When Allergan (NYSE: AGN) reported 3rd quarter earnings they missed by 24 cents. Brent Saunders, Allergan's CEO pointed the blame on legacy products and immediately announced an increase of 5b to their share repurchase program and announced they would complete 10b of share repurchases during the 4th quarter.
To me this seems like a desperate act by Saunders to boost the EPS figure on their next quarter but underneath the hood there's a bigger program: Restasis. Restasis accounted for 10% of Allergan's third quarter revenue but it's quickly losing market share and now it faces a patent challenge. Very quickly revenues from Restasis could take a big hit. At approximately 13.60X EV/EBITDA post Teva transaction Allergan has a rich valuation and is priced for perfection. We caution investors against taking any new positions in the company until we have more clarity on Restasis but we don't believe the company is a short. Allergan is a hold.
Back on July 12th, the FDA approved Allergan's Restasis competitor Xiidra manufactured by Shire. Analyst Ronny Gal from Bernstein predicted that over time Xiidra was going to be able to gain market share and estimated that sales of Restasis will be 900 million by 2020 down from 1.3b now. In the same article Isi analyst Umer Rafat estimated that through price increases they would be able to keep that 900 million figure and pegged the market share of Xiidra at 30% over time.
Even Saunders was quick to dismiss the challenges during the 3rd quarter earnings call pointing to a 13% increase year over year in sales but he never mentioned that 9.9% of that increase came from a price hike in January of 2016.
Here is Saunders talking during the 3rd quarter earnings call:
"we have a business that I think has some very important characteristics that even despite the miss today on some of the older products are the thing I hope investors focus on. We have top tier growth. We have a portfolio that's diverse with many growth drivers, not one big growth driver but many growth drivers. You can look at products like Botox up 15%, Restasis up 13%, Linzess up 42%. Even drugs like Lo Loestrin up 16%, Ozurdex up 25%."
William J. Meury, Allergan's chief commercial officer mentioned during the call the following:
"Oh. Dry eye. I would make the following observations. The first is, as you know from the IMS data, and I think that this is a good development, the market for dry eye, if you look at total prescriptions, is up over 20%. If you look at new prescriptions, it's closer to 30%. Most of the expansion is coming from, as I mentioned earlier, patients who are on over-the-counter tear products or were receiving no treatment at all. The next observation is that the revenue stream for Restasis has been very durable. If you look at the six-week period, for example, before the launch of Xiidra and the six-week period after."
What no analyst was quick to point out was that the prescription growth on the dry eye market was almost 30% higher year over year of which Allergan only was able to capture 3%.
I am sorry to state the obvious which nobody even pointed out but when a market is growing 30% year over year and you only grab 3% you are actually losing market share. The 13% increase claimed by Saunders is a smoke screen due to the price increase.
Xiidra has grown a lot faster than analysts thought taking already 28.2% of the new prescription market and 18.5% market share in the red eye market new December data points out.
From analysts, Saunders and from Meury you could sense arrogance but the share price has caught up to reality dropping from $240 to $193 even with the almost 10B in shares being purchased. To make things worst Mylan (NASDAQ:MYL) just won the opportunity to challenge the patent rights in Restasis which I believe though it will take a long time to resolve it will eventually be ruled out on Mylan's favor. We estimate if Mylan wins the case Restasis sales will drop to $500 million in 2020.
Allergan has a very real threat to lose its second best product through a combination of both increased competition and generics.
Even though we like the company we believe that the shares will remain challenged until the success of the new products for red eye hit the market and until investors are more comfortable in knowing what direction Washington will take in terms of Obamacare.
At valuation of approximately 13.6x EV/EBITDA post Teva transaction and not accounting for possible drops in revenue for Restasis we believe the company is fairly valued. Bret Saunders is a loved CEO due to its execution record and for that reason Allergan trades at a premium valuation but until further product launches we remain cautious in the short term.
After a 45% increase in active R&D programs we believe Valeant trading at only 8.16 EV/EBITDA represents a more compelling opportunity for aggressive investors. We also recommend investors buying shares of GILD trading at only 5.52 EV/EBITDA.
Disclosure: I am/we are long VRX.
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.