Mullet. Source: msmarketmaker.wordpress.com
Allergan's (AGN) share price has been rather volatile over the past six weeks. The stock hit a 52-week low of around $143 in early March and bounced back immediately. It is now up 15% since that period. In early April, management announced it was seeking options for its women's health unit, including a sale:
Allergan Plc is considering options for its women’s health unit, including a sale, Bloomberg reported on Monday, citing people with knowledge of the matter. A sale, which would likely attract interest from private equity firms, could value the business at more than $5 billion, according to the Bloomberg report. The women’s health unit, which makes oral contraceptive pills to menopause treatment, raked in $1.04 billion sales in 2017.
A decision pursuant to a sale apparently has not been made yet. I interpret this as an attempt to protect the stock if interest is far less than the $5 billion number being bantered around. Nonetheless, the company is more than willing to use the sale as a catalyst to spur the stock. Below is my take on the market chatter.
Allergan Continues To Seek A New Narrative
Allergan's stock has been under pressure since September when Judge William Bryson invalidated its Restasis patents, removing an obstacle for patent challenges from Teva (TEVA) and Mylan (MYL). AGN is down about 30% since it sold the Restasis patents to the St. Regis Mohawks to protect them from an inter partes review ("IPR"). Restasis is the company's second-largest drug and represents about 9% of total revenue. In late February, Mylan and Revance (RVNC) announced a collaboration to create a biosimilar to rival Botox, Allergan's top-selling product. That was likely the catalyst that sent AGN spiraling to its 52-week low.
In mid-March, the company announced it was seeking strategic options to boost the share price. All options - including a break-up or sale of the entire company - were on the table. The news was counter to management's previous assertions that a break-up was untenable because of its cost and complexity. At its 52-week low, AGN was valued at 9.6x run-rate EBITDA (last three quarters EBITDA and annualized). In my opinion, the stock was likely headed lower as the market was pricing in potential LOE for Restasis and impending headwinds for Botox.
Sans acquisitions, Allergan's growth is likely dead. If you layer on LOE for Restasis and Estrace vaginal cream (about 2% of total revenue), then a 9.6x EBITDA multiple may have been kind. Management stepped in with its new narrative of asset sales before full price discovery for the stock could take place.
Allergan Is Seeking Mullet Money For Women's Health Unit
Allergan is asking a buyer to value its women's health unit (or other units) at a higher multiple than it was being valued by the market. In my opinion, the company is asking private investors to provide mullet money - an investment where the returns do not warrant the risks involved. Given the patent challenges faced by Allergan and questions over its pipeline, who is to say 7x-8x EBITDA would not be a fair value for the total company? To buttress cash flow the company cut R&D as a percentage of revenue to 9% in Q4 2017; this was down from 24% in the year earlier period. It is also lower than Mallinckrodt's (MNK) whose R&D is 11% of revenue. Mallinckrodt also trades just shy of 5x EBITDA.
U.S. General Medicine generates about 36% of Allergan's contribution margin, so I assumed it was responsible for 36% of total EBITDA. At $1 billion in 2017 sales, the women's health unit would be about 17% of total U.S. General Medicine sales. I estimated Allergan's run-rate EBITDA at $7.5 billion. The EBITDA for U.S. General Medicine could be around $2.7 billion (36%) and women's health unit EBITDA could be around $459 million or 17% of total U.S. General Medicine's.
At a $5 billion asking price, the unit would be valued around 10.9x EBITDA. This is higher than the 9.6x EBITDA AGN traded at before management talked up its strategic options; the total company currently trades at 10.4x EBITDA. In my opinion, a sale of the women's health unit would not be a boon to Allergan, and does not justify the recent spike in the stock. Secondly, Estrace generated 2017 revenue of $367 million or 37% of women's health total revenue. Mylan launched generic Estrace in December and its impact may not be fully reflected until the second or third quarter of 2018. The diminution in Estrace's revenue and EBITDA contribution could have a major impact on the unit's expected sale value.
What's Next For Investors?
I believe there are two important dates investors should stay abreast of regarding AGN.
April 30th - Allergan's Q1 2018 Earnings Report
The first date is April 30th - this is the date Allergan is expected to release Q1 2018 earnings. I do not believe investors will show serious interest in the women's health unit until they receive audited Q1 financial statements, and can confirm the hit to revenue from generic Estrace. On the earnings call, I would expect management to [i] give an update on Q1 revenue and EBITDA for women's health and [ii] total 2018 outlook.
According to the IMS Institute For Healthcare Informatics, from 2002 to 2014, the price of medicines was reduced by 51% in the first year generics entered the market. Price erosion and loss of market share could reduce Estrace's revenue by greater than 50%. Assuming a 51% decline in price and 20% loss of market share for Estrace, run-rate revenue for the women's health unit could fall to about $780 million - a decline of 22%. After Q1 results, AGN bulls should be better able to ascertain the value investors could place on the unit and timing of a sale.
June 2018 - Expected Decision On Restasis IPR
A second key date is June 2018. A Federal Circuit Court stayed an inter partes review ("IPR") pursuant to patents for AGN's dry eye drug Restasis. The IPR could be stayed until shortly after the Federal Circuit Court hears arguments, which could take place in June. The patents were invalidated by a federal court judge in September 2017. Lawmakers also expressed outrage over Allergan's attempt to use the St. Regis Mohawks's sovereign immunity to protect the patents.
That said, Senator Claire McCaskill drafted a bill disallowing tribal sovereign immunity to be used to block a U.S. Patent and Trademark Office review. Ultimately, I expect Allergan to lose the IPR. An IPR loss for Restasis - Allergan's second-best selling drug at 9% of revenue - may not be priced into the stock until after June.
By the end of June, I expect LOE for Estrace to impact the potential sale of the women's health unit and an IPR loss for Restasis to be priced into Allergan's share price. AGN remains a sell until that time.
Disclosure: I am/we are short TEVA, AGN, MNK. 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.