Endo Pharmaceuticals ENDP
June 25, 2002 - 1:27pm EST by
kurran363
2002 2003
Price: 5.40 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 1,300 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

ENDP was posted 6 months ago by Evan73. However, a lot has changed since then, and the stock is a lot cheaper, so I am reposting it.

RECENT EVENTS
Yesterday, ENDP announced disastrous results from one of its key drugs, MorphiDex. The results sent the stock down 46%. I believe the stock is a tremendous bargain right now.

ENDP is a unique opportunity to buy a pharmaceutical company with a couple potential blockbuster drugs without taking any of the normal “pharmaceutical-stock” risk. Unlike most small cap "specialty" pharmaceutical or biotech companies, ENDP makes money currently and has a full sized sales staff of nearly 250 sales people (which depresses current results). Many small cap pharma's like AEGN, ALKS, ARDM, ILXO, INHL, KISP, SKYE do not make money and their valuations are based on hope for the future. ENDP has similar hope, but it also makes money now.


RELATIVE VALUATION

ENDP trades at 6.7x this year's EBITDA. The average larger cap specialty pharma company that actually makes money (including AGN, BVF, ELN, FRX, KG, and MRX) trades at 15x EBITDA. When compared to small cap specialty pharma's ENDP is by far the cheapest because it actually makes money. When compared to larger cap pharma's (which is unfair due to ENDP's much bigger growth potential) ENDP is still one of the cheapest in the industry and trades at a discount to the industry average. Yet, despite the large cap pharma’s higher valuations, I don’t believe any of these companies have nearly the growth potential of ENDP.

THE UPSIDE:

More important than the relatively attractive current valuation is the future earnings power of ENDP and the relatively near term timing of those earnings. ENDP will be filing a big drug (Oxymorphone) with the FDA in approximately 4 months. The company will be releasing the clinical trial data for Oxymorphone in August. ENDP will also be in a position to launch a $1.5 billion generic this coming March. These drugs could more than double ENDP’s sales in the next couple of years.

HISTORY:

Founded in the 1920s, its flagship drugs (Percocet and Percodan) have been on the market for more than 30 years. Despite facing generic competition for more than 15 years, Percocet 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.

MARKET:

Endo sells Percocet, the 'gold standard' for treatment of pain; Lidoderm, a lidocaine patch; and several other 'pain' drugs. The broadly defined pain treatment market is over $13 billion per year and has been growing 25%+ per year. That includes everything from morphine based and codeine based prescription drugs to aspirin. The Codeine segment, where Percocet resides, is over $2 billion. However, almost the entire opioid analgesic market is generic. There have been NO NEW OPIODS invented in over 20 years! The market would probably be 4-10x bigger if it was "branded," so for new branded drugs the opportunity is equivalent to a $50-$100 billion industry. Everybody in the world has used or will use pain medication. The market will never go away and will likely continue to grow as long as world population grows. The aging population also is spurring growth.

CURRENT RESULTS:

Up until 3 years ago, Percocet had been a no growth cash cow. With 90% of all Oxycodone/Acetaminophen prescriptions written as "Percocet," the brand is dominant. However, 85% of all prescriptions are filled generic. Thus Percocet has maintained a small relatively steady market share with high margins and no R&D or marketing expense. After current management acquired the company, they re-invigorated Percocet by introducing new formulations that had no generic competition, and ENDP took back much market share and grew revenue dramatically. Last year, generics were introduced for the new lines and they started to lose share again. Last November, ENDP introduced more new formulations and in just a few months have already won back the recently lost market share. Percocet market share and sales should continue to grow for at least the next two years with no generic competition.

Lidoderm is their other major drug. It is a lidocaine patch and was introduced in 9/99. The drug was originally rejected by the FDA. ENDP then acquired the rights to the drug, believing they could get it approved. They did, and the drug has been extremely successful and is growing rapidly. They currently have a 20% market share and growing. Lidoderm has orphan status and so will not face generic competition until at least 3/06.

ENDP's other drugs are a few generics (including generic Percocet) and some small branded drugs.

PIPLELINE:

MorphiDex
MorphiDex was supposed to be one of their big revenue drivers. However, due to recently announced results MorphiDex is likely worthless. They are continuing to do trials for it, so any positive results would be purely upside.

Oxymorphone
ENDP also has a drug called Oxymorphone that they will file this year. This drug could be very big. It could easily do over $300mm in sales in a couple of years. They own 50% of the drug, and the other 50% is owned by a publicly traded company, Penwest Pharmaceutical ("PPCO"). I also own PPCO stock and think it is a great investment. I posted it on this board as an idea a while back, so if you want more discussion, you can read that post (which I of course think is worth reading).

Oxymorphone is basically PPCO's only valuable asset, so most of its market cap is related to Oxymorphone. Thus, we know exactly how the market is valuing Oxymorphone. ENDP’s market cap is currently ascribing no value to it’s Oxymorphone, despite a readily ascertainable market value. In addition, I believe the current market cap is much too low for Oxymorphone.

Oxymorphone is already currently available on the market in suppository form. ENDP owns and markets the drug, but the suppository market is tiny. It is already proven to work safely and effectively. So, the clinical risk is very low. We already know it works.

OPPORTUNITY:

The extended release and immediate release oral formulation of Oxymorphone will compete in the moderate to severe pain area. It will compete against other controlled-release opiod pain medications. Currently there is only one drug that dominates that category -- Oxycontin (by Purdue Fredrick). Oxycontin is a $1.5 billion drug. The opportunity here is two-fold: 1) Oxymorphone should be able to compete in an enormous, relatively uncompetitive market simply by being the first “new” opioid introduced in the US in over 20 years 2) and more importantly, Oxymorphone overcomes some the serious problems of Oxycontin.

Oxycontin currently has a serious publicity problem. Tens of thousands of people in the US are addicted to it. Addicts say it is better than herione. For a while there was a story in some newspaper in the US almost every week about the problems of people dying from over-doses of this drug. Despite $1.5 billion in sales, doctors across the US are scared to prescribe Oxycontin. They do not want to support drug addicts and they do not want any over-dose deaths on their hands.

The Timerex extended release technology, from PPCO, makes the pill much more difficult to abuse than Oxycontin. For this reason alone, Oxymorphone should take significant market share from Oxycontin. The Timerex technology cannot be disolved in water so it cannot be injected and snorting it is more difficult. I can go into more details on the specifics of these benefits later.

Oxymorphone will finish clinical trials in the next few months and will file with the FDA then. If it takes the normal approximate 1 year review time, Oxymorphone should be launched by the end of 2003.

If Oxymorphone can achieve a not-aggressive 20% market share from Oxycontin, they will do $300mm in sales. The drug will have approx a 90% gross margin.

Generic Oxycontin

ENDP is a first to file on generic Oxycontin. Even with all the negative press recently, Oxycontin did $1.5bln in revenue last year.

The generic Oxycontin suit is a Paragraph 4 lawsuit. It seems that paragraph 4 patent suits are fairly rare but recently a number of them have been won. Win/loss seems to be running at better than 75/25 for recent decisions. It seems the generics usually don't undertake the expense of the research and the lawsuit if they don't think they will win.

ENDP will be in a position, legally, to launch generic Oxycontin in March '03, when Purdue Fredrick's 30 month Wax Hatchman grace period ends. I’m not sure they will actually launch then, it depends on the status of their lawsuit.

CURRENT VALUATION:

Share outstanding: 130mm shares (includes all dilutive warrants)
Enterprise value: $676mm.
>
2002 Sales: $300
2002 EBITDA: $100mm
2001 EPS: $0.40
>
EV/EBITDA= 6.7x
P/E = 13x

FURTHER VALUATION:

On a relative valuation basis ENDP is by far the cheapest pharmaceutical company in the industry. Normally, biotech and pharmaceutical companies do not trade at levels that ordinary “value investors” would even look at. However, at 6.7x EBITDA and 13x current earnings, ENDP could very easily stand as a decent “value” investment; with its Percocet franchise and its high margins. However, the current results do not reflect any contribution from the two big drugs that will come to market in the next 12-18 months. These drugs will make an already cheap valuation absurdly cheap.

DETAILED VALUATION:

The company will do about $100mm of EBITDA in 2002 on revenue of $300mm, just from existing drugs. Percocet is probably 40% of that and Lidoderm is probably another 30%. Lidoderm is growing very fast and penetration is only 20% right now, and ENDP is trying to expand the labeling into new areas. So growth is still big there. While new Percocet lines are doing well, recent share gains (and this year's and next year’s expected further gains) will eventually be taken back by generics. So, the $100mm in EBITDA will probably grow a little next year and be steady after that, given the two off-setting factors.

On a stand-alone basis, the existing EBITDA is worth at least 6-8x, (probably low given the brand value of Percocet, the growth in Lidoderm and the average industry multiple of 15x). R&D of about $40mm is included in that EBITDA, but it is not spent on existing drugs. R&D is just capex for new drugs. So, existing drugs actually produce about $140mm of EBITDAR, or pure operating cash flow. ENDP will finish clinical trials on their two big drug platforms, MorphiDex and Oxymorphone, this year so R&D should fall significantly next year if they don’t start on new drugs.

If you give a modest 6.0x multiple to the $140mm of cash flow, you get $840mm in value for existing drugs.

ENDP's 50% ownership of Oxymorphone is being valued at approximately $235mm, based on Penwest's (PPCO) current market cap and backing out the value of their other business, (I put the value of the other business at $60mm). So, there is no guesswork, that's what the market says it’s worth and that's what you can buy it for or hedge it right now.

Generic Oxycontin could be big. Typically generic sales are easy to predict and have no “market” risk. Generics normally take over 50% of the market in their first 6 mo's and as much as 80%-90% a few years out (like generic Percocet). That means ENDP's generic could easily do a run-rate of $300mm in sales within a year (only assuming 20% of the $1.5bln in sales of Oxycontin), given their first to file status. With expected margins of approximately 35%-40% for this kind of generic drug, that gives $105mm-120mm in operating profit, $65mm-75mm after tax. Since generics don’t command high multiples, I apply a very conservative range of 3.5x-5.0x operating profit (a modest 5.5x-8x after tax earnings) or about $370-$600.

Because of the uncertain timing of the legislation involved in Paragraph 4 generic lawsuit, Wall Street Analysts have given ENDP zero credit for this drug. A first to file on a $1.5 billion generic, worth nothing? Seems illogical.

If you give a modest 50/50 chance of victory in their Paragraph 4 generic lawsuit, then the expected value of the generic Oxycontin is (0.5)*450=225. The current market cap of ENDP ascribes no value to this drug.

SUMMARY:

Sum of the parts:
+840 -- value existing earnings
+235 – value of Oxymorphone
+225 – value of generic Oxycontin
=1,300 million = $10.00/share.


So, as you can see, the cash flow from the existing franchise is worth MORE than the current market cap. You get two potentially big drugs, Oxymorphone and generic Oxycontin for FREE – despite already knowing the current market value of Oxymorphone.

And I believe the current market value of Oxymorphone is too low. I believe ENDP’s share of Oxymorphone will be worth at least $500mm when it gets approval. So even further upside exists there.

You also get all other future products for FREE. They have several other generic filings, including a generic suit for the multi-billion dollar Paxil drug. They also have a full R&D staff working on new drugs. These other future opportunities are difficult to quantify in terms of chance of victory or timing, so although their R&D efforts clearly have value, I have ascribed an absurdly low value of ZERO to all future products.


UPSIDE:

Potential new Sales:
+$300 Oxymorphone
+$300 Generic Oxycontin
= $600mm

Assuming an expected 90% incremental operating margin for Oxymorphone (less the 50% profit split), and a 35% margin for the Generic Oxycontin

= $240mm of Additional Operating profit from new drugs

= $1.10/share in additional fully diluted earnings
+ $0.40/share of current earnings
= $1.50/share of earnings.

This could be the run-rate earnings by 2004.

At 20x earnings (the large pharma average), the stock would trade at $30.

CONCLUSION:

Risk/reward is tremendous. With consistent earnings and cash flow, no net debt, and a low valuation, downside is practically zero, but upside is easily to $30/share.

Because of ENDP’s existing earnings power and relatively low valuation, ENDP offers “biotech” upside, with worst-case-scenario downside similar to normal “value” investments.

CATALYST:
Two drugs of hundred million+ dollar potential could be approved in the next 18 months.

August ’02 = release of Oxymorphone trial data
Q3 ’02 = Filing of NDA for Oxymorphone
Q1 ’03 = Approval (or rejection) of Generic Oxycontin
Q4 ’03 = Approval (or rejection) of Oxymorphone

Catalyst

CATALYST:
Two drugs of hundred million+ dollar potential could be approved in the next 18 months.

August ’02 = release of Oxymorphone trial data
Q3 ’02 = Filing of NDA for Oxymorphone
Q1 ’03 = Approval (or rejection) of Generic Oxycontin
Q4 ’03 = Approval (or rejection) of Oxymorphone
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