Endo Pharmaceuticals ENDP
December 24, 2001 - 10:04pm EST by
2001 2002
Price: 11.35 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 1,141 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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In the last 30 days, a new FDA approval boxed out Endo's generic competition, and the company showed confidence in its pipeline with a buyback offer for 13.5 million warrants that would expire worthless without FDA approval of their main pipeline drug (MorphiDex - in Phase 3 trials).

Founded in the 1920s, its flagship drugs (Percoset and Percodan) have been on the market for more than 30 years. Despite facing generic competition for more than 15 years, Percoset is still widely prescribed by doctors and enjoys a high level of public recognition and trust. After selling to Du Pont, Endo ended up a division of a Merck/Du Pont joint venture and was taken private in a 1997 management buyout. In July 2000, Endo acquired Algos Pharmaceuticals. The transaction made them public again.

Endo sells Percocet, the 'gold standard' for treatment of pain; Lidoderm, a lidocaine patch; and other 'pain' drugs. The broadly defined pain treatment market is over $13 billion per year. That includes everything from morphine based and codine based prescription drugs to aspirin. The Codine segment, where Percocet resides, is over $2 billion.

New Formulations
On November 26 the FDA approved two new formulations of Percocet. Doctors had been clamoring for new formulations because Percocet contained 500 to 650mg of acetaminophen, which has side effects (kills your liver). The new formulations contain 325mg, up to 50% less, yet have the same oxycodone strength. This is safer, allows the patient to take fewer tablets per day, and is less costly for hospitals to administer.

Doctors were writing fewer Percocet prescriptions until recently. November's 705,000 Prescriptions was less than the 726,000 to 823,000 range in the prior six months. The reduction was due to generic competition, largely from Watson Pharmaceuticals who has been knocked out of the box by the lower acetaminophen version. Endo's window until reformulated generics arrive should be at least 2 years, allowing Endo to take back market share.

IMS data showed 12,000 prescriptions of the new formulations for the initial week after approval (which was only a partial week for Endo due to timing and logistics after the approval). Although 12k is small, it is very telling about how much demand exists for the lower acetaminophen versions. They should have done zero prescriptions. The new formulations are not being "launched" until January and the salesforce had not yet made the rounds to inform doctors. I view the 12,000 as coming from alert doctors who were acting on their own. I predict that the Dec & Jan data will show a fast ramp up because the Percocet brand is already so well known.

Pipeline - MorphiDex
In phase 3 trials, MorphiDex promises to amplify the effectiveness of painkillers. This has two big benefits. First, it allows a given amount of pain to be treated with a lower dosage of medicine. And second, it makes pain killers LESS addictive to the patient due to the lower dosage. MorphiDex has billion dollar sales potential because it could be perscribed as a "take along with..." drug for the entire range of pain management prescriptions. Announcement of Phase 3 results is expected for late March or April. FDA filings should be done by summer and the FDA already said they will give MorphiDex "expedited review" status. Revenues could kick in by early 2003.

Warrant Buyback
Endo recently offered to buy back 13.5 million of its outstanding warrants at 75 cents each, an outlay of over $10 million if all warrant holders tender. The warrants would convert into 4.7 million shares of ENDP if MorphiDex receives FDA approval by end of Q1 2003. If not, they would expire worthless. The offer shows management's confidence in the product and their willingness to protect their stock from dilution. Management owns 10% with options to get to 20%. Large holders include Third Point, Greenlight, and Chilton.

Sales Ramp
The new Percocet formulations should ramp quickly and add several hundred million to sales by 2003. MorphiDex could really make the stock move if the data released by Spring 2002 spins positive. Plus, the company has put its money where its mouth is through the buyback offer. TTM sales are $250 million. The ingredients are in place for analysts to start modeling $750+ million in sales for 2003 (roughly $200m Percocet, $100m Lidoderm, $400m MorphiDex, and $50m generics and others). Currently sell side models have MorphiDex doing far less sales because it has not yet received approval. However, analysts note that they expect to up these figures significantly if the spring MorphiDex data confirms what the buyback implies.

In this space, comps trade at ludicrous multiples of 20x 2002 EBITDA and 18x 2003. Sidestepping discussion of why they are not worth it... If Endo can show real strength in its pipeline and get the analysts forecasting rapid sales growth, it will get a premium to the group.

Endo's story largely rests on MorphiDex receiving FDA approval. Although I do think they will eventually get approval (maybe late Q3 2002), I am even more certain that there will be opportunities to sell stock into the inevitable hypefest that will precede the FDA decision this spring and summer at prices approaching $20.


Recent FDA approval provides growth and wards off generics; Warrant buyback shows confidence in pipeline; Study data out by Spring.
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