At the Goldman Sachs CEOs Unscripted Healthcare Conference Thursday, Allergan PLC's (NYSE:AGN) Chief Executive Officer Brent Saunders said that the company expects to deliver non-GAAP mid-single-digit top-line net revenue growth for 2017 and double-digit non-GAAP earnings growth. The company is moving away from "aspirational goals", likely motivated by the problematic third quarter earnings release in which Allergan missed quarterly expectations, expectations initially set-forth by Allergan.
We've previously been critical of the company for failing to adjust its unrealistic 2016 guidance when it had multiple opportunities to do so (i.e., post-Pfizer M&A failure, post-Teva transaction closure, etc.). The new 2017 guidance reset is a tacit admission that the company's and perhaps the market's expectations had gotten ahead of itself.
Manage Expectations to Exceed Them
As Allergan tamps down expectations, we're cautiously optimistic that the company can now beat them. We believe that management (with Board approval) is now measuring themselves against conservative figures, mitigating the risk of a miss and having the market again call into question their capability and credibility. Exhibit A, the third bullet point of the accompanying press release states
"Accretion from our recently announced acquisition of LifeCell is not included."
For 2016, Allergan had anticipated LifeCell assets to generate $450M in revenue, growing at a mid-single digit rate, with a 75% gross margin and 40% operating margin. Assuming some rationalization of LifeCell's headcount and G&A functions, we can likely increase operating margins to 60% and revenue growing to $475M for 2017, which means bottom line earnings of $285M.
With 357M shares outstanding as of December 2, 2016 (excluding the additional $2B of Accelerated Share Repurchase ("ASR") remaining), this is $0.80/share of earnings not accounted for. So let's just call this a "cushion" for achieving or beating Allergan's guidance, apply a 12x multiple and this is about $10 of share price appreciation currently not "baked in" the forecasted earnings. Fantastic . . . and smart.
For 2017, we do see some risks, albeit manageable ones:
1. Vitae failure - Allergan acquired Vitae Pharmaceuticals in September 2016 for $639M. Subsequently, Vitae's dermatology drug VTP-38543 failed its Phase II endpoints, which likely means we'll see an impairment charge for Q4. This certainly won't be the last time one of Allergan's acquisitions fails to pan out, however, given that the failure occurred only a few months after the due diligence exercise leading up to the September acquisition calls into question the depth and accuracy of that due diligence process. As Allergan embarks on further acquisitions, it remains to be seen whether this was a one-off and/or whether Allergan's previously "aspirational guidance" drove an unnecessarily aggressive M&A process. Either way, it's likely shareholders can write-off most of the $639M Vitae investment.
2. Allergan M&A - Allergan concluded 12 deals last year, including the $1.7B acquisition of Tobira Therapeutics, and the largest acquisition of all, the $13B deal (thus far) of its own stock. Given that Allergan elected to spend a large portion of the Teva (NYSE:TEVA) proceeds to conduct an ASR (cash which largely offset Allergan's debt) means that Allergan's future acquisitions will likely add to its debt burden and interest costs. Could this also mean that Allergan will use its shares as consideration? TBD.
3. Continuing competitive threat by Xiidra against Restasis. Our informal surveys of prescribers indicates that Xiidra's better label has incentivized them to prescribe the product over Restasis. Patient satisfaction is a high priority and "customer captivity/brand loyalty" is less of a "moat" in this instance. IMS data currently supports this notion as Xiidra has gained market share. As such, we'd expect Xiidra to continue its momentum at the expense of Restasis. Although Allergan's press release forecasts a steady Restasis revenue base, this remains to be seen.
4. Teva stock - we're waiting to see if/when Allergan will monetize and sell the Teva stock it received in the sale of its generics business. Recall that Allergan received 100.3M shares of Teva stock, the value of which has fallen from $5B to $3.5B, given today's 8% decline. The Master Purchase Agreement contained a Stockholder's Agreement, which provides that Allergan had a 1 year lock-up period before it could divest the stock. So we'll look for news on this as we approach Q2/Q3.
Ultimately, yesterday's announcement was a reasonable one in light of what occurred in Q3 2016. Allergan has set-up an achievable hurdle and we think the company will be able to clear it. 2017 can be the year where management reestablishes its credibility, and with a few quarterly "beats", Allergan's multiple could rise again. For now, we think the stock's weakness at the end of 2016 and recent strength coming into the new year was largely the abation of tax loss selling and investors again repositioning into the stock. For now we're leaving our price target the same at $240-$270/share, but could raise it once a few "beats" are in hand.
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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.