We believe Actavis (ACT) is a high quality asset led by a management team with a track record of value creation that is mispriced due to technical factors and other short-term noise. As these abate and ACT delivers on the promise of the recently acquired Allergan asset, we expect earnings estimates to rise and the multiple to re-rate. This could propel ACT to $400 over the next 18 months, ~35% upside from current levels. Furthermore, the management team could create additional upside by deploying its balance sheet, as it has successfully done in the past. Under this scenario, ACT could be worth as much as $450 offering ~50% upside. At less than 13x our 2016 estimates, a ~20% discount to the S&P 500, the risk of capital impairment is limited, making this an attractive position for the medium term.
ACT is the product of a tremendous transform over the last 8 years led by current executive chairman Paul Bisaro. Formerly known as Watson, ACT has completed a series of deals – Arrow Group (2009), Specifar (2011), Ascent (2012), Actavis (2012), Warner Chilcott (2013), Forest (2014) and Allergan (2015) – that has transformed it from a US generics company to a global, diversified pharmaceutical company.
Post the close of the Allergan transaction, ACT’s key therapeutic areas include the central nervous system, dermatology & aesthetics, ophthalmology, women’s health and gastrointestinal, none of which makes up more than 15% of total sales. Its key products include Botox, Restasis, Namenda, Lumigan and various facial aesthetics products, with Botox the largest at ~11% of total sales and no other product >5%. ACT is ~80% US and ~20% OUS. Within the US, sales are ~65% branded, ~25% generics and ~10% distribution. ACT’s diversity limits the risk from any one competitive threat or regulatory change.
In addition to having a diversified portfolio, ACT’s portfolio does not face significant headwinds in the near term from patents expiration (i.e. it is long duration). For the ~50% of sales that are US branded products, where patent expirations matter the most, we believe that after Namenda goes generic this summer (see Risks section), no major product will face generic competition until 2020. ACT has also disclosed the average patent life for its major therapeutic areas ranges from 2020 to 2030+.
Paul Bisaro is the executive chairman of ACT, a role that he assumed upon the close of the acquisition of Forest. Prior to that, Bisaro had been CEO of ACT since September 2007. From 9/30/07 to the present ACT returned ~800%, over 10x the S&P 500’s return during that time period. Bisaro directly owns ~400K shares or ~$120M at current prices.
Brent Saunders has been CEO of ACT since it merged with Forest in 2014. Brent has a similar track record of success, first at Schering Plough, then Bausch & Lomb and finally Forest. In all instances he oversaw turnaround efforts and major deal integrations.
Valuation & Standalone Return
Management is targeting 2017 adjusted EPS of $25. Our bottom up analysis suggests this is conservative as does management’s prior track record – since Bisaro joined the company they have met or beat consensus estimates every quarter. We model ~$27 of EPS in 2017, which implies that ACT is trading at ~11x at current prices.
ACT does not have a pure play comp, so we compare it to 3 types of pharmaceutical companies – Generics (MYL, TEVA), Specialty (ENDP, JAZZ, MNK, PRGO, SHPG LN, VRX) and Large Cap (AZN LN, BMY, GSK LN, LLY, MRK, NOVN VX, PFE, ROG VX, SAN FP). On 2017 consensus estimates, ACT is the cheapest of all of these in spite of 2017 revenue growth and EPS growth that is in the top 3rd overall and best in class among Large Cap other than BMY which trades at >20x earnings.
Median P/ Adj. E
2017 YoY Growth
Large Cap Pharma
If ACT is on path to achieve our $27 EPS forecast and it eventually trades at 15x NTM EPS, we believe it could be worth ~$400 within 18 months.
Potential Returns with Capital Deployment
Our 2017 estimates assume that ACT uses free cash flow exclusively to pay down debt, which would take debt to EBITDA from ~4x currently to ~1x by the end of 2017. If ACT maintains ~3x debt to EBITDA it will have an additional $33B to deploy over the next 2.5 years. Assuming it can invest this at ~12x PF EBIT, with a 15% tax rate and 3% after tax borrowing costs, ACT could generate ~$3.50 of additional EPS. $30.50 of adjusted EPS at 15x = $457.50
US corporate tax reform
ACT benefits from having a lower tax rate than many of its peers. While the risk from additional regulations from the US Treasury is minimal, comprehensive Congressional legislation to lower the overall US tax rate and/or reduce the amount of US income foreign companies can shield with internal interest expense would negatively impact ACT. We believe the earliest any action could come would be in 2017, after the next presidential election, and that action remains unlikely given the political divisions on the issue.
Namenda loss of exclusivity
Namenda, a ~$1.8B product in 2014, will lose exclusivity in July of 2015. ACT is currently switching patients to next generation formulations and as of early May had switched ~50%, but there won’t be visibility on the final impact until 2016. Our 2017 estimates include $1B sales or ~$1.30 EPS from Namenda. So, in the event that the switch goes poorly only a $1 of EPS is at risk.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.
We believe that ACT trades at a material discount to peers and the overall market for two reasons. First, it is a relatively new name for many investors (18 months ago it was 1/4th the size), and given the flurry of recent deal activity they want to see the company execute before getting involved. Second, “fast money” which had been involved with the name during its deal run has now left to play other names like PRGO, MYL and TEVA. Therefore, continued progress in integrating the Allergan assets demonstrated by “beat and raise” quarters, like the one they reported on 5/11, and FCF generation to pay down debt should be significant catalysts.
Other than that some of the potential key catalysts we watching for are:
ACT becomes sole provider of generic Concerta (May 2015)
Actavis changes name to Allergan (June 2015)
FDA responds positively to applications for Eluxadoline and Cariparzine (Q2 2015)
Impact of Namenda loss of exclusivity becomes clear (Q4 2105)
ACT holds investor day to walk through the new company (Late 2015/early 2016)
ACT issues 2016 guidance which suggests street estimates of $21.40 are beatable (Early 2016)