Allergan Enjoins St. Regis Mohawk Tribe To Protect Restasis Patents

Summary

• AGN enjoined St. Regis Mohawk Tribe to protect Restasis patents.
• It highlights how important Restasis is to AGN.
• Investors could focus on Restasis' decline or AGN's lack of R&D prowess.
• Growth is dead and so is AGN.

AGN CEO BRent Saunders. Source: Institutional Investor

Allergan (NYSE:AGN) shocked the market with news that it was partnering with St. Regis Mohawk Tribe to protect Restasis patents:

Allergan plc (NYSE: AGN), a leading global pharmaceutical company, and the Saint Regis Mohawk Tribe today announced that the Tribe now owns all Orange Book-listed patents for RESTASIS® (Cyclosporine Ophthalmic Emulsion) 0.05%, and that Allergan has been granted exclusive licenses in the patents related to the product. The Tribe, a recognized sovereign tribal government, is filing a motion to dismiss the ongoing inter partes review (IPR) of the RESTASIS® patents based on their sovereign immunity from IPR challenges.

The agreement does not impact current patent litigation between Allergan and generic rivals who have filed abbreviated drug applications ("ANDA") regarding Restasis. A trial on the matter was recently completed in Federal District Court in Marshall, Texas. According to Allergan it was St. Regis who approached the company about the unique structure. The tribe is to receive a $13.75 million up front payment and $15 million in annual royalties beginning in 2018. The royalties end when the Restasis patents expire or are no longer valid.

The market welcomed the news. AGN rose nearly 2.5% to $233.55. I had the following takeaways on the partnership.

Restasis Could Be More Important To Allergan Than Once Thought

The arrangement with St. Regis appears rather unique and crafty. Restasis patents are being challenged by generic rivals Mylan (MYL), Teva Pharmaceutical (TEVA), Akorn and Inno Pharma, a division of Pfizer (PFE). I understand that Restasis had exclusivity through 2014. Allergan extended patents for the drug through 2024 as generic competition approached. The argument made by generic rivals is that the patent extension was a defacto attempt to extend exclusivity.

Allergan also faces an inter partes review at the U.S. Patent and Trademark Office - a quicker, less-expensive process to determine the validity of patents. The arrangement with St. Regis appears to have removed the threat of an inter partes review, yet the federal court case is still relevant.

Restasis is the company's second-largest drug with Q2 sales of $354 million; this equates to about 9% of Allergan's $4.0 billion in quarterly product sales. This is important as organic growth has been difficult to come by for Allergan. Secondly, the therapeutics segment that Restasis is part of has a higher contribution margin (nearly 69%) than other product segments. It likely has a higher contribution to EBITDA than its 9% share would suggest; a hit to Restasis could reduce EBITDA by double-digits and hurt sentiment for the stock.

A commenter on my previous article tried to downplay the importance of Restasis:

Commenter: Yes, the Restasis patent dispute could heavily disrupt AGN's profitability if they lose (which I think it is more likely that they will have to settle with a sooner date, like 2020, just not right away). It is important to note though that even if we cut the Restasis profit in half in 2018, the value of their present and future revenue will only be cut by a fraction.

If loss of Restasis patents is not important then why would Allergan go to such lengths to protect it? Why would it put out a press release to draw the market's attention to its arrangement with St. Regis? I believe a patent loss could hurt sentiment for AGN and potentially hurt its credit rating. Management's behavior is almost a defacto admission that its importance would be more than "a fraction" as suggested by the commenter.

This Is A Dangerous Arrangement For Allergan

I believe the arrangement is dangerous for Allergan for the following reasons:

• It makes Restasis key to Allergan's narrative - There remains a risk that Allergan could lose the federal court case pursuant to Restasis. A loss could sink the stock. Even if it won the patent case the company still might not be out of the woods. It dominates the dry eye market but has faced resistance from Shire's (SHPG) Xiidra which entered the market in the second half of 2016. Restasis' Q2 revenue fell 9% Y/Y and could continue to fall due to a loss of market share to Xiidra which is still ramping up. If Restasis is the focal point of Allergan's Q3 earnings report then bulls could be disappointed.
• It could indicate Allergan's inability to develop new products - Allergan has tried hard to position itself as a traditional biotech company. If that is the case then it should be able to generate new products from its R&D machine. Taking unconventional measures to protect Restasis could connote to the market that its product development capabilities are lacking. Sans new acquisitions and an efficient R&D shop it could be difficult for the company to justify its robust 15x EBITDA multiple.

Takeaway

Allergan's growth is dead. Its arrangement with St. Regis might have tied its narrative to a product whose near-term decline is irreversible. AGN remains a strong sell.

Disclosure: I am/we are short AGN, TEVA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.