Endo International: Cellulite Opportunity Vs. Opioid Overhang

About: Endo International plc (ENDP)
by: David DeWitt

I take a look at the reasons for the multi year slump in Endo shares.

I look at the future growth opportunities, most notably CCH for Cellulite.

I examine the current largest risk to shares, the opioid litigation.

I conclude with a look at the stock's valuation.

Investing in Endo International (ENDP) is not for the faint of heart. Taking a look at the chart over the past several years you see some ups, but mostly what you find is downs. As it stands today, the main topics of discussion for investors of Endo represent two powerful pulls in opposite directions: The potential blockbuster CCH for cellulite drug launch and the opioid overhang. In this piece, I will go through the story of Endo's fall from grace, briefly touch

Data by YCharts

on the actions the company has taken to right the ship, and finish up talking about what lies ahead for the company. I will also spend some time on the opioid litigation that Endo is involved in and see if any of the recent developments have any read through to Endo, whether positively or negatively.

Endo Logo

Why the Multi-Year Slump?

Was Rajiv de Silva, the former CEO of Endo and the protege of the former and infamous Valeant Pharmaceuticals CEO Mike Pearson, good or bad for the company? For many reasons, the obvious answer is that he was terrible for the company. However, in a couple of ways, if it was not for de Silva's actions, the companies future might look bleak. Let us start with the bad. Taking a page directly from the Valeant playbook, de Silva went on a two-year buying spree using debt, stock, and cash. In total, de Silva made six acquisitions valued over $14 billion, as seen below.

Company Acquired Acquisition Value (In millions)
Boca Pharmacal $225
Paladin Labs $2,700
Somar* $124
Dava Pharmaceuticals $575
Auxilium $2600
Par Pharmaceuticals $8,000
Total $14,224

*Somar purchase price was undisclosed, so I have used the eventual divestiture proceeds in its place

The graph below does a great job encapsulating the cause of Endo's steep decline from a high of $96.58 in April 2015 to a low of $5.27 in April of 2018. The result of all these "accretive" deals amounted to accretion in only one category: total debt. As it turned out, the generics industry was peaking during the time that de Silva made his most significant and final deal, which just so happened to be a generics business. In the press release to purchase Par Pharmaceuticals, de Silva said Endo would be a "specialty pharmaceutical company with one of industry's fastest growing generics businesses." The irony and lack of foresight were exposed over the next two years as Endo's generics business proceeded to erode by 50% as the generics market rapidly changed. Generic approvals began pushed through the FDA at a record pace while the largest generic buyers formed consortiums to exert leverage over the manufacturers. With revenues declining quickly against fresh new debt, the company's leverage continued to increase while the valuation of the equity plummeted, as displayed in the chart. While de Silva's overall contribution to the company appears to be quite harmful, there is a silver lining that I will address later. Endo's Downfall Encapsulated Source: Bloomberg

On top of the eroding business fundamentals, Endo began to be sued by states left and right for falsely advertising their branded opioid product, Opana. With dollar signs flashing in attorneys eyes, comparisons to the $200B tobacco lawsuit being thrown around, and media coverage that focuses mainly on the plight of the plaintiff, it is no surprise a significant discount is slapped on shares of Endo. While there is much uncertainty about what the ultimate liability will be to Endo, recent activity suggests it may not be as bad as many expect. I will dive deep into the latest updates later in the article.

The Turnaround Plan

Every presentation since Paul Campanelli was named CEO in 2016 starts with Endo's strategic priorities to turn the business around. When Campanelli was handed the business, the company was disjointed and bloated. He got to work quickly by selling off non-core assets. Further, the company saw very early what was happening in the generics market and made the difficult decision to shut down their Alabama manufacturing plant which was responsible for producing low margin, commoditized generics products. As a result of these hard decisions, the company became leaner and more focused on maximizing their differentiated capabilities. The company is now prepared to enter the next phase of its turnaround plan, which is all about growth.

Gross margin increase vs. headcount decrease Source: Bloomberg This chart shows the gross margin improvement against the decrease in headcount which is reflective the hard, but prudent business decisions made by the company.

An Era of Growth for Endo?

The silver lining of de Silva's excessive buying-spree is that with the purchase of Par came Paul Campanelli, who has done an excellent job in setting up the company for growth. Second, with the purchase of Auxilium, Endo has Xiaflex, their flagship drug. Without Xiaflex, the company's growth outlook would not be nearly as exciting as we will see in the next section. Lets now take a look at the outlook for Endo's businesses and see what will be driving growth going forward.


Xiaflex (Collagenase clostridium histolyticum) is an enzyme produced by the bacterium Clostridium histolyticum that dismantles collagen. It is currently approved in two indications, Peyronies disease, and Dupuytren's contracture. Xiaflex revenues were $264 million in 2018, up 23% over 2017. The company expects Xiaflex to grow in the mid to high teens in 2019. I believe Endo will quickly hit the upper range of this target and may even hit the 20% range again. After all, they did only guide for mid-teens growth in 2018. What makes me particularly excited about the ability for these two indications to keep growing are some statistics that CCO Pat Barry laid out in the fourth quarter conference call. For Peyronie's disease, Xiaflex has about 60% market penetration of patients that are treated. However, only about 3% of cases are diagnosed, and of those, only about 14% are treated. This is why Endo has been focusing on consumer activation. In the more mature indication of DC, market penetration is about 25%, but the diagnosis rate is 3%, and the treatment rate is 30%. Beyond Cellulite, there is still enormous potential for Xiaflex in new indications. In a recent conversation with investor relations, I was told that the next indications likely to be developed would be plantar fibromatosis and frozen shoulder. Frozen shoulder, or adhesive capsulitis, affects 20-50 million people worldwide with 300K cases diagnosed annually in the U.S. Of those, 10% are treated invasively. Assuming frozen shoulder would be treated like the other indications with up to four courses of treatment, then a simple frozen shoulder peak sales estimate would be around $540 million. Feel free to do your own math with your own assumptions, understanding that a vial of Xiaflex is about $4,500. Plantar fibromatosis is diagnosed in about $200,000 patients in the U.S. It is a condition that causes pain and disability caused by the thickening of the feet's deep connective tissue. Interestingly, patients who have this condition often also have Dupuytren's contracture, Peyronie's disease, and adhesive capsulitis. There are synergies that would come from adding these two indications down the line.

Xiaflex Pipeline Source: BioSpecifics (NASDAQ:BSTC) Corporate Presentation


The most exciting opportunity for Xiaflex (coined CCH for cellulite by the company) is the upcoming cellulite indication. Endo is on track to submit a BLA in the second half of 2019 and launch in the second half of 2020. In terms of the market opportunity, Endo estimates that their target market consists of six million women between the ages of 25 and 54. If they use the age range of 21-59, there are an additional five million women. Endo has taken into account age, target BMI, household income, as well as the percentage of women that acknowledge they have and are bothered by cellulite to come up with this estimate.

Cellulite Market Opportunity Source: Endo JP Morgan Presentation

JP Morgan recently put out a note where they estimate Endo will price CCH for cellulite at $1,500 for a full course of treatment. While I think this is a very conservative estimate, it would open the therapy to a large number of women. If Endo were to capture 5% of the 6 million women ultimately, then that would result in $450 million of peak revenue. I think this is a very conservative way to think about the potential. Seven out of ten participants who saw at least a 1-level improvement in the patient-reported photonumeric cellulite severity scale also reported a substantial increase (statistically significant against placebo, p<0.01) in PR-CIS Happy scores. If this data holds up in practice, I believe the conservative peak sales estimate in the ball-park of $450 million will prove to be too low.

Happy Scores!

If we increase the penetration rate to 15%, then all of a sudden we are looking at $1.35 billion in peak sales. Further, if we up the price by a modest 500 dollars per treatment to $2,000, peak sales estimate increases to $1.8 billion. Time will tell how the pricing shakes out, but there is plenty of upside to conservative estimates. Thinking about these numbers relative to the company's current revenue prospects for 2019 of between $2.76 billion and $2.96 billion, it is clear that even $450 million in peak sales form CCH for Xiaflex drug can have an enormous impact on longer-term growth rates for the company.

The impact on growth rates may also happen quickly, considering uptake should be strong. On the 2019 Q1 conference call, CCO Pat Barry detailed all the precommercial activities that they are currently undertaking and plan to take. The ones that stick out to me as being very important marketing strategies are their plan to use non-branded television as well as securing influencers to spread the message and endorse the treatment.

Endo 2-PT Composite Change in phase 3 Source: Endo JP Morgan Presentation

BLA or sBLA?

One hot topic regarding CCH for cellulite is the debate about whether or not Endo will be able to secure approval based off a separate BLA filing or a supplemental BLA (sBLA). This is an issue because if Endo were unable to have it approved under a BLA, then they would be unable to price it differently then the price of the current indications, which is reimbursable. Management is under the belief that they will be able to get approval on the back of a separate BLA due to a formula change for the cellulite indication, different potency, different application techniques, different market, and different patient population. In their Q1 conference call, CCO Pat Barry reiterated that their talks with the FDA have been positive and they are confident they can go the separate BLA route. He says "Again, the patient populations are much different. Presentation is different, so there is a safety play important to dose correctly, not under-dose or over-dose, but to the two presentations wouldn't be transferable within the indications. And, based on this, the different presentation products, not only is it appropriate but allowable to have a separate BLA submission. So that's based on - that's what our regulatory strategy is based on."

Morgan Stanley analyst, David Risinger, takes the other side believing Endo will not get approved off of a BLA. His point is well taken as he compares Allergan's (AGN) failed attempt to have Botox for cosmetics approved as a separate biologic. One of the critical differences, however, is that Allergan did not initially attempt to have Botox Cosmetic approved as a separate drug. They retroactively sued the Center for Medicare and Medicaid Services (NYSE:CMS) in 2013, ten years after Botox Cosmetic was approved as an sBLA, arguing that Botox Medical and Botox Cosmetic are two separate biological products because the US Pharmacopoeia identified them separately. The court ruled in favor of CMS, as both Botox Medical and Botox Cosmetic contained the same active ingredient. While this would appear to set an unfavorable precedent for Endo, the court did cite in the ruling that the FDA's approval of Botox Medical and Botox Cosmetic under the same BLA as confirmation that they constitute one biological product. This helps explain Endo's strategy of going for the separate BLA.

In a note from JP Morgan, analyst Chris Schott believes differences in dosing and concentration should enable differentiated pricing but acknowledges that it is still unclear whether the FDA will accommodate the separate BLA pathway. Apart from Botox's history, there is no other clear precedent, and it will be interesting to see how this issue unfolds. If Endo is unable to secure a separate BLA, then pricing becomes a severe issue. At current Xiaflex pricing of $4,323 for 0.9mg, treatment would range from $4,000 to $13,000 depending on how many sessions are necessary. Of course, Endo could slash prices, but that would be very painful for revenues of the currently approved indications. While my stance is that Endo will be able to secure a separate BLA and have differentiated pricing, it is undoubtedly a risk to keep track of.

Cellulite Competition

The primary sources of competition for CCH for cellulite are Cellfina and manual subcision. There are also devices that use lasers and radio frequency, but the medical aesthetics community is somewhat unanimous in their dismissal of these devices as not generating significant levels of patient satisfaction. In a terrific research piece from Cantor Fitzgerald where physicians were interviewed, one doctor mentioned that "lasers and radiofrequency treatment devices are known throughout the medical aesthetics community as options that do not work as well in treating cellulite." Most physicians interviewed viewed Cellfina and manual subcision as the gold standard treatments for cellulite. Cellfina is a hand-held mechanical instrument that uses a vacuum and motorized microblade that works back forth to cut the fibrous septae which causes the cellulite. It is approved to work for three years, and it is expected to have data expanded upon to support five-year efficacy. Patient satisfaction for cellfina is high. The downside to Cellfina is that the device costs around $150K and costs $3,000-6,000 per treatment. It also requires a large machine that takes up office space. Cellfina requires downtime for patients of 3-7 days which can take as long as 14 days. Just take a look at this anecdotal account of a Cellfina patient's experience of severe pain in her recovery.

Cellfina Diagram The other gold standard of cellulite treatment is manual subcision where the surgeon will manually cut through the fibrous septae. Results are generally permanent, and patient satisfaction is typically high. Downsides are that the operation is riskier and complicated, requires lengthy recovery times (up to four weeks), and may require a course of antibiotics. Generally, the costs for subcision is around $4,000 per treatment.

Subcision Diagram One of the takeaways from the Cantor Fitzgerald research piece was that most of the physicians prefer non-invasive alternatives such as CCH for cellulite. The doctors also agreed that they think their practices will grow if CCH comes to market. The doctors were generally pleased with the low occurrence of adverse events, the phase 2 data, and the potential for CCH to be quickly adopted. CCH will be easily tolerated, administered, and if it can be approved with three to four-year efficacy and at a price for the consumer less than Cellfina and subcision, it stands to reason that CCH can be very successful for Endo, physicians, and patients alike.

CCH for Cellulite Phase 3 Data

Despite the market's adverse reaction to the phase 3 data, the company was delighted with the results. I was also quite pleased. From the companies press release we saw that for RELEASE-1, 7.6 percent of subjects receiving CCH demonstrated a highly significant (p=0.006) improvement in the composite investigators' and patients' assessments of the appearance of cellulite, as measured by a two-level response in both the Clinician-Reported- Photonumeric Cellulite Severity Scale (CR-PCSS) and Patient Reported- Photonumeric Cellulite Severity Scale (PR-PCSS) scores, for the target buttock at Day 71, compared to only 1.9 percent of placebo subjects. For RELEASE-2, the numbers were 5.6 percent of subjects (p=.002) compared to only 0.5 percent of placebo subjects. Some market participants were discouraged by the fact that the phase 2b results appeared more impressive at 11 percent versus 2 percent. The key difference, however, is in trial design. In the phase 2b design, participants could not have a Hexsel CSS score greater than 13. This means they could not have the most severe of cellulite. The phase 3 trial is an all-comers study that does not exclude severe cases. Endo is currently conducting a more strict phase 2 open-label study which is focusing on non-obese patients with less severe cellulite. This data, when released, will be important as this patient population is more reflective of their target market. I expect to see data from this trial throughout the year at influential aesthetics medical conferences.

Growth Drivers Beyond Cellulite

There is more to the growth story than just cellulite. The company has considerable strength in its U.S. branded sterile injectables segment. This is a market where Endo has a core capability to develop products that are higher margin and typically purchased directly by hospitals, bypassing the consortiums that have been pressuring generic prices. The U.S. branded sterile injectables revenue increased 24% in 2018 over 2017, from $750m to $930m. Endo has guided for full-year 2019 revenue growth for the segment in the high single to low double-digit percentage range. Given it is Endo's modus operandi to be very conservative, it is likely they beat that guidance handily. The star assets are Vasostrict and Adrenalin. Vasostrict revenue grew 13% from $400m in 2017 to $454m in 2018. Adrenalin revenue grew 88% to $143m in 2018 from $77m in 2017. Vasostrict has been the center of some drama from both a regulatory standpoint and a competitive standpoint. Long story short, the drug is likely safe from competition until late 2021, early 2022. The timeline goes something like this: After Eagle filed their ANDA, Endo sued to trigger a 30-month stay. The Endo vs. Eagle case is set for May 2020, and if Eagle wins, Endo will appeal. Unless Eagle makes the unlikely decision to launch at risk, the entire appeals process will have to be completed before they launch, which takes us to late 2021 or early 2022. The FDA removing vasopressin from the bulk compounding list has also been fantastic news for the company. Adrenalin is also likely to face some competition, as they have been notified of a paragraph four filer for the 1 mL presentation, where they control about 35% of the market. They go to trial in July and are bullish on their intellectual property, as noted in the Q1 conference call during the Q&A section. These two important products need to be watched closely, understanding that competition is on the horizon.

Another growth driver coming down the road comes from a recently inked licensing deal with Nevakar for the development of five differentiated sterile injectable products in the U.S. and Canada through the 505(b)(2) regulatory pathway. In the deal, Nevakar will develop and seek FDA approval, and Endo will launch and distribute the products. 505(b)(2) products are valuable as they are eligible for 3-5 years of market exclusivity.

Another growth driver for Endo in the future is their considerable first-to-file (NYSEMKT:FTF) and first-to-market (FTM) pipeline of products.

Endo's FTF and FTM opportunities Looking at the 2017 IQVIA sales, the yearly total sales of these branded products is over $3B. For the ones that are FTF, this means when launched; Endo enjoys six months of market exclusivity which typically result in significant revenue bumps, albeit mostly short-lived. However, there is usually a first mover advantage, and depending on how many competitors move into the market after the six months are up, the revenue fall-off can range in severity.

The Opioid Overhang

It is time to talk about the wrinkle in the story. Endo is heavily involved in the ongoing opioid lawsuits. The following are notable disclosures from Endo's 2018 10-K: As of February 21, 2019, Endo is facing 12 cases from states, 1,711 cases from counties, cities, Native American tribes and/or other government-related persons or entities, 121 cases from hospitals, and 56 cases from individuals. Many of the cases in the U.S. have been consolidated in a federal multidistrict litigation (MDL) pending in the U.S. District Court for the Northern District of Ohio (MDL No. 2804). The MDL court has set a trial date in October 2019 for the claims of two Ohio counties which will allow for certain discovery and establishing other deadlines and procedures.

For the October trial, it still unknown who will be named as the defendants. In my opinion, the defendants have a strong chance in court, and overall, the courtroom is something I think the plaintiffs want to avoid. The plaintiffs argue that the opioid manufacturers misrepresented the opioids and engaged in deceptive marketing. The marketing downplayed the risks of opioid addiction which enabled physicians to prescribe them comfortably. The manufacturers argue that the opioids are FDA approved with labels that detail their risks. The FDA never requested or directed new restrictions on how the opioids were labeled or distributed. They argue that the blame should fall on the individuals who misused the drug, and the physicians who were too loose in their prescribing. They argue that there are more than just manufacturers to blame, and thus they shouldn't be liable for all the damages. They argue that they should not be to blame because they changed their promotion activities in response to the ballooning opioid epidemic.

My personal opinion on the issue is summed up perfectly by Teva (TEVA) CEO Kare Shultz's recent comments in their Q1 conference call. He remarks, "What about alcohol? Imagine if we said that the bill for all the alcohol-related traffic accidents and broken families should be picked up by everyone manufacturing, distributing, and selling alcohol?" He continues, "The plaintiff lawyers look at where they can get some money. We have a lot of debt, so we don't have that much money, I think they will have to find someone else if they want big settlements. It won't be with us." This is directly applicable to Endo, who is also heavily indebted without much money to spare. The most poignant statement from Schultz that drives the issue home for me is where he says "The principle is that you can in any way be deemed responsible for something you are doing when you are following all the laws of the land. Teva used the exact labeling required by the FDA." In my opinion, plaintiffs are trying to find a scapegoat when in fact it is the government which dropped the ball.

While I can argue all day why Endo should have no liability, at the end of the day, some liability is likely. Going to court, even with a solid case, is a risky proposition. One of the few estimates that are publicly circulated is from Bloomberg Intelligence, shown below.

Estimated Liabilities Bloomberg Intelligence analyst Holly Froum is using the tobacco case as a comparison to come up with the total settlement amount and each companies liability. Using the 1998 settlement case as a comparison is flawed, because the plaintiffs' argument, in this case, is arguably far weaker. Further, the tobacco case was a product liability case whereas the opioid MDL is a personal injury case. There are also flaws in her market share percentage. If you look at data from IQVA, courtesy of Morgan Stanley research, you'll see Endo only has 11% share.

IQVA Market Shares Also, according to Morgan Stanley, since 2000, Endo's cumulative sales for branded opioids Opana ER and Percocet have totaled ~$4.7B. It is hard to imagine Endo could be hit with a settlement larger than this in a worst-case scenario, considering they no longer promote any opioid products (They sell Percocet, but no longer promote it).

Going to back to Schultz's comments about Teva not having money to spare, the same goes with Endo. Endo is not going to settle for an amount that threatens bankruptcy, and if that is what the plaintiffs ask for, then all Endo has to do is threaten chapter 11 to get the upper hand. According to a March 25 Bloomberg article, a chapter 11 filing shields that defendant from litigation by imposing a stay on all U.S. suits. For the defendant, this means the ultimate settlement would be substantially less. Logically, the plaintiffs are well served to go after amounts well within the capacity of the defendant. This willingness to take what they can get is somewhat evidenced in the recent Purdue settlement with Oklahoma. After Oklahoma grabbed $270M from Purdue, they proceeded to drop all cases but the nuisance charges against Teva and J&J. To me, this shows Purdue is the big fish the plaintiffs are trying to catch. In a recent note from Mizuho, analyst Irina Koffler says the recent narrowing of the Oklahoma case is a positive for the drug manufacturers, as it demonstrates "insufficient fraud evidence against the remaining parties." In her note, she posits that the risks for Endo are to the upside as the litigation progresses. She also notes, after speaking with an expert, that unless there is evidence that other companies (besides Purdue) colluded, or defrauded doctors themselves, the likelihood of a big settlement is slim.

As far as liquidity is concerned for any potential upfront legal settlements, Endo ended the first quarter of 2019 with $982.7M in unrestricted cash. Further, they have an untapped revolver capacity of $300M. With this strong liquidity position, I believe they would be able to absorb a worse than expected initial settlement payment.

Valuation and Cash Flow

Endo has been cheap for a long time. Now that the company is beginning to grow year over year again, I find it hard for the market to continue rationalizing it's current 3.5x forward P/E ratio, 6.9x forward EV/EBITDA ratio, and 0.62x price/sales ratio.

Valuation Metrics The stock is being heavily discounted for fewer and fewer reasons every day, and the biggest reason remaining is surely the opioid overhang. With growth returning for the business overall and a potential blockbuster on the horizon, it is only a matter of time before the market has to rerate this stock to more fair valuation. I understand that the days of a market multiple for Endo might be behind us, but if Endo can begin to deliver consistent growth from here on out as I expect, multiple expansion will be warranted as leverage begins to fall over time.

Another way to view the value Endo presents down here is by looking at their free cash flow generation. This year they will end up using cash, but that is because 2019 is the last year of vaginal mesh payments. Before legal expenses, Endo is generating between $430M and $530 of free cash flow (cash from operations - capital expenditures). Assuming Endo generates this level of free cash to equity owners in 2020, we are looking at a free cash flow yield of nearly 28%. Just as a comparison, The S&P 500 currently has a FCF yield of 4.6%! Assuming Endo can trade at a (still very cheap) FCF yield of 10% over the next two years, the stock has to more than double to $22 per share to get there which I think this a more than reasonable medium-term price target. Keep in mind that due to the various unresolved risk factors, achieving this target assumes a manageable opioid settlement and their ability to file CCH for cellulite under a separate BLA to facilitate a clear pricing strategy to drive uptake.

S&P FCF Yield

Endo's Cash Flow Guidance Source: Endo Q4 2018 Earnings Presentation


In conclusion, I believe Endo is a very attractive long term buy at current levels for an investor with an appetite for risk. I cannot stress enough that unless you are well versed in stomaching large amounts of volatility, this may not be a stock for your consideration. If we remove the opioid issue altogether, then Endo would likely already be trading near my two years $22 price target because otherwise there would be no immediate or overbearing threat to Endo's future cash flow, and this cash flow could be valued with much less discount. Management has expertly navigated a turnaround in the business, the launch of a potential blockbuster new drug is on the horizon, and the valuation is dirt cheap for a firm that is capable of generating significant free cash flows to equity. However, with the litigation risk still largely unquantifiable, placing a bet on Endo is not without substantial risk.

Disclosure: I am/we are long ENDP. 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.