Medicis Has an Earnings Glow

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From Standard & Poor's Equity Research

Solodyn: Fuel for Growth

Key competitors to Medicis' dermatological products include Bristol-Myers Squibb (BMY; S&P ranks strong buy; $28), GlaxoSmithKline (GSK; S&P ranks buy; $51), Johnson & Johnson (JNJ; S&P ranks buy; $62), and Pfizer (PFE; S&P ranks hold; $24). In the facial aesthetics (dermal fillers) market, the company competes against Allergan's new Juvederm dermal filler.

We forecast revenues for 2007 of about $455 million, up from a reclassified $349 million in 2006. The gain should be led by an expansion in key anti-acne and dermal filler franchises.

We believe the company's largest-selling prescription acne product, Solodyn, should continue to fuel above-average growth. Based on recent weekly prescription data, sales of Solodyn are currently annualizing at about $200 million, which we believe is impressive for a product on the market for a little over one year.

Premium priced relative to older competitors at about $360 per prescription, Solodyn sales will benefit, we think, from the company's recent introduction of a Smartcard program aimed at helping patients and pharmacists to adjudicate managed care co-pays, resulting in savings to the patient. More than 10,000 persons have joined this program, with more than 90% of enrollees filling their prescriptions within five days.

Consumer Advertising Push

The acne franchise was recently enlarged with the launch of Ziana. While initial uptake of the product has been somewhat short of our expectations, we think volume will pick up in the second half of the year and come in near the $40 million mark for full-year 2007.

With respect to the dermal filler line, we think the company's key Restylane franchise is performing well despite having to compete with Allergan's Juvederm hyaluronic acid dermal filler, which came on the market in early 2007. By our analysis, Restylane's popularity and customer loyalty have not been significantly impaired by the competition, which has resulted in stronger growth for the overall dermal filler market. In that sense, Restylane has benefited with the rising tide lifting all ships. Medicis' latest dermal filler is Perlane, a thicker and denser formulation of Restylane, which is injected deep into the skin to correct moderate to severe facial folds and wrinkles such as nasolabial folds.

Even though they're prescription products, we view Restylane and Perlane more like consumer products, and as such, we think they should benefit materially from a major ongoing direct-to-consumer TV and print media advertising campaign. Medicis noted recently that it had already received many thousands of hits on its dedicated RestylaneTV.com site. We project combined sales of Restylane and Perlane of close to $140 million this year, up from Restylane sales of $118 million in 2006.

With Allergan now competing with Medicis in the hyaluronic acid-based dermal filler space, we also see Medicis preparing a competing product to Allergan's popular Botox botulinum toxin dermal filler line (estimated sales of $1.1 billion in 2007). This product is Reloxin, which was purchased from French drugmaker Ipsen in March, 2006. The purchase price was $90.1 million in cash, plus an additional $103.5 million contingent on the successful completion of various clinical and regulatory milestones. The deal calls for royalties of 30% on Reloxin sales to be paid to Ipsen.

Price Target: $42

We expect the company to file a new drug application with the FDA for Reloxin during the fourth quarter. Assuming about a 12-month review process, we think the product could be on the market by late 2008 or early 2009. We project Reloxin sales in the $150 million to $200 million range by 2011.

We foresee a modest expansion in gross margins in 2007, reflecting increased sales and a more profitable product mix. We expect selling, general, and administrative (SG&A) costs as a percentage of revenues to decrease, and for research and development spending to decline. We look for the effective tax rate to rise to 36%, from 32% in 2006. We estimate operating EPS of $1.20 in 2007 (after about 20¢ in projected stock-option expense), excluding business development milestones or contract payments. For 2008, we forecast operating EPS of $1.60.

Medicis shares were recently trading at 17.2 times our 2008 EPS estimate of $1.60, and about 2.8 times our 2008 revenue forecast of $530 million. Our projected price-earnings (p-e) multiple reflects a modest premium to peers in the specialty pharmaceutical sector. But on a p-e to projected three-year growth-rate basis, the shares had a price-earnings to growth (PEG) ratio of 1.0, which is a discount to the comparable 1.3 PEG that we estimate for the overall specialty drug industry.

In our discounted free cash-flow model, we assume a beta of 0.8 for the stock, a risk-free interest rate of 5.2%, and an equity risk premium of 5.5%, to derive a current weighted average cost of equity of 9.6%. Our current and terminal weighted average cost of capital is 8.5%, and we assume a terminal growth rate of 2%. Based on our DCF analysis, we calculate an intrinsic value of about $42 per share.

Corporate Governance

Our view of the company's corporate governance is generally favorable. Medicis' board has only one inside director, company founder and CEO Shacknai, and no affiliated outsiders. In addition, both the nominating and compensation committees are comprised solely of independent outside directors.

On the negative side, we believe board independence is somewhat compromised by the dual roles of the CEO and chairman of the board. Another negative we see is a poison pill anti-takeover provision in place. In addition, shareholders are not allowed to call special meetings, and the board may change corporate bylaws without shareholder approval.

Risks to our recommendation and target price, in our view, include the instability of the discretionary cosmetic pharmaceuticals business, especially with respect to higher-end, expensive treatments. Medicis also faces formidable competition from the much larger Allergan in its principal aesthetic franchises. The company is also subject to risks associated with the development and regulatory approval of new products.

We view Medicis as an attractive specialty pharmaceutical company with expanding positions in rapidly growing aesthetic drug markets. We believe the company has arranged a compelling lineup of new high-margined products that will propel robust EPS growth over the coming years. We also see the company as an attractive takeover candidate given its strong cash-flow generation and solid growth prospects.

Analyst Saftlas follows shares of pharmaceutical companies for Standard & Poor's Equity Research Services.