An Appealing Play in Pain Management

S&P sees Alpharma capturing a sizable piece of the transdermal pain-treatment market in coming years and rates the shares a strong buyby Herman Saftlas

From Standard & Poor's Equity Research

Pharmaceutical concern Alpharma (ALO; recent price, 27) in recent years has streamlined its overall corporate structure and paid down a prior heavy debt load, using proceeds from the sale of a slow-growing generics business. More recently, under the helm of a new management team led by Chief Executive Dean Mitchell (who came to the company in mid-2006), Alpharma set course to significantly expand its exposure in the high-margin, specialty, branded pharmaceutical business, with particular focus on the pain-management market.

Building on the success of its Kadian extended-release morphine sulfate pain treatment, Alpharma has expanded its reach in this market through the recent launch of the Flector pain patch, the first topical, nonsteroidal anti-inflammatory drug (NSAID) approved for the U.S. market, and the recent in-licensing of what we see as a promising ketoprofen gel pain treatment.

Boosted by these products, we see Alpharma eventually capturing a sizable piece of a projected multibillion-dollar transdermal pain-management market by 2012. In addition, we expect Alpharma to grow its oral pain-management franchise through the planned launch of Embeda, an abuse-deterrent version of Kadian, as well as new abuse-deterrent versions of oxycodone and other pain treatments.

We view the planned sale of the company's Active Pharmaceutical Ingredients (API) business for $395 million in cash, subject to necessary approvals, as a positive event in enhancing shareholder value. Management recently noted that to remain competitive in the API business would have required significant investments in resources that Alpharma believes, and we concur, are probably better invested in higher-margin, specialty pharmaceuticals or in buybacks of the company's common stock.

Despite the recent runup in the shares, we still believe Alpharma offers attractive value. We also think Alpharma also offers a measure of takeover appeal at current levels. Our recommendation is 5 STARS (strong buy).

Company Profile

New Jersey-based Alpharma produces and markets pharmaceutical products for human and animal health markets. In 2007, animal health products accounted for 51% of revenues and operating income of $72.6 million; active pharmaceutical ingredients for 26% of revenues and operating income of $34 million; and pharmaceuticals for 23% of revenues and an operating loss of $61.5 million (largely reflecting a $60 million in-licensing payment for ketoprofen gel). About 72% of 2007 revenues were derived from the U.S., 8% from Denmark, 2% from Norway, and the remainder from other countries.

Alpharma's animal health business produces medicated feed additives and water-soluble therapeutic-type products for poultry, cattle, and swine. The global medicated feed market is estimated at about $1.6 billion. Animal health products primarily consist of anti-infectives such as bacitracin and chlortetracycline that are added to the feed and water of livestock and poultry. Although this is a relatively slow-growing business, operating margins of 20% have been maintained in recent years, as Alpharma has maintained its No. 2 position in the medicated feed market.

Pharmaceuticals presently consist of two products: Kadian, an extended-release morphine sulfate product, and the Flector pain patch. Kadian was in-licensed from F. H. Faulding & Co. in 2006 pursuant to a perpetual, royalty-free license. Sales of Kadian increased 21%, to about $168 million, in 2007.

Representing the first prescription topical NSAID approved by the FDA, the Flector patch delivers anti-inflammatory analgesic effects of diclofenac epolamine to treat acute pain associated with minor strains, sprains, and contusions. Alpharma purchased Flector from Institut Biochimique, a Swiss drug company, for $100 million in cash, plus certain other patents, in August, 2007.