Should Mylan's Shareholders Hang On Following Government Settlement?

| About: Mylan Inc (MYL)

Summary

Mylan's common stock has soared from $35.94 per share at closing on 10-7-2016 to $40.40 at the opening bell on 10-10-2016 following a $465 million settlement with the U.S. government.

Although Mylan’s total returns were significantly above their peers’ returns from August 2013 until October 2015, Mylan’s performance has lagged behind that of its peers since May of 2016.

Mylan has had a substantially lower return on invested capital than the rest of its peer set at 0.71% compared to 2.84%.

The drugmaker Mylan (NasdaqGS:MYL) has come under fire lately from both the federal government and general public for increasing the price of its EpiPen auto-injector while maintaining an above-average CEO compensation plan. Yet, their common stock has soared from $35.94 per share at closing on 10-7-2016 to $40.40 at the opening bell on 10-10-2016 following a $465 million settlement with the U.S. government over contested medicaid rebates. To gain a better understanding of the underlying internal factors affecting Mylan's decision-making and performance, this analysis compares corporate governance and operational analytics for Mylan and its peer set through leveraging the Enlight monitoring platform.

This analysis uses the peer set listed in Mylan's June 2016 Proxy Statement. The peers companies include AbbVie Inc. (NYSE:ABBV); Boston Scientific Corp. (NYSE:BSX); Perrigo Company (NYSE:PRGO); Agilent Technologies Inc. (NYSE:A); Allergan, Inc. (NYSE:AGN); Amgen Inc. (NasdaqGS:AMGN); Baxter International Inc. (NYSE:BAX); Becton Dickinson & Co. (NYSE:BDX); Biogen Inc. (NasdaqGS:BIIB); Bristol-Myers Squibb Company (NYSE:BMY); Celgene Corp (NasdaqGS:CELG); Eli Lilly and Company (NYSE:LLY); Endo International plc (NasdaqGS:ENDP); Gilead Sciences, Inc. (NasdaqGS:GILD); Medtronic plc (NYSE:MDT); St. Jude Medical Inc. (NYSE:STJ); Stryker Corp. (NYSE:SYK); Teva Pharmaceutical industries Ltd. (NasdaqGS:TEVA); Thermo Fisher Scientific Inc. (NYSE:TMO); and Zimmer Biomet Holdings Inc. (NYSE:ZBH). Also listed in Mylan's proxy statement were Actavis plc and Hospira inc. However, they have been excluded from this comparison because they are now subsidiaries of Pfizer and Teva, respectively. Mylan specifies in their proxy statement that they chose their peer set by finding companies in the Pharmaceuticals, Health Care Equipment & Supplies, Biotechnology, and Life Sciences Tools & Services industries with revenues ranging from 5x-2.5x Mylan's revenue. Although we could analyze CEO compensation as part of the corporate governance analysis, this has been widely covered in recent weeks and therefore have focused on other aspects of board oversight and shareholder returns for this analysis.

Total Shareholder Return

Although Mylan's total returns were significantly above their peers' returns from August 2013 until October 2015, Mylan's performance has lagged behind that of its peers since May of 2016. Returns for Mylan were at 66% at market close on 10/6/2016, well below the 146% return from the median composite from the peer group. Below are two charts: one comparing the averaged returns and one that is broken down by individual peers. Click to enlarge

Exhibit 1: Total Shareholder Return

Source: Enlight Research, LLC

Note: Total shareholder return assumes dividend reinvestment.

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Exhibit 2: Total Shareholder Return Broken Out By Individual Peer

Source: Enlight Research, LLC

Note: Total shareholder return assumes dividend reinvestment.

Return on Invested Capital

Mylan has also had a substantially lower return on invested capital than the rest of its peer set. At the end of the second quarter, Mylan had a return of 0.71%, which is one fourth of the return of the peer set's median for the same quarter. Outliers to notice are Gilead Sciences, inc. (NasdaqGS:GILD) and Baxter International Inc (NYSE:BAX), both with returns over 10%.

Click to enlarge

Exhibit 3: Return On Invested Capital

Source: Enlight Research, LLC

Research and Development Expenditures

As Mylan and its peers all have revenue models that depend upon the production of patentable medical technology, they have very high R&D expenditures compared to other corporations. Mylan has had a lower ratio of R&D spending to revenue than its peer group since Q1 2012. At the end of Q2 2016, Mylan's R&D was about 2% lower than the median peer group composite. Yet, the companies shown range from 23% above Mylan's spending to 3% below, which allows for a great degree of upward skewness from large outliers like Bristol-Myers Squibb Company (NYSE:BMY). Note that the companies in the peer set are from a variety of industries, and therefore not all of them have the same growth strategy and R&D expenses. Although R&D expenses are a valuable indicator, they should not be used alone when comparing corporate performance.

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Exhibit 4: Research and Development Costs as a Percentage of Revenue

Source: Enlight Research, LLC

Director Compensation

Mylan ranks fourth with respect to long-term incentives with about, which compose over half of its board compensation plan. With over $611 million in long-term incentives, it is good to see that compensation is largely dependent upon long-term growth. Long-term incentives can be Total compensation is sixth in the peer group, while director fees and other compensation are both the fourth highest in the set. Click to enlarge

Exhibit 6: Director Compensation

Source: Enlight Research, LLC

Common Stock Held by the Board of Directors

In addition to analyzing compensation plans, it is important to look at the common stock investments that board members have in their company. Compared to its peer set, the Mylan board holds the third largest percentage of common stock in its company. However, the board jumps to first when compared to only the other pharmaceutical companies from its peer set. As of 10-7-2017, the board's stock was valued at $121 million. This number was fifth in the peer set and over double the $57 million worth of shares held by the median peer.

While shareholders do not currently approve of recent actions taken by Mylan's board, the board's large financial investment in their company is a positive attribute. Considering the volume that the board has invested in Mylan, they have an appreciable incentive to improve their company's performance. Common stock prices for Mylan have been volatile during the year 2016, but it should be noted that the board shares the gains and losses in Mylan's value along with typical shareholders.

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Exhibit 7: Percent of Common Stock Held by the Board of Directors

Source: Enlight Research, LLC

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Exhibit 8: Value of Common Stock Held by the Board of Directors

Source: Enlight Research, LLC

What Does This Mean?

It will be interesting to see if the upward trend in Mylan's stock continues as it recovers from public censure over its epipen pricing and executive compensation. Furthermore, it will be valuable to see what steps, if any, Mylan's board will be taking to improve their approval rating. Much of this depends on Mylan's Q3 earnings report, which has been projected to be lower due to costs associated with their settlement with the U.S. government. If Mylan can adjust to its new compliance framework and the associated increase in operating costs in time to beat its new projected earnings, then a similar jump in share prices is likely in the future. With government worries largely out of the way, Mylan should have little trouble incorporating these new changes into its long-term strategy.

Although the dollar amount of Mylan's CEO compensation plan has been front page news, it is important to break the plan down into its respective parts and compare it to plans from similar corporations. Also important but largely neglected are the details of the board's governance. Such information provides deeper insight into the processes that steer the company and allows for improved competitive and industry analysis when examining performance drivers.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.