August 24, 2020 - 3:50pm EST by
2020 2021
Price: 16.32 EPS 4.38 4.00
Shares Out. (in M): 517 P/E 3.72 4.08
Market Cap (in $M): 8,250 P/FCF 3.3 4.7
Net Debt (in $M): 11,900 EBIT 0 0
TEV ($): 20,000 TEV/EBIT 0 0

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Large generics and specialty pharma manufacturer that has faced one challenge after another since 2015.  Currently trading at less than 4x earnings due to number of reasons including leverage, skepticism about the generics market, possible liability from ongoing litigation and a pending acquisition that will lead to downward revisions of 2021 estimates.  But after several years of issues, it appears that the company has returned its core business back to growth and will be able to pay down debt quickly once the pending PFE deal closes.    

Why it’s cheap

The stock has been a horrible investment since 2014/2015, when it looked like most of the problems began (or at least started coming to light).  At the time, the company has exclusivity on the blockbuster EpiPen allergy medication.  Given the rapid uptake of the drug and lack of competition, the company continually pushed pricing and showed rising margins, but they didn’t provide quite enough detail to figure out how exactly how much of the profit came from the drug, and consequently, how much was at risk when competitors finally arrived.

At the same time the company, along with other generics manufacturers, were riding high as the US generic market was still growing double digits on the heels of several blockbuster drugs going off patent in the 2010-2014 timeframe.  Not only were there many new drugs to target, a rising backlog at the FDA limited the number of new entrants further protecting profits.  In addition, there appears to be good evidence (given the number of lawsuits from the DOJ and states) that the industry was colluding on price for commodity generics. 

Then the industry started to change.  A law passed in 2012 provided additional funding for the FDA to help clear the drug approval pipeline with program goals going into effect in 2015.  Approvals, which had been running at 400-600/year, began to increase rapidly with over 800 approved in 2018 rising to over 1,100 in 2019, with the majority going to drugs that already had generic competition.  The result being that commodity generics profit margins likely came under stress.  Generic price erosion accelerated, and the overall market declined in 2016 and 2017.  To make matters worse for the drug manufacturers, their customer base consolidated.  From 2012 to today, various joint ventures and acquisitions have led to approximately 90% share being sold to three large buying consortiums: Red Oak (formed as a JV between CVS and Cardinal in 2013), Walgreens Boots and McKesson.  As early as 2015 Sandoz began talking about consolidation in the chain and the rising competitive environment impacting their US generics business. 

Mylan, facing erosion in the US generics business and looming competition in EpiPen, continued their strategy of growing through acquisitions (and leverage).   In 2016, after failing to buy Perrigo in 2015, the company bought Meda, leaving the balance sheet levered around 4x.  The company hit its initial 2017 guidance but didn’t generate meaningful cash flow as net debt exiting the year was flat with when they entered.  They guided 2018 to over 10% EBITDA growth but had to cut numbers after Q2 as they faced manufacturing issues, product delays, competition in US generics and continued erosion of their EpiPen sales.  North American sales fell 12% in 2017 and a further 17.5% in 2018 as they dealt with the various issues and exited some of the less profitable generics programs.  From its peak in 2015 the stock fell from $70 to under $30 at the end of 2018 with the forward 12 month PE falling from 16x to under 6x. 

In 2019 the company set a low initial bar with EBITDA and EPS guidance coming in well below street estimates after admitting they need to increase expenses to invest in the business. Then they missed Q1 estimates on weaker sales in Europe but maintained guidance.  On that miss the stock fell to the low 20’s and ultimately drifted down to current levels (high teens).  For the remainder of the year, however, the company was able to grow sales in both North America (for the first time in two years as generics pricing declines stabilized) and Europe, and it looked like things were beginning to get back on track. 

With the US business past the trough and issues in Europe behind them, the stock recovered a little to the low 20’s.  At that point it looked like they would be able to start growing earnings again with the major overhang now being leverage and potential litigation as the government went after the industry for price fixing as well as their part in the opioid crisis (although they were never a big player in opioids). 

I have seen recent estimates putting their potential settlement at $2bn using Taro and Sandoz’s recent agreements. (Street estimates seem to range from 1-3bn)  These estimates looked at volumes and grossed up those smaller settlements to the volume of drugs MYL sold.  I’m not sure anyone knows at this point but believe even a $2bn settlement could be manageable given expected cash flow.  

New acquisition will help the balance sheet but created another near-term risk

In July 2019, the company announced they would merger with Pfizer’s Upjohn business.  UpJohn is PFE’s off-patent business that manages drugs that no longer have, or are in the process of losing, patent protection.  Given high pricing and limited upside to investing in drugs that don’t have exclusivity, the business generates high margins and is expected to throw off substantial cash flow.  The stock traded up on the deal as it will lower leverage ratios and the subsequent cash flow can be used to right-size the pro-forma balance sheet.  It did, however, create another overhang for the stock. Pfizer shareholders will own over 50% of the outstanding shares post-closing and could create a lot of selling pressure.  In addition, the pro-forma company will have lower EPS in 2021 versus current stand-alone street estimates for Mylan, meaning you have one more round of downward revisions coming. 

2021 guidance is expected early next year and management has called it a trough year.  Current sell-side estimates of $7bn in EBITDA for the combined company were deemed directionally by the company.  The pro forma entity would come in above that this year but they will lose sales as Lyrica faces competition in Japan and China pushes through price cuts.  On the deal closing, I expect pro-forma models to take down current MYL 2021 estimates from the current $4.50 range to around $4.00. 

Could see substantial upside after they get past the initial 2021 guide

Beyond 2021 the mgmt. team expects to hold the topline flat while generating $1bn in cost savings (could be up to $0.65 to earnings on an approx. $4.00 base) and generate $4bn in FCF per year allowing leverage to fall below 2.5x by year-end 2021.  If they get there, they would have a flat to slightly up topline, substantial free cash flow, a reasonable balance sheet and EPS growing off of a $4.00 base vs. a current stock price of $16.50.  Even an 8-10x multiple on those numbers would provide substantial upside from here.      

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


Deal closing and 2021 free cash flow guide

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