1035 Capital recently wrote an article on TLGT highlighting the underappreciated value of this turnaround generic manufacturer. As we predicted, there has been significant volatility in the share price. Since publication on Aug 8th, the price spiked up to ~$1.10 and has recently slid all the way back to the $0.60 range. In our previous article, 1035 Capital provided background information on TLGT and we argued the company is worth $2-2.75/share. Recent announcements within the past month have provided us a better understanding of the value of the company’s assets and based on this new information, we believe the sum of TLGT’s parts are worth at least double the current market cap even after paying back all its debt.
Within the last month, several pieces of new information provided us with an opportunity to calculate a sum-of-the-parts valuation for TLGT. First, the company announced a strategic review of its assets on Oct 1st and 30 days later, management provided more details on the unsolicited 3rd party offers which triggered the strategic review.
To be clear, we expect management to continue to operate the company, but this article explores TLGT’s sum-of-the-parts value to provide further supportive evidence of the current undervaluation of TLGT shares.
What happened to drive the recent spike up in shares? The short answer is most likely speculation on upcoming catalysts which are discussed later. As a result, it is not all that surprising to see shares fall back to where they started. However, the trigger for shares beginning to fall after the spike was a misunderstood press release issued on 10/01/19. It announced that management hired SVB Leerink to help it undertake a strategic review of assets. Apparently, the market took this announcement as a sign that the company was in dire straits. However, we believe this was a misread and discuss why below.
Beginning October 1st, TLGT shares have fallen almost 40%. Generally, large moves in share prices happen when something majorly negative occurs, like a CRL on its orphan drug or 483 observations on a new injectable facility. However, neither of those things happened. The only significant event was the announcement that management received outside interest from 3rd parties seeking to acquire some non-core assets of the firm.
The market’s reaction to this news was rather interesting. After a brief pop, the stock has more or less fallen in a straight line since the announcement. We believe this implies a significant misread on the part of investors. While we acknowledge that announcing a strategic review of assets at this point could be seen as closing the barn door after the horse has escaped, we think this is a misinterpretation of what happened.
When the strategic review was announced Chief Executive Officer, Jason Grenfell-Gardner, specifically stressed “we remain committed to our TICO strategy, but recognize that in the face of a changing marketplace and inbound interest (emphasis added) in the assets we developed, it’s in our shareholders’ best interest to explore options to monetize these assets. If successful, our intent is to use the proceeds from such transactions to pay down debt and continue our efforts to realize the full potential of our future US sterile-injectable manufacturing capabilities, pending FDA inspection and approval.”
It appears that investors focused on the part about a changing marketplace and interpreted that to mean the company is in worse shape than previously thought. Instead, the second part about inbound interest was more telling. To us, this says the company has real assets that other companies want and are willing to pay for, which is a good thing for a company in a distressed state. Furthermore, we believe management is acting in the best interest of shareholders and fulfilling their fiduciary duty by evaluating the offers that came in.
In the 8K TLGT filed on October 29th discussing the new $34M bond issuance, there was a section regarding the recently announced strategic review that we would like to highlight for investors. Prior to initiating the previously announced strategic review, “the company received unsolicited, preliminary, non-binding offers of $60 million for a portion of the Company’s U.S. portfolio of topical products and up to $45 million for certain foreign assets.” This is not bad for a company with a current EV of ~$200M.
The new loan announced on 10/29/19 is a major piece of positive news for TLGT and shows its continued progress toward putting this dark chapter of the company behind them. While the new loan does remove the refinancing overhang, it comes with a 7% interest rate versus the prior 3.5% rate. Additionally, like the last note, there is a conversion option but it has been lowered to $0.72/share. Given the company’s financial situation, we believe this note is a reasonable financing method and provides additional clarity on funding for the company.
Unfortunately, the new bond transaction does seem to have riled the feathers of existing bondholder, Highbridge Capital Management ('HCM'). HCM sent TLGT a letter on 10/24/19 expressing concern that the above financing would disadvantage existing bondholders, aka themselves. They expressed optimism that TLGT and HCM can find a mutually agreeable solution. We believe HCM is effectively saying that they want their conversions option repriced. While it is difficult to determine how the HCM disagreement will play out, we expect management to continue to do what is necessary to avoid bankruptcy.
On a final note, TLGT still has to maintain the covenants needed to avoid triggering default on the outstanding Ares Note. The most important covenant to watch for in Q3 is a TTM EBITDA of $3.0M. The trailing 9-month EBITDA for the company was $2.7M as of last Q, implying they need just $300K of EBITDA this Q to maintain compliance. We believe this should be easily achievable for TLGT given the disruption in the previous Qs related to the serialization of the EU contract manufacturers which should now be in the rearview mirror. Additionally, on the last call, management said they did not expect further failure to supply penalties which were causing significant financial distress for the company.
Through our due diligence, we did not find any major supply or demand disruptions for TLGT’s main products during the quarter. As a result, we expect a more or less in line quarter which should easily keep TLGT in compliance with its covenants.
On October 28th, TLGT announced the first filing from its new injectable facility. While this was expected by the end of the quarter, the company highlighted that it was delayed due to the recent FDA alert “regarding certain ranitidine medicines, including Zantac, which may contain low levels of a carcinogen called NDMA.” Out of an abundance of caution, management commented that the FDA note led to the company doing additional precautionary tests to ensure its products are within pre-prescribed NDMA levels. We believe this delay was an appropriate decision to ensure no excess NDMA is in its products given the importance of approval of the new injectable facility for TLGT.
The new injectable facility has been a long time in the making and is the most important and strategic asset for the company. As discussed in our previous article, the injectable plant is the linchpin of TLGT’s move toward higher margin, less competitive injectable markets. Management noted in their press release on October 28th that they expect their prior approval inspection to occur within 4 months of the filing. Coincidentally, on the same day, the FDA announced a statement on the root causes of drug shortages and potential solutions. TLGT could not have asked for a more ringing endorsement for their strategy to shift focus toward generic injectables.
The FDA’s Task Force found that “the number of ongoing drug shortages has been rising, and that their impact is likely underappreciated…Shortage drugs were more likely to be relatively low-price and financially unattractive drugs and were more likely to be sterile injectables. Shortages often occurred as a result of disruption in supply due to a variety of factors. Importantly, prices rarely rose after shortages began, and during shortages, production typically did not increase enough to restore supply to pre-shortage levels. Many manufacturers reported discontinuing the production of drugs before a shortage for commercial reasons (e.g., loss of profitability). These results suggest a broken marketplace, where scarcity of drugs in shortage or at risk for shortage does not result in the price increases predicted by basic economic principles.”
This is an interesting observation from the FDA and highlights the need for additional manufacturers in the sterile injectable space. One of the biggest hurdles to producing injectables is building a facility to do so. TLGT is now at the precipice of overcoming this hurdle with news of their first US injectable filing.
The FDA Task Force also recommends several strategies to help improve this ‘broken marketplace’ dynamic. The most relevant for TLGT is the committee’s recommendation to consider “new contracting approaches that help ensure a reliable supply of drugs. This may include providing financial incentives to make certain that manufacturers, especially of older generic drugs, earn sustainable returns on their products.”
In recent years, one of the big headwinds for all generic drug manufacturers including TLGT has been pricing pressure. Yet, the FDA itself is advocating for ways to increase pricing and return profiles to incentivize production of drugs on shortage of which, most are injectables. TLGT’s new injectable facility and its plan to file 13 – 15 aNDA injectable applications over the coming quarters upon completion of the facility inspection puts the company in an ideal position. While an intangible, the fact that the FDA recognizes an issue with capacity and increasing shortages of sterile injectable drugs seems to be a tailwind for TLGT regarding these filings and bringing new state-of-the-art capacity online.
Finally, recall TLGT and the FDA have already agreed to an accelerated review of the first filing which should help the company launch the product around year end. Last quarter, management noted they expected a year-end launch for this drug, but since the injectable filing seems to have been delayed by about 30 days this makes us think that the launch timing may have pushed into early 2020.
As mentioned above, TLGT received unsolicited 3rd party offers for a portion of the company’s US topical product portfolio for $60M and up to $45M for certain foreign assets of the company. TLGT has stated that it will use the proceeds from these potential non-core asset sales to pay down debt. Combined, the company could bring in more than $100M to pay down its ~$170M of outstanding net debt.
Management disclosed they are entertaining offers to sell certain of the company’s foreign assets. The only foreign assets are the Canadian injectable business and an office in Tallinn, Estonia that does R&D and acts as a supply chain for products purchased from contract manufacturers in EU and then sold in Canada. Given the $45M offer price, we believe this comment refers to part or all of the Canadian injectable business.
For demonstration purposes, we assume the company will sell two thirds of its revenue-generating assets consisting of half of the US topical portfolio plus the Canadian business. Given the current enterprise value of TLGT is just under $200M with a market cap of ~$32M, we can infer net debt of ~$170M. If the company sells the assets mentioned above, and they equate to two thirds of the sales of the company, and management uses proceeds to pay down debt, the remaining company would have ~$70M of net debt and roughly $25M in sales. Assuming a 1.5x sales multiple (the same multiple we applied in our last article), the market cap of the Newco should be roughly $37.5M with an enterprise value of roughly $107M.
A competitor, Nexus, recently announced it would spend “$85 million to build and equip a 100,000 square foot, three-story [sterile injectable] production operation, construction of which will begin in August and be completed by 2021.” In 2018, Pfizer announced construction of a 400k sq ft sterile injectable facility in Michigan for a total cost of $465M. TLGT’s injectable facility is 80k sq ft. This gives us a range for the replacement value of TLGT’s injectable facility of roughly $70-95M. Assuming the midpoint of the range, it implies the facility is worth roughly $82.5M. The company has an another 30k sq ft of topical manufacturing space at the same facility which should easily be worth an additional $10-20M. Therefore, using a round number of $100M in asset value (based on replacement cost) for the company’s Buena NJ facility seems reasonable.
The company’s first-to-file complex orphan generic product is another significant asset that has an IQVIA market size of $115M. This product is currently on file with the FDA and has an action date of December 16th, 2019. We believe this single product could be a $12-23M opportunity for TLGT. We base this SAM on TLGT achieving 10-15% of the $115M total market opportunity which is likely low given its first-to- file status. Additionally, the company has 17 TLGT aNDA’s on file with the FDA currently, representing a $1.4B total IQVIA market opportunity. For reference, when the company bought the Canadian assets from Alveda Pharmaceuticals, it paid $47M CAD for $16M CAD in sales and a pipeline of 8 injectable products with nowhere near the total market opportunity as the 17 aNDA’s in TLGT’s pipeline now represents.
Using the same 1.5x sales we assumed above, the company paid ($16M x 1.5 = $24.8M) roughly $25M CAD for the sales of Alveda and another $22M CAD for the pipeline. At current conversion rates of roughly 0.76 CAD/USD, $22M CAD is about $16.5M USD. Knowing that TLGT currently has twice the number of filings that represent at least 2x the relative market size, we think it is fair to value TLGT’s current pipeline at least $20M USD plus another ~$20M for the complex generic currently on file plus the $100M above for the New Jersey facility equaling $140M in remaining assets and ~$70M in Debt.
Bringing this altogether, using the assumptions above, we think the sum-of-the-parts of TLGT is roughly $70M ($240M in current assets – $170M in current debt) after paying off all of the company’s debt or about $1.30/share which is over 100% more than where shares are currently trading. We erred on the conservative side for the value of these assets, so the true value may be well north of what we outlined above.
We at 1035 Capital do not believe TLGT’s management is planning to file for bankruptcy or break up the company and sell its component parts. The purpose of the above exercise was to show the intrinsic value of TLGT and highlight the significant opportunity for investors today. While the sum-of-the-parts value could provide shareholders with an excellent return, we think management’s plan to pivot production to the US injectable market will be worth much more to shareholders over the next couple years.
In our previous article, we highlighted a YE 2021 share price of roughly $2.75, assuming they operate the business as is. If management sold non-core assets to pay down debt, it would actually enhance the operating value of the company due to lower leverage ratios and a faster pathway to higher margins because the upcoming injectable margins would not be diluted by the lower topical margins.
Finally, TLGT has a handful of significant catalysts expected to play out over the next 3 - 4 months that could lead to a significant revaluation of shares. First, the announced filing of the prior approval supplement has triggered a 4-month countdown until the pre-approval facility inspection. We expect this announcement to be a significant catalyst for shares with results by February 2020 at the latest. Second, we should receive Q3 earnings in the next few weeks which we expect will show progress toward the TLGT’s 2019 financial plan and reassure investors the company is comfortably within its covenants and improving operations. Third, the company’s complex generic drug’s FDA action date is Dec 16th, 2019 providing another significant catalyst for TLGT. And fourth, with the ongoing strategic review, we believe management will provide an update on non-core asset sales in 1Q 2020. More information on all these opportunities can be found in our previous TLGT article. While we do not expect the next few months to be care-free, we continue to believe the future looks bright for this generic manufacturer.
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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.