Teligent: Micro-Cap Specialty Generic

Aug. 08, 2019 8:00 AM ETTeligent, Inc. (TLGTQ)13 Comments

Summary

  • TLGT is a rapidly growing micro-cap specialty generic manufacturer with 200%+ upside potential over the next 12-18 months.
  • The company has a significant revenue opportunity with an upcoming approval decision on their orphan drug opportunity with a $100M+ IQVIA market value.
  • The upcoming inspection/approval of their new sterile injection facility should be a strong value creator as the company focuses more on higher margin injectables moving forward.
  • Consensus estimates are expecting an average annual 3-year sales growth rate north of 25% with EBITDA growth rates expected to grow more than 130%/year.

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Background

Teligent (TLGT) currently produces over 70 topical and injectable products across the US and Canada. TLGT was once an exciting high growth generic manufacturer but stumbled in the last few years as they invested to expand their manufacturing capabilities. The company embarked on a strategy to focus on TICO, topical, injectable, complex and ophthalmic generics in 2014 under the premise that there are less competition and greater pricing stability in these niche portions of the generic market. Given the small size of TLGT, these niche markets still provide plenty of room for growth. While the strategy to shift the focus of the company toward TICO and away from the historic lower barrier oral generics was and is sound, in this author's view, it hasn't been a smooth ride for shareholders. The combination of high debt and severe pricing pressure in the generic drug industry perhaps combined with poor timing/luck conspired to create a company flirting with bankruptcy.

Realizing the dire situation unfolding, the company refinanced their debt to extend maturities and underwent a portfolio rationalization process in late 2018 as pricing pressure made some of their historic products no longer economic to manufacture. The company stopped manufacturing these products and improved customer mix which contributed to an 1800 bps improvement in GM in the 2Q YoY, potentially the first step toward achieving managements target of 40% GM and 10%+ EBITDA margins for full year 2019.

Over the last two years, TLGT has invested roughly $65M on their Buena, New Jersey Manufacturing plant which is why their most recent debt was incurred. The $65M was used to expand topical capacity via the addition of a high-speed topical filling line and add a sterile injectable facility. TLGT's new facility has expanded manufacturing space from 30,000 sq ft to 110,000 sq ft while adding sterile injectable capabilities. The sterile injectable facility will begin with a capacity of 4-8M units and has the potential to ramp to 40-50M units by adding a high-speed injectable filing line.

I think what encourages us as a management team is that we have in place, a really robust team for being able to manage not only at the beginning of the startup of the sterile injectable capabilities, but also the future trajectory of what we need to do for commercial production and eventually the addition of the high-speed filling line.

I think all of us are in a position right now that we want to see the first sterile capacity online approved and running, before we make the investment go, no go decision on the high-speed filling line. I think that that's prudent, inappropriate, but we feel really good about our chances of success with the team that we have."

- (Jason Grenfell-Gardner - Q219 Earnings Call)

Current State of TICO Generic Markets

On TLGTs website, they indicate their "focus on TICO ensures we commit sufficient resources to critical projects and high-impact opportunities. For example, we are committed to the development of certain, niche medicines to resolve drug shortages or to provide a more affordable, generic alternative."

"According to Coherent Market Insights, the global specialty injectable generics market was valued at US$ 31.3 B in 2017, and is projected to exhibit a CAGR of 10.4% over the forecast period (2018 - 2026)." The article goes on to comment on injectable generics saying "Injectables are important additions to the generic product portfolio [of companies] as they are relatively protected by price pressure and comparatively less commoditized than their oral counterparts."

According to CEO Jason Grenfell-Gardner on the 1Q19 earnings call:

moving forward, more of our development program will be based on our anticipated injectable PAS (prior approval supplements) and ANDA submissions. We anticipate preparing injectable exhibit batches for over 10 products this year to support submissions in 2019 and into 2022, and this transition to injectable development is well underway."

The timing appears right as the FDA is currently seeing drug shortages for 122 drugs currently with more than half of them being injectable drugs, roughly 10% being ophthalmic and topical drugs. One can see that focusing on the areas where the FDA is seeing the most pressing need and drug shortages should help the company gain approvals more easily while also providing greater and opportunistic revenue share and profitability in these markets.

Debt Issues

As is often the case with stocks trading under $1, TLGT has considerable debt, roughly $180M as of June 30, 2019, meaning that bankruptcy is a real risk to be considered. However, given that the most restrictive debt covenants are tied to their Ares $20M revolver and Ares has amended the terms of their term loan twice, it appears Ares is comfortable being paid to wait for TLGT's financial outlook to improve. Thus, the risk of outright bankruptcy, in our view, appears unlikely and more than priced in at these levels, offering an attractive risk-reward opportunity.

TLGT's debt consists of:

  • $88 million related to convertible bonds
    • $13 million of which matures in December 2019
    • $75 million of which matures in May 2023
  • $91 million relates to the Ares financing commitment due December 13, 2019.
  • Each component of debt carries a different interest rate, but the weighted average interest rate is between 7% and 8%, depending on changes in the LIBOR.
  • TLGT has the option to pick or defer interest payable on the $71 million Ares term loan.
    • Currently, TLGT is exercising their right to pick interest providing incremental liquidity needed to address their highest priorities - i.e. building inventory and preparing for the FDA prior approval inspection.

There is no other way to slice it - $180M is a lot of debt for a company of this size and cash of only $4.1 M. As the chart (via KoyFin) below shows, TLGT started to take on additional debt to improve their manufacturing presence just as their EBITDA fell off. Creating and exacerbating fears of bankruptcy driving the stock to a recent low price of $0.42.

https://static.seekingalpha.com/uploads/2019/8/1/16469732-1564705005805666.png

Covenant Requirements

The financial covenants on the Ares revolver are more restrictive than the Ares term loan. Below are the current requirements for the revolver:

  • TLGT easily beat their Q1 & Q2 trailing TTM revenue covenants of greater than $55 million
  • In the third and fourth quarters of 2019, a TTM consolidated EBITDA covenant of greater than $3 million and $5 million, respectively.
    • As of Q219, Trailing 9-month EBITDA per the Ares agreement was $2.7M. Given the Ares Loan EBITDA is slightly more generous than the Adj EBITDA presented in the company's press release we believe they are well positioned to beat the Q3 & Q4 covenants easily given Q3 and Q4 reported Adj EBITDA consensus estimates are $2.5M and $3.3M respectively.
  • According to Damian Finio on the Q119 Earnings call: "Executing our 2019 plan translate into delivering our guidance and passing this year's financial covenants." Given the information we gained on the 2Q call last night, it seems that is a very conservative statement as they should easily maintain Q3 and Q4 covenant compliance.
  • The adjusted EBITDA results for 1Q & 2Q have far exceeded consensus expectations and management again reaffirmed full year guidance noting it had very little sterile injectable revenue included.

Full Year 2019 Guidance

  • Revenues in excess of $72.5 million (Current Consensus $72.7M);
  • a consolidated gross margin above 40%;
  • a consistent investment in R&D of $13 million to $15 million;
  • Adj EBITDA margin greater than 10% after adding back any foreign currency gains or losses and non-cash stock expenses (Current Consensus is $6.8M).

Current Consensus Estimates

as of 8/6/19 (Via KoyFin)

  • 2019 Revenues Consensus $72.7 M; 2020 Consensus $91.0M; 2021 Consensus $110.4M
  • 2019 EBITDA Consensus $16.8M; 2020 Consensus $17.9M; 2021 Consensus $24.8M
  • 2019 Non-GAAP EPS -$0.15; 2020 Consensus $0.01; 2021 Consensus $0.52

Why do we like TLGT?

Part of 1035 Capital's investment philosophy is that over the intermediate to long-term, equity prices tend to improve if their underlying fundamentals improve. Although, there are times when it takes "Mr. Market" longer to realize the sustainability of the improvement, especially in underfollowed micro caps like TLGT. We believe TLGT is just a current example of the market being overly pessimistic due to historical troubles while ignoring the current and future catalysts to significantly improve fundamentals. As the chart below (Via KoyFin) shows, we can see that TLGT's share price and EBITDA directionally move together fairly closely over time. The chart also shows that EBITDA has bottomed and is now growing again, however the share price has continued to make new lows.

When considering the drivers of the expected financial improvement discussed further below, the imminent inspection of their sterile injectable facility, and potential approval of their orphan drug product, we believe that TLGT's fundamentals have indeed bottomed. TLGT is at an inflection point in their financials and given the information on the Q2 call, in our opinion, will avoid triggering their near-term revolver covenants. Meanwhile, due to concerns around solvency, the valuation has become attractive. This combination of meaningful catalysts and relatively cheap current valuation should lead to corresponding improvements in the share price of TLGT over the intermediate term as risk of bankruptcy subsides and they execute on their strategic plan of pivoting toward niche higher value, lower competition TICO generics.

Raymond James Life Science Conference Highlights that stood out to us:

  • A comment from Damian that they understood the cadence of revenue and earnings for 2019, as did Ares when they entered financing agreement and that fears of bankruptcy were misplaced.
  • This comment combined with exceeding internal expectations in Q1 and reiteration of their full year 2019 guidance is a positive indication that management believes they can avoid triggering debt covenants/bankruptcy.
  • Management reaffirmed the expected disruption due to serialization of the European market affecting the contract manufacturing component of the Canadian subsidiary last Q was coming and expect to be back at full run rate in Q3.

Q2 Conference Call highlights that stood out to us:

The Good

  • Inventory positions in Canadian business improved in the quarter as EU customers completed their required serialization changes
  • TLGT will continue to create exhibit batches for up to 8-10 additional drugs, in addition to current 5 they have already created
  • A total of 13-15 injectable aNDA filings over the next few quarters split between relaunches/supplemental filings and internally generated filings to build up the injectable pipeline
  • Starting to see more price stability in the Topical Market - which is great given Topicals still represent two thirds or more of the portfolio
  • Adding to new private label partners in Q3 which provide longer term higher margin relationships
  • Not planning to do any equity capital raises for working capital - believe they have enough cash to manage until the injectable facility comes online.
  • The base business is again profitable and we are on the doorstep of the profitability turbocharger for the business - the sterile injectable facility.
  • Will file aNDA to trigger inspection by the end of this Q - have already agreed to an accelerated approval timeline with the FDA

The Bad

  • Ended the Q with $4.1M - down from $6.4M last Q. The company pointed out that they believe $4.1M in cash will be the low point as that was depressed due to the timing of orders in the Q. They commented they currently have more cash than $4.1M and expect to build cash from here.
  • Delayed filing their sterile injectable triggering inspection due to new hires pointing out some improvements that should be made to the facility before inspection - effectively delaying this process a Q. As mentioned above this is somewhat offset however by the accelerated review from the FDA.
  • No new orphan drug updates

TLGT Pipeline

With regards to TLGTs pipeline, we are most interested in two key milestones. The first is potential approval of their partnered orphan drug candidate, which has a TAM of $100M+ according to management. While approval of this product has proven elusive for the company since its first filing in 2018, we are again approaching the PDUFA date for the resubmitted CRL. According to CEO Jason Grenfell-Gardner on the Q1 19 call:

with respect to our generic orphan drug application. As mentioned in our press release on April 22, 2019, our development partner has submitted our response to the FDA's complete response letter on April 16th of this year. As a result, the FDA has assigned us a new PDUFA goal date of December 16, 2019, based on not needing to re-inspect any associated facilities. Our submission has been granted competitive to generic therapy or CGT designation, which means per FDA's draft guidance that the FDA may ask to expedite the review of our ANDA."

During the Q&A segment, CFO Damian Finio added:

...because the drug has competitive generic therapy designation, the FDA may use its own authority to expedite that review… As we move throughout the year, we hope that we get better informed. But for right now, the best answer is December 16th as an approval date or as a goal action date depending on whether the FDA needs to inspect any of the facilities in the application or not…should the FDA decided it needs to inspect facilities again as part of that application, that date may change. It could change out all the way through to February 16, 2020…In terms of product launch, we have had product launch plans ready for this drug since its original goal date back in 2018."

The second major milestone that we are paying attention to, while not technically part of the pipeline but does directly affect it, is the progress with respect to getting the Buena, New Jersey Sterile Injectable facility inspected and producing product. Below are some pertinent management comments on the topic from various earnings calls.

In order to accelerate our site inspection and approval, our regulatory team has sought and received FDA consent to review our first drug submission on an expedited basis. FDA has given this consent as the first target drug that that we are submitting is an already approved NDA that is currently on drug shortage. Working together with FDA, Teligent will submit stability data concurrent with the ability program to allow FDA to move quickly to review the product and ease the drug shortage for this specific product.

We have already made the supporting batches for this submission and our R&D and regulatory teams will be reviewing the data generated from these batches to eventually trigger the prior approval supplement submission to FDA."

- Jason Grenfell-Gardner - Q119 Earnings Call)

we've recently made two significant changes to our team that impact (the injectable filing), as we brought on the new Vice President of Operations Mr. Antonio Di Nicola, and new Vice President of Quality, Mr. Ken Bonnell. These are critical roles for the success of this venture.

During their reviews of our readiness to launch, they have identified a few issues that they recommended to be remediated prior to submitting our first injectable prior approval supplement. We have undertaken that work and it is largely completed. We now anticipate that we will file our triggering submission at the end of this quarter. For this submission, we have agreed and accelerated review timeline with the FDA that may still allow us to launch this product before the end of 2019 depending on the timing of FDA's inspection and their review."

- Jason Grenfell-Gardner - Q219 Earnings Call)

https://static.seekingalpha.com/uploads/2019/8/1/16469732-15647050081732814.png

(Source: Company Investor Presentation)

Additionally, given the significant scale opportunity at the facility, management plans to engage other manufacturers who may "have the need for contract manufacturing to utilize our capacity, and welcoming the opportunities to continue to grow capacity utilization and partner with industry peers." This additional volume should help TLGT fill the new capacity they are bringing online faster than they would be able to with internally products only. While this is likely lower margin business, it should assist them in overcoming the fixed operating costs of this new facility. As mentioned above, over the next 3 years, we should see additional focus on injectable approvals both from internal R&D projects as well as prior approval supplements to fill the capacity with internal products that likely carry higher margins.

As of Q2 2019, TLGT has 16 Teligent ANDAs and 2 partnered aNDAs currently pending at FDA representing an IQVIA total addressable market of approximately $1.6B plus various supplemental approval application which can also trigger new market approvals. Additionally, TLGT is planning to make 13-15 new injectable aNDA filings over the next several quarters. And currently have 5 exhibit batches to support filings on hand awaiting inspection of the injectable facility with plans to make another 10-12 exhibit batches in the next few Q's.

Valuation

TLGT is currently at an inflection point between investors focusing on the potential of it failing to meet covenants and potentially leading to bankruptcy and the upcoming significant growth opportunities the company has positioned itself for. One of the key characteristics we look for at 1035 Capital is for opportunities to "front run the black box." We mean to look forward 9-24 months at what the financials/fundamentals will look like, instead of focusing on the backward-looking data of the previous quarters.

As shown by management's execution in the 1H of 2019, we believe there is a significant opportunity for the financials of TLGT to improve markedly in the 2H of 2019 and continue that improvement into 2021 and beyond allowing the company to resume its place as a growth leader among specialty pharmaceutical companies. Additionally, we love that management has pivoted the strategy toward niche products that have less competition and pricing pressure than their historical market. Over the long term, we believe this will provide better shareholder value.

While TLGT is not for the faint of heart, as the significant debt load does legitimately increase the likelihood of bankruptcy, we believe the market is currently pricing it near a dire scenario and ignoring the fact that maintaining its 2019 covenants appears very achievable as mentioned above. Additionally, there are several large value drivers that are likely to unfold over the next several quarters that are being given no credit today in the market.

Given the distressed and fluid nature of the company's financials, traditional valuation metrics aren't as relevant as they would be otherwise in our opinion. So, in this case, we look back to the 2016-2017 time period when TLGT was able to achieve a TTM EBITDA of $9.2M in Q1 2017 starting from -2.0M in TTM EBITDA in Q4 2015. That dramatic growth in EBITDA was during a time when TLGT had a Low EV of 265M and a high of 550M and a share price of about $4.50 up to almost $9.

Consensus is currently expecting roughly $6.8M of EBITDA in 2019 which is similar to the TTM EBITDA of $6.3M TLGT had attained exiting 2016. Yet at that time, TLGT was trading with an EV of around $400M compared to just $192M today (see chart below via KoyFin). Looking ahead to 2020 and 2021, consensus estimates for EBITDA of $17.9M and $24.8M showing the powerful EBITDA growth trajectory that lays just beyond if TLGT can avoid triggering their covenants, which now appears likely.

https://static.seekingalpha.com/uploads/2019/8/1/16469732-15647050098239279.png

Assuming TLGT can hit managements estimates ($7.2+M) for 2019, it will maintain compliance with covenants and as such it is reasonable to assume the company should be worth something similar to the ~$400M EV it was worth in 2016 when it was earning $6.3M in TTM EBITDA. Doing the math, including all of the new debt and the lower cash level now, implies TLGT shares should be worth roughly $4 by the end of 2019 on an apples to apples basis compared to 2016.

Unfortunately, the higher debt and more stringent covenants do increase the likelihood of bankruptcy meaning it is prudent to apply a heavy discount to the share price for the heightened risk. We have conservatively applied a 50% chance of bankruptcy to come to our target price of $2 for TLGT based on attaining the $7.2M+ in EBITDA management reiterated yesterday on their Q2 conference call.

Using a more traditional valuation method - below is our peer comparison/valuation for TLGT. Given the ongoing transition from negative EPS and EBITDA to positive, which cause outliers in the data, we use P/S as our comparison valuation metric. Some readers may recognize that many of the companies in the comp group have had their own significant trouble with declining generic prices and/or considerable debt, which we believe improves the validity of the comparison.

https://static.seekingalpha.com/uploads/2019/8/1/16469732-15647050063391225.png

(Source: Author's Calculations)

As you can see from the table above based on 2019 P/S multiple, we believe the stock is worth about $1 if the peer multiple is applied. However, due to the much higher expected, sales, EBITDA and EPS growth rates that TLGT is expected to achieve over the next few years (primarily/all on an organic basis), we believe a premium multiple is warranted. The premium multiple we chose to use is the midpoint of the median and mean competitor multiple which is 1.53x 2019 sales vs the straight peer median of 0.69x leading to a price target of about $2.

Doing the same math based on 2020 numbers implies a TLGT target price of $2.70 assuming they can avoid triggering any covenants in the meantime. Finally, as a note, we used closing prices from 7/30 for our calculations.

Conclusion

We believe the worst-case scenario is currently being priced into TLGT at these levels, despite considerably improved visibility into the company to meet their financial covenants after the Q2 earnings numbers. Leaving TLGT in a good position to execute on their strategy of shifting toward sterile injectables despite a somewhat tight cash balance. Leaving a mostly de-risked stock with considerable upside to our conservative $2 target price.

As with all sub $1 stocks, we expect to see considerable volatility in the shares of TLGT over our expected holding period of 12-24 months.

This article was written by

At 1035 Capital, we focus on small and micro cap equities and look for both growth and value names to create a small cap core portfolio with better than index valuation and growth metrics. All of the stocks in our portfolio must have a strong catalyst to drive change at the company - a concept we call "front running the black box." Check out our website at www.1035Capital.com to learn more.

Disclosure: I am/we are long TLGT. 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.

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