Earlier this week, specialty generics company Impax Labs (NASDAQ:IPXL) announced a transformative acquisition. To help facilitate Teva's (NYSE:TEVA) attempted merger with Allergan's (NYSE:AGN) generic business, Impax purchased 15 on-market products, 3 currently approved but not yet marketed products, 2 pending pipeline products (abbreviated new drug applications, or ANDAs), 1 product under development, and the commercial rights to Impax's Concerta generic - a product previously partnered with Teva. In aggregate, this acquisition will cost $586 million and its certainty to close is dependent upon customary regulatory approvals, and more importantly, the closing of the Teva deal for Allergan's generics business.
Equally as interesting, the company used the deal to attempt to hide a substantial guide-down in revenue and earnings. Overall, I think the deal was excellent for shareholders, but the market's reaction was only slightly overdone given the implied deterioration in Impax's base business.
Though the products only accounted for $150 million in revenue in 2015, the portfolio has an outstanding gross margin profile in the 65%-67% range, meaning Impax paid a little over 6x gross margin with tons of upside from a hard-to-manufacture generic in Concerta and pipeline products with $3.1 billion in TTM sales per IMS. As these products will all leverage Impax's existing salesforce, I think it is fair to say the company paid 6-7x EBITDA (some incremental cost for maintenance R&D, shipping, etc.), which I think is a very reasonable price.
While we are unsure of the products in the portfolio, we do know they are products with low levels of competition thus likely more sustained pricing durability. Why did Impax win the auction for these assets? My guess is that bids were not terrifically high because most potential buyers have conflicts with some of these assets. Impax also likely had greater comfort regarding the approval of generic Concerta - a product with a checkered history as a generic thus far - allowing Impax to make a higher offer.
Impax's current gross margin is in the 50% range, and these new products will increase gross margins to the low 50s. Further, the new product portfolio may lead to some increased penetration for other products, as generic drugs are contracted, meaning it may be advantageous to create a larger portfolio of customers to become a more comprehensive supplier. Overall, I think the deal not only positively transforms the business, but it also likely helps the base business.
Great deal, bad guide-down
The market ultimately did not react to the deal, but the market did react to Impax's attempted subtle guide-down. Aggregate revenue guidance remained unchanged in spite of approximately $80 million in incremental sales in the back half of 2016. Two of Impax's core products, a muscle relaxant, metaxalone, and topical NSAID diclofenac sodium, experienced dramatic declines as their respective markets became much more competitive. The fact that management did not forecast this competition is quite troublesome given the variety of resources to predict new entrants. Further, given this large miss, I would question management's ability to understand the fundamental competitive dynamics in generics markets. Or, though I don't have enough to detail to know for certain, it may highlight the weakness in Impax's smaller portfolio against larger generic players.
In spite of this dramatic revenue hit, the new products' robust margin profile will actually increase EPS over prior guidance, implying EPS of $1.75. Yet, given how poorly the company has forecasted thus far in 2016, I would not be surprised to see further deterioration, which is why the stock was down 11% on the news. The company also increases its financial leverage at a time when the pharmaceutical space is under tremendous scrutiny for pricing practices.
After today's decline, shares trade at about half an EBITDA turn discount to peers (8.4x vs 8.9x), which I think is completely justified given the large guide. I have no interest in shares at current levels, and I would much rather search for value elsewhere in the generics space.
Disclosure: I am/we are long AGN.
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.
Additional disclosure: Also long Allergan Preferreds