Allergan (AGN) is facing a loss of exclusivity (“LOE”) in certain of its key products, including dry eye regimen Restasis which represents about 9% of the company’s total revenue. During its Q3 earnings call management intimated it would cut costs in the face of generic competition. Earlier this month the company announced 1,000 layoffs in response to expected revenue declines:

In response to the anticipated loss of exclusivity of several key revenue-generating products in 2018, the Company is optimizing and restructuring its operations in early 2018. As part of an internal restructuring plan, the Company intends to eliminate over 1,000 currently filled positions, impacting employees in commercial and other functions. Commercial reductions will primarily focus on products and categories subject to loss of exclusivity. In addition, the Company will eliminate approximately 400 open positions.

The company expects to incur restructuring charges of about $125 million. Allergan also expects cost cuts to generate expense savings of $300 million to $400 million. I do not expect the cost savings to fully offset the impact of LOE related to certain drugs. I explain below.

The Situation

In October 2017, Judge William Bryson invalidated Restasis patents and I view this as a big threat to Allergan. Restasis is the company’s second-largest drug and represents 12% of total income. The inter partes review (“IPR”) pursuant to Restasis could be moot. Judge David Ruschke recently ruled the University of Minnesota waived its immunity in an IPR by filing patent infringement charges in federal court.

Mylan (MYL) and Teva (TEVA) also recently launched a generic version of Estrace vaginal cream, a synthetic hormone called estradiol which behaves similarly to estrogen. Estrace represents 3% of total revenue. Allergan also faces threats pursuant to Alphagan/Combigan (3% of revenue) and Linzess (5% of revenue). However, I believe LOE related to Restasis and Estrace as the most likely in the near term.

EBITDA Loss Could Exceed Expense Savings

I estimate generic competition could cause EBITDA from Restasis and Estrace to decline by $774 million annually, exceeding the $300 – $400 million in cost savings management expects. I explain in the following chart:

  • Annualized EBITDA – Restasis represents 12% of Allergan’s total income so I assumed it also represented 12% of Allergan’s annualized EBITDA of $7.5 billion. The contribution from the U.S. General Medicine segment (where Estrace is included) is slightly less than other segments. I assumed Estrace’s EBITDA was 2.6% of total EBITDA.
  • I assumed a 51% decline in price in the first year generics arrive. According to the IMS Institute For Healthcare Informatics, from 2002 to 2014 the price of medicines was reduced by 51% in the first year generics entered the market.
  • Run-rate revenue would fall to $948 million combined.
  • I assumed a 40% decline in market share. This is consistent with a projected 40% decline for Teva’s (TEVA) Copaxone once generics entered the market.
  • After the market share loss run-rate revenue would decline to $569 million.
  • Assuming no decline in EBITDA margin, run-rate EBITDA would fall to $322 million. The total decline in run-rate EBITDA of $774 million would exceed the high-end of Allergan’s costs savings of $400 million.

I estimated Allergan had a 47% EBITDA margin in Q3. The issue is that Restasis and Estrace have a weighted average 57% margin, so LOE would potentially impact higher margin businesses. The above analysis reflects this. In Q3 2017 Allergan reduced R&D and SG&A to a combined 40% of total revenue from 49% in the year earlier period. I expect more reductions in these areas in the future. Nonetheless, I believe the negative hit to EBITDA from LOE would outweigh these adjustments.

Conclusion

Allergan’s restructuring efforts in the face of LOE proves growth is dead. I believe the negative impact to EBITDA will outweigh cost savings from layoffs. Sell AGN.

On Trump And

Trump And The Global Economy Town Hall took place October 24th in Fort Greene. It Featured Professor Lance Brofman, Coconut Rob (Coconut Rob Smoothies), Wuyi Jacobs (AfroBeats Radio) and Ralph Baker, author of Shock Exchange: How Inner-City Kids From Brooklyn Predicted the Great Recession and the Pain Ahead.

The event was well-received by the community. We parsed through President Trump’s proposed tax plan and [i] how it was pure economic folly and [ii] high net worth individuals could potentially game the system by shifting income around. Apparently, Kansas Coach Bill Self did this when the state of Kansas cut taxes in the past. We discussed the pros and cons of technology on workers and the economy. How will the economy and country prosper under Trump’s leadership vis-a-vis Obama? What’s behind the verbal sparring with black athletes, ESPN’s Jemele Hill and North Korea’s Kim Jong Un?

 

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