Mylan (MYL) has undergone a corporate metamorphosis that has transformed the company from a U.S.-only midsize generic drugmaker into the third-largest player in the over $70 billion global generics market. This has been accomplished principally through the acquisitions of the generics division of German drugmaker Merck—not related to U.S.-based Merck (MRK) for $6.9 billion in October 2007 (Merck Generics); and Matrix Laboratories, an India-based manufacturer of active pharmaceutical ingredients in January 2007 for about $776 million.
Prior to these deals, we believe Mylan was competitively disadvantaged relative to rival generic firms such as Teva Pharmaceutical Industries (TEVA) and Barr Pharmaceuticals (recently acquired by Teva), which had already established strong presences in international markets. However, we think Mylan's recent expansion moves have provided product and geographic diversification to cushion the volatility that has characterized the company's former business model that focused only on U.S. generics.
The Merck Generics business provided entry into European markets that should see rising generic utilization rates, by our analysis, while we believe Matrix has given Mylan a secure and inexpensive source of active pharmaceutical ingredients, the basic raw materials used in pharmaceuticals. In addition, as the company successfully integrates the recent acquisitions, significant cost reductions and synergies should accrue. Annual merger-related savings, estimated at about $100 million in 2008, are expected to reach $300 million in 2010, in our view.
Mylan's key objectives are to successfully integrate Merck Generics, and capitalize on the company's strengths of global reach and vertical integration. Mylan also plans to focus on difficult-to-develop generics and specialty pharmaceuticals. The company also seeks to be the first generic company to penetrate a new market or capture a new product opportunity, such as obtaining first-to-file status with 180-day exclusivity in the U.S. Mylan expects Merck Generics to be dilutive to cash EPS in year one, to break even in year two, and to be accretive thereafter.
While MYL shares, which recently traded at around 12, have rebounded nicely over the past two months, they are still well below previous highs. Based on our discounted-cash-flow-derived target price of 15, we believe they offer significant appreciation potential. The stock carries Standard & Poor's highest investment recommendation of 5 STARS (strong buy).
A long-established Canonsburg (Pa.) manufacturer of generic pharmaceutical products in finished tablet, capsule and powder dosage forms, Mylan significantly expanded its sales base with the 2007 acquisitions of Merck Generics and Matrix Laboratories. Generic drugs are the chemical equivalents of branded drugs, and are marketed after patents on the primary products expire. Generics are typically sold at prices substantially below those of comparable branded products.
Including the acquisitions, total operating revenues for the nine months ended Sept. 30, 2008, totaled $3.4 billion, and were divided as follows: North American generics 37%, European generics 34%, Asia/Pacific generics 12%, specialty drugs (Dey) 9%, and Matrix Laboratories 8%.
Mylan's U.S. generic division markets about 180 generic products—primarily solid oral dose drugs encompassing some 50 therapeutic categories. Some 16 generics are extended-release drugs. The company's UDL Laboratories is the largest U.S. repackager of pharmaceuticals in unit-dose formats, which are used primarily in hospitals, nursing homes, and similar settings. Mylan Technologies develops and markets products using transdermal drug-delivery systems.
Merck Generics markets over 400 generic products, and had estimated sales of close to $1.6 billion in the first nine months of 2008. The operation has a strong presence in key foreign generic markets, including Australia, Britain, Canada, France, and Japan. Under terms of the acquisition agreement, Mylan has rights to purchase German Merck's generic businesses in 17 additional countries in Latin America, Europe, and Asia until October 2009.
As part of the Merck Generics acquisition, Mylan also acquired Dey, a producer of branded specialty respiratory and allergy drugs. Key Dey products are EpiPen, an epinephrine auto-injector treatment for allergic reactions; and Perforomist, a nebulized formoterol fumarate maintenance treatment for chronic obstructive pulmonary disorder (COPD).
Matrix Laboratories is the second-largest maker of active pharmaceutical ingredients (APIs) in the world, producing high-quality APIs for Mylan's own generics, as well as for third parties.
As of January 2009, Mylan had some 119 generic product applications pending at the FDA (including Matrix products), representing products with estimated branded sales of about $75 billion. Of the applications, 33 represent potential first-to-file opportunities with six months of marketing exclusivity. Mylan filed an estimated 70 ANDA submissions with the Food & Drug Administration in calendar 2008. Key pipeline products, in our opinion, include generic formulations of Actos type 2 compound, Lamictal for bipolar and epilepsy, Benicar cardiovascular, Copaxone for multiple sclerosis, and Crestor cholesterol regulating agent.
We believe key near-term growth drivers include generic versions of Depakote ER treatment for bipolar and epilepsy, Keppra anti-epileptic, Paxil CR antidepressant, and Sular anti-hypertensive agent. Fentanyl, a generic version of the Duragesic transdermal pain patch, remains a key product for Mylan, although we think it may see greater competition in this market during 2009. In total, we believe Mylan has launched close to two dozen new generic products since late 2007.
The acquisition of Merck Generics was initially financed through borrowings of close to $7.3 billion. Much of that debt has been refinanced, with the first major debt repayment of $600 million not due until 2012. As of the end of September 2008, Mylan's long-term debt amounted to $5.2 billion. Cash and equivalents totaled $656 million at that date.
Although growth in the global generic drug market has slowed from past double-digit gains under a weakening worldwide economic environment and intensified price competition, we still expect generics to outpace comparable growth in the branded drug sector, reflecting greater emphasis on the use of inexpensive generic therapies, both in the U.S. and abroad. We also think pricing trends in certain therapeutic classes may firm as the number of key players in the sector has grown smaller after several major mergers, and many generic facilities around the world have recently been shut down because of manufacturing problems.
But we believe the strongest impetus for growth in this sector should come from a relatively large number of branded blockbuster drugs that are scheduled to lose patent protection over the coming years. IMS Health, a provider of health-care data, identified $24 billion in branded sales that will face generic competition in 2009, with that total estimated at $33 billion in 2010, $33 billion in 2011, and $30 billion in 2012.
Some of the larger drugs scheduled to lose patent protection over the 2009-12 period include Johnson & Johnson's (JNJ) Topamax anti-migraine drug, Abbott's (ABT) Prevacid gastrointestinal agent, Wyeth's (WYE) Effexor XR anti-depressant, Pfizer's (PFE) Liptor cholesterol regulator, and Eli Lilly's (LLY) Actos diabetes treatment.
IMS projects worldwide generics sales to expand some 5%-7%, to between about $68 billion and $72 billion, in 2009, as compared with growth of 4.5%-5.5% seen for the total pharmaceutical market. This forecast indicates a reversal from recent slowing trends. For the 12 months through September 2008, global generic growth declined to 3.8%, with fierce pricing erosion resulting in a 2.7% sales decline in the U.S. generic market, according to IMS.
Despite the lackluster showing in the U.S., other world generic markets continue to expand at double-digit rates. For the 12 months through September 2008, markets showing robust growth included France at 6.9%, Italy 12.5%, Japan 10.2%, and Spain 10.5%, based on IMS data. The top 10 generics companies currently hold about a 47% share of the generics market worldwide, with the largest players being Teva with 11%; Sandoz, a division of Novartis (NVS), 9%; and Mylan 8%, according to IMS. We believe growth in Europe should be driven by increased generic utilization rates, as fiscally constrained governments stress less expensive generic therapies.
Biogenerics, or as they are often called, biosimilars, represent a key long-term opportunity for the generic industry, targeting an estimated $75 billion branded market. Essentially generic versions of biological products, biogenerics have been launched to a limited extent in Europe and Asia, but not in the U.S. because presently there is not a regulatory pathway at the FDA to facilitate their marketing approval. We believe prospects for the creation of an approval process for biogenerics have improved with the new Obama Administration, which has included this in its health-care agenda. We see an important opportunity for Mylan in biogenerics.
We forecast 2009 revenues of about $5.0 billion, up from $4.6 billion that we estimate for 2008, which excludes some $466 million in revenues related to the sale of rights to its Bystolic drug to Forest Laboratories (FRX). Revenues in 2008 were boosted by the acquisition of Merck Generics. We believe revenues should also be bolstered by growth in North American generics, driven by a robust lineup of new products. Despite a likely foreign-currency headwind, we also see generic sales in the Europe and Asia/Pacific regions benefiting from increasing generic utilization. We also see growth in sales of international generics, as well as increased revenues in the Matrix and Dey divisions.
We look for gross margins in 2009 to widen somewhat on the projected better volume, productivity enhancements, and increased sales of higher-margin specialty products. We also see tight controls of selling, general, and administrative (SG&A) costs and research and development (R&D) spending, helped by ongoing merger synergies (estimated at $100 million in 2008). However, the effective tax rate is expected to rise slightly in 2009.
After preferred dividend payments, we project 2009 cash EPS of $1.00, before acquisition-related charges and other items, up from an estimated 66¢ in 2008. We forecast cash EPS of $1.50 for 2010.
Our discounted cash flow (DCF) model implies an intrinsic value of $15, which is our 12-month target price.
Besides our DCF analysis, we also find support for our target price from our comparative p-e-to-projected growth (PEG) analysis. Using an assumed 23% compound annual growth rate (CAGR) in EPS for Mylan over the next five years, a 0.95 peer PEG—Teva and Watson Pharmaceuticals (WPI)—over the same period, and our 2008 EPS estimate of 66¢, we arrive at a value of $14.50.
We view Mylan's overall corporate governance position as superior to most peers in the pharmaceutical industry. Positive factors, in our view, include that independent outsiders make kup more than two-thirds of the board, and the nominating and compensation committees consist solely of outsiders. Mylan also maintains a special committee that supervises governance issues. In addition, the board is fairly large, with between nine and 12 directors, and the full board is elected annually.
Negative factors, in our view, include that shareholders do not have cumulative voting rights in director elections; the board is authorized to increase or decrease the size of the board without shareholder approval; and a plurality standard is employed in director elections. In addition, a poison pill is in place, and a supermajority vote of shareholders is required to amend certain provisions of the charter or bylaws.
The main risks to our recommendation and target price include failure to successfully integrate the Merck Generics business, and possible steeper-than-expected price discounting throughout the global generic market. Given the company's highly leveraged capital structure, the above-mentioned risks could have an especially adverse impact on earnings. The company also faces possible dilution from its $2.1 billion of mandatory convertible preferred shares that convert by mid-November 2010.
Our risk assessment also reflects risks inherent in the generic pharmaceutical business, which include the ability to successfully develop generic products, obtain regulatory approvals, and legally challenge branded patents.
Analyst Saftlas follows shares of pharmaceutical companies for Standard & Poor's Equity Research Services .
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