $505 million. Non-GAAP earnings are expected to increase towards $2.10-$2.20 per share as the gap with GAAP earnings is narrowing. GAAP earnings are seen at $1.56 to $1.66 per share for the current year.
This pretty much means that at $22 per share, Akorn now trades at 13-14 times GAAP earnings as the leverage ratio is anticipated to fall to 1 times EBITDA by the end of the current year. The company furthermore stresses that the guidance might be cautious as it does not include incremental FDA approvals, while it does factor in an increase in competition for some of its key products. For the long run, the pipeline appears healthy. Akorn has 87 ANDA´s pending approval and another 65 being in various development phases.
Akorn has never been a true roll-up story, although it has been quite active in dealmaking in recent years. The financial statement debacle might saved the company, as it possibly prevented Akorn from making big deals into 2015. As a result leverage is very much contained and coming down rapidly, while the share price and firm valuation has been impaired over the past twelve months.
A very healthy pipeline and actual solid operating performance reveal that Akorn owns some quality businesses. Furthermore, it does not seem that the company relied heavily on aggressive drug price increases, unlike some of its competitors.
All in all it seems that the market has been pretty pessimistic on Akorn over the past year amidst tougher operating conditions and worries about the financial statements. The good news is that management has addressed the issues. Akorn looks on track to finalize the financial restatements, it is rapidly reducing leverage, and management continues to guide for solid growth in this year.
This certainly favors the upbeat investment thesis, as the company has only grown more diversified, backed by a solid pipeline. That being said, the entire industry is facing scrutiny, even as Akorn does not appear to have been aggressive with price hikes, while issues with the financial statements could still hurt investors.
Weighing it all together I have a slightly upbeat stance on the stock, certainly after taking into account the price action in both 2015 and 2016.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in AKRX over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.