By Parke Shall
Our readers know that we're large Mylan (NASDAQ:MYL) bulls. Yesterday we got significantly more bullish, to the tune of more than tripling our position in the company on what we believe to be a substantial and unprecedented misunderstanding of a headline by the market. We continue to believe $72 is a fair target for Mylan based on 12x 2018 earnings estimates which in no way appear to be in any jeopardy.
Despite what many people think, and as an analyst said yesterday, the generic drug business isn't going anywhere.
By now, we all know the generic drug makers were slammed yesterday on a headline that stated that numerous companies, including Lanette, Teva, and Mylan, had received subpoenas relating to anti-trust matters. What the market did not seem to notice yesterday, at least for MYL, was that these probes seem to link back to an issue that was already under investigation and that fines for these anti-trust issues have never exceeded $500 million.
We believe this has created one of the best buying opportunities we have ever seen in any equity with MYL now trading at just 5X 2018 earnings. We dismiss the theory written about on Seeking Alpha yesterday that "valuation doesn't matter" as neither Mylan's product portfolio nor its cash flow stream is in any immediate danger and because Mylan generates enough cash in a quarter to pay off any of the largest anti-trust fines ever issued in history.
Bloomberg stated yesterday,
The antitrust investigation by the Justice Department, begun about two years ago, now spans more than a dozen companies and about two dozen drugs, according to people familiar with the matter. The grand jury probe is examining whether some executives agreed with one another to raise prices, and the first charges could emerge by the end of the year, they said.
Though individual companies have made various disclosures about the inquiry, they have identified only a handful of drugs under scrutiny, including a heart treatment and an antibiotic.
Two dozen companies? Two years ago?
There's a legitimate chance based on that statement that Mylan could have very little, if anything, to do with eventual charges. We're guessing this is an investigation based on one or two companies colluding on prices for doxycycline (the antibiotic) of which Mylan does very little business on. Estimates we reviewed yesterday showed Mylan did only about $5 million of the almost $250 million in total doxycycline sales for all of 2016 so far. They are hardly a major name for the drug.
The same estimates we reviewed showed Mylan's contribution for Digoxin (the other drug in question) were at far less than 10% of the total market.
Why would Mylan collude on pricing for a drug that contributes nearly nothing to their revenue?
We believe Mylan is the victim of collateral damage here. Not only that, but this investigation has already been disclosed by the company in its most recent 10-Q filed weeks ago,
Department of Justice/Connecticut Subpoenas
On December 3, 2015, a subsidiary of Mylan N.V. received a subpoena from the Antitrust Division of the U.S. Department of Justice ("DOJ") seeking information relating to the marketing, pricing, and sale of our generic Doxycycline products and any communications with competitors about such products. The Company is fully cooperating with DOJ's inquiry.
On December 21, 2015, the Company received a subpoena and interrogatories from the Connecticut Office of the Attorney General seeking information relating to the marketing, pricing and sale of certain of the Company's generic products (including Doxycycline) and communications with competitors about such products. The Company is fully cooperating with Connecticut's inquiry.
We believe this headline creates an unprecedented opportunity to get long MYL for the course of the long term. We added significantly to our position yesterday and will continue to do so if the stock continues to fall from here. There simply does not seem to be a common sense straight line that we can draw between this antitrust investigation, which has already appears to have been disclosed by MYL, and an event that could cause the company to lose billions of dollars and market cap.
As a reminder, these anti-trust investigations have never yielded a fine larger than $500 million in history. Mylan currently right now has $6.4 billion in cash on hand and is generating $2.1 billion in new cash every 12 months. Unlike many other drugmakers, Mylan does not have significant leverage to worry about either. Their debt is serviceable, their cash is real, and their cash flow stream remains incredibly potent. If you are a MYL bull, this headline is possibly the best thing you could've asked for. It perpetuates the misunderstanding in the media about these companies, driving the equity prices lower despite valuations that are implying almost nothing but bankruptcy type scenarios.
Mylan is so far from that type of scenario it is honestly laughable.
1. The fact is that Mylan generates in one quarter enough cash to have paid for the largest antitrust fine in history.
2. The fact is that Mylan has already disclosed this subpoena in their most recent 10 Q filing.
3. The fact is that this relates to drugs that Mylan does almost nothing in revenue from, leading us to believe they would have zero part in a price fixing charge
The point is simply that the markets punishment of the stock does not fit the potential outcome of what we're talking about. The worst case that'll come from an antitrust charge would likely be $500 million. This is absolutely nothing. We're confident Mylan will not even be among the companies charged. For MYL to lose billions of dollars of market cap over this, while already trading in an extraordinarily depressed valuation makes it one of the most unique buying scenarios we have ever seen.
This is the company that has come out and reiterated that it can do six dollars per share in EPS in 2018. The company is now trading at almost just 5X earnings. Under any type of discounted cash flow scenario, you are going to find that MYL, if they can stay in business for the next five years (they will) and produce even half of what it has produced over the last few years (they will), is grossly undervalued. With the election just days away, we expect focus to come off drug companies and we expect Mylan to more than double.
In terms of putting our money where our analysis is, we took the opportunity yesterday to raise our position in the drugmaker by several hundred percent. We are hedged with a spread of put options across the industry as well as with put options on the major market indices. We will periodically use these hedges to turn around and buy more stock as these equities fall.
Disclosure: I am/we are long MYL. 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: Very long MYL