AMAG Pharmaceuticals - Makena's Exclusivity Overhang Creates Heightened Uncertainty

| About: AMAG Pharmaceuticals, (AMAG)
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AMAG Pharmaceuticals has refound operational momentum in 2016 after making two large deals in 2014 and 2015.

While these deals are resulting in record sales, the issue is that AMAG's top selling drug Makena will lose patent exclusivity in 12 months' time, currently responsible for 70% of sales.

As AMAG has no effective defense to differentiate Makena from generics, the company operates with quite some debt, and no immediate replacement is available, prospects for investors are uncertain.

Despite these concerns, AMAG continues to throw of cash and has a strong liquidity position, giving management time and room to maneuver in 2017.

AMAG Pharmaceuticals (NASDAQ:AMAG) is seeing real challenges at the moment, at least in terms of its future as actual results continue to set new records in terms of sales. The issue for AMAG is the upcoming expiry of its top-selling drug Makena in early 2018, as the company does not seem able to differentiate the drug from generic competition looming in little over 12 months.

This potential expiry, with Makena being responsible for 70% of sales, combined with a still high gross debt load, makes investors very fearful at this point. A quick fall in sales of Makena next year could even stir leverage concerns again, making investors rightfully careful with few immediate candidate/plans to fill the gap.

A Look Back In History

AMAG has been founded back in 1981 and quickly went public in 1986 at prices of around $5 per share. While investors have nearly four-folded their investment since that time, the IPO took place over 35 years ago, resulting in an average return of just 4% per year.

Amidst these mediocre returns, investors had to swallow quite a bit of volatility over time. After trading in the single digits in 2005, shares exploded to a high of $60 in the period 2006-2007. While the company had two products on the market at the time, treating CDK patients who had iron deficiencies, sales were barely a couple of million dollars each year, resulting in still sizable losses. Fortunately, AMAG issued stock at these elevated levels, bolstering the balance sheet before shares retreated and fell back to levels around the $20 mark in the period 2011-2014.

Shares promptly doubled from $20 to $40 in the second half of 2014, in part resulting from the $675 million acquisition of Lumura Health which was announced in November of that year. Note that this amount only reflects the upfront payment, not taking milestone payments into account. With the deal, AMAG got ownership of Makena, the only drug used to reduce the risk of preterm birth in women with a singleton pregnancy.

The company incurred some debt with that deal, ending 2014 with $145 million in cash and $500 million in debt, including convertible debt. The 25 million shares outstanding, which ended 2014 at $44 per share, valued equity at $1.1 billion and the business at close to $1.5 billion. This valuation was based on two products: Makena and AMAG's own drug Feraheme.

Makena contributed $22.5 million in fourth quarter revenues in 2014 at a run rate of $90 million a year. Sales of Feraheme rose by 21% in 2014 to $86 million. Including $15 million in royalties and license agreements, the run rate of the business approached the $200 million mark, valuing AMAG at 7-8 times sales by the end of 2014.

The $1.5 billion valuation at the end of 2014 marked a huge difference compared to 2013. Note that AMAG started 2014 with just 22 million shares outstanding which traded at $20. This $440 million valuation worked out to just $240 million if net cash was subtracted, equivalent to 3-4 times the sales generated by Feraheme. This reveals that the valuation of AMAG rose by $1.2 billion throughout 2014 on the back of a low valuation to start from and the $600 million deal, which allowed the company to own Makena.

2015 Stock Momentum Continues, Then Reverses

Shares of AMAG continued their momentum run in the first half of 2015, rising from $45 to a high of $75 in July of that year.

The company issued an upbeat guidance when it reported its fourth quarter results for 2014 in early 2015. For 2015, it projected revenues of $380-420 million, comprised of $245-270 million in Makena sales, and $90-105 million in sales from Feraheme and MuGard, the small mouth and throat soreness therapy of AMAG. The guidance included a one-time $45 million payment, which was the result of the company terminating a previous agreement with Takeda (OTCPK:TKPYY).

In May of 2015, AMAG reported its first quarter results. The company ended the quarter with $360 million in cash, as debt stood at $500 million, excluding $220 million in contingency payments related to past dealmaking (Makena). Shares had risen towards $60, which valued the company at up to $2.3 billion given that the diluted number of shares (including conversion) had risen to 38 million shares. The company reported product revenues of $77 million as well as $12 million in license and collaboration revenues, with operating profits coming in at $29 million that quarter.

Confidence of management grew amidst growing revenues, profits and the booming share price. In June, AMAG announced the purchase of CBR Holdings (Cord Blood Registry). This stem cell collection and storage company was bought for $700 million in cash, less than a year after which Lumura was acquired. This privately held firm had over half a million umbilical cord blood and tissue stem cell units stored. Its services are used by mothers who want to store cells and generated $126 million in sales in 2014, a number which was expected to be flat or slightly higher in 2015.

Late July, the second quarter results were released, and welcomed by the investors at the time as well, with shares still trading in the $60s. Product revenues of Makena and Feraheme totaled $85 million as operating profits ballooned to $61 million as a result of a jump in license and collaboration revenues towards $39 million.

When the third quarter results were announced in November of 2015, shares had already seen a meaningful correction as the entire biotech sector came under pressure, trading at just $30 at the time. Operating with $442 million in cash and a billion in debt, excluding contingency payments related to the two acquisitions, net debt stood at $560 million. Product revenues from Makena and Feraheme as well as half a million from MuGard totaled $89 million, as growth was slowing down.

The company recorded $7.2 million in service revenues from CBR. This deal, closed on August 17, suggested that it still contributed nearly one and half month to the third quarter, implying that sales were trending at just $60 million a year. This was a shock as the deal of CBR was announced as recent as June, with management at the time indicating a sales rate which was roughly double the revenues reported.

The 33 million diluted shares outstanding valued equity of the company at $1 billion, or the entire business at $1.5 billion. With the purchase of CBR and Lumura combined coming in at nearly $1.4 billion, it was evident that a lot of value had been destroyed.

2016 - Difficult Start, Improving Through The Year

Shares fell to the low-20s in early 2016 as the company reported its full year results for 2015. Sales of Makena came in at $252 million within the guidance outlined at the start of the year. Sales of Feraheme and MuGard were flattish at $90 million, coming in at the lower end of the full year guidance, after falling a bit in the fourth quarter. Revenues of the cord blood registry business totaled just $17 million in Q4, at a rate of $70 million which is much less than the $125 million run rate suggested when the deal was announced.

For 2016, AMAG guided for further growth of Makena with sales seen at $310-340 million and Feraheme/MuGard sales of $95-105 million. Non-GAAP CBR revenues were guided to come in at $115-125 million. While this outlook supported shares at levels in the mid-20s, they fell to $20 again in May of 2016 following the release of the first quarter results.

Product revenues from Makena, Ferahame/MuGard totaled $90 million in the first quarter, as CBR service revenues came in just shy of $20 million. While total product revenues totaled $110 million the company was barely profitable on an operating basis, as limited operating earnings were eaten by interest charges. This results in part from the inefficient structure in which the company holds nearly $500 million in cash yet has a gross debt position of $1 billion, resulting in interest expenses of $75 million on a net debt load of $500 million. That suggests that the company is paying an effective interest rate of 15% in order to preserve liquidity.

In August of 2016, the second quarter results looked pretty decent with product sales growing to $103 million on the back of further growth of Makena, as CBR service revenues grew to $24 million. The boost in sales resulted in operating earnings of $18 million, sufficient to cover the quarterly interest bill, as investors reacted conservatively with shares being stuck in the mid-20s.

Third quarter results, as released in early November 2016, showed further reasons to become optimistic on the back of continued adoption and wider usage of Makena. Total product revenues grew to $115 million as CBR added $28 million in sales, both pretty encouraging results. The company earned $38 million in operating earnings, which was, again, very solid. On the back of these results, shares rose towards $35 again. Given the convertible feature of some of its debt, the number of outstanding shares rose towards 42 million, valuing equity at $1.5 billion, or the company at $1.9 billion including net debt of little over $400 million.

Back To Square One?

While shares of AMAG rose nicely to $35 in recent months on the back of solid momentum in Q2 and Q3 of 2016, shares have fallen back to $23 overnight. AMAG released the guidance for 2017 which looks encouraging given that sales are expected to grow across all three product categories, even as the guidance falls a bit short compared to expectations.

Makena sales are seen at $410-440 million in 2017, revenues from Ferahame/MuGard are seen at $100-110 million and CBR revenues are seen at $110-120 million. Operating earnings are seen anywhere between $103 million and $173 million in 2017, with EBITDA expected at $270-340 million. As the shares dropped, and the number of diluted shares at this range has fallen to 35 million shares, the equity valuation now comes in at just $800 million, for a $1.2 billion enterprise valuation at $23 per share.

The key reason behind the disappointing reaction is that AMAG indicates that Makena will lose its orphan drug status in February of 2018. While that does not come unexpected, the company stopped the pain study which should differentiate Makena from its generic rivals which undoubtedly will hit the market early next year.

With Makena being responsible for nearly 70% of sales in 2016, it will be hard to estimate how bad the situation in 2018 and 2019 can look like if competition comes in. Having 70% of sales at risk could easily push AMAG back to reporting losses, which is a dangerous situation given the current net debt load of $420 million. Worse, Feraheme patents are expiring in 2020, not creating rosy prospects at all. CBR is the exception to the other businesses, having really sticky revenue streams, which are not threatened by patents with attrition rates of a percentage per year or less.

To combat these painful outcomes, AMAG will explore alternative injective sites and formulations to increase the value of Makena, but that hardly seems enough to protect against the loss of exclusivity. Worse, the total list prices of $30,000 per pregnancy are very elevated compared to the costs of Makena in the past when it was still privately held, running at just a few hundred dollars.

The company has another wild card in play as it has reached a licensing agreement with Palatin (PTN) for Rekynda. AMAG will pay $60 million upfront and reimburse $25 million in development expenses for Rekynda, a treatment to focus on HSDD. While Rekynda is currently in Phase III trials already, with a drug application timeline for 2018, this deal gets little attention by investors who hoped that Makena could be differentiated from generic competition.

As such, investors can embrace themselves for an uncertain 2017, as management has to pull a lot of strings to create any appeal and secure the future of AMAG.

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.