Allergan’s Q3 Proves Growth Is Dead

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Allergan (AGN) reported more solid results in Q3, at least on the surface. The company delivered revenue of $4.0 billion and eps of $4.15. Revenue was in line with expectations and eps beat by $.09. Revenue and EBITDA were up Y/Y by 11% and 32%, respectively.

Revenue from U.S. Specialized Therapeutics was up 19%, International was up 16% and U.S. General Medicine was the laggard with 1% growth. At $775 million the company’s blockbuster Botox treatment remains its largest revenue stream. It represents 32% of total revenue and it grew 12% Y/Y. The treatment could potentially grow at double-digits for the foreseeable future. I expect therapeutics like Botox and Coolsculpting to be Allergan’s main growth drivers going forward. They will have to offset stagnant growth from U.S. General Medicine which has been hampered by rising generic competition in certain of its product lines.

All of the company’s revenue growth was not organic, however. Sales from Coolsculpting (body contouring) and Alloderm (regenerative medicine) were $193 million during the quarter. These products were recently acquired and were not reflected in sales during the year earlier period. They represented 5% of total sales and helped goose Allergan’s top line. Sequential growth – which is more apples-to-apples – was flat. Allergan is known as a growth company, but its lack or organic growth is proof that growth is dead.

Management Headed The Restasis Debacle Off At The Pass

Allergan has dominated the financial news cycle since it sold patents for dry eye drug Restasis to the St. Regis Mohawk Tribe. The goal was to use the Mohawks’ sovereign immunity to dismiss an inter partes review (IPR) of the patents brought on by Mylan (MYL). Judge William Bryson ruled the patents were invalid in federal court and raised serious concerns over the Mohawk deal:

“The court has serious concerns about the legitimacy of the tactic that Allergan and the Tribe have employed,” Bryson writes. In his view, Allergan has paid the Tribe to “rent” its sovereign immunity at the US Patent Office.

The IPR is scheduled for next month but Judge Bryson’s ruling on the patents and concerns over the Mohawk deal could reduce the odds an IPR success for Allergan. After evaluating potential scenarios related to Restasis the company recognized a $3.2 billion impairment charge, and a $164 million impairment pursuant to other dry eye in-process research and development. This was a positive sign. By recognizing the potential impact a patent loss could have on its balance sheet management removed another potential worry for investors.

Restasis’ revenue of $382 million was actually up 3% Y/Y. This is a sharp departure from Q2 when its revenue fell 9%. Shire’s (SHPG) dry eye drug Xiidra also experienced revenue growth; this could connote the overall dry eye market is growing. The general consensus is that if Allergan loses the IPR then generic Restasis could arrive as early as 2018. That could be problematic since Restasis represents 9% of Allergan’s revenue and about 12% of the company’s contribution margin.

Sentiment

While revenue was up 11% EBITDA rose 32%; the company’s EBITDA margin improved to 47% from 39% in the year earlier period. Allergan reduced SG&A expense from 32% in Q3 2016 to 29% this quarter. Management intimated it would cut more costs going forward. Assuming a loss of exclusivity for Restasis management will have to take costs out of the business to maintain margins:

We are facing some loss-of-exclusivity challenges, just like any biopharma company in our space. Those challenges are manageable, and we will deal with them head-on. We know how to take costs out of our company while maintaining the right level of investment to drive future growth. We’ve done this before.

Allergan’s organic growth is dead. In September the company announced a $2 billion share repurchase plan. Now management expects to cut costs as it faces a loss of exclusivity in key products. This does not sound like a growth company. AGN is off over 25% since the company announced the Mohawk deal. The the stock still trades at 11x run-rate EBITDA, which connotes a growth company. As Allergan’s stagnant growth and threats from generics continue to materialize, sentiment for the stock could turn down. I believe an EBITDA multiple in the single digits is more appropriate which implies AGN could fall further.

Conclusion

AGN’s growth is dead yet its share price does not reflect it. AGN remains a sell.

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