Allergan: Is LOE Fully Priced In?

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Allergan CEO Brent Saunders. Source: Business Insider

Allergan (AGN) delivered a Q4 revenue and earnings beat. The company reported revenue of $4.3 billion and EBITDA of $2.1 billion. Revenue and EBITDA grew Y/Y by 12% and 72%, respectively. Revenue from U.S. Specialized Therapeutics, and International both grew by double-digits. Their growth was offset by a 1% decline in U.S. General Medicine.

U.S. Therapeutics revenue was up mainly due to acquisitions. At the end of 2016 Allergan acquired Alloderm and Strattice tissue matrices used in breast reconstruction and abdominal wall surgeries. In Q4 revenue from these two products (“regenerative medicine”) was $129 million under U.S. Therapeutics and $6 million for the International segment. It was non-existent in the year earlier period. In February 2017 the company acquired Zeltiq Aesthetics, which develops its CoolSculpting system that helps reduce fat through a natural biological process called apoptosis. Body contouring revenue was $121 million during the quarter, but was non-existent in the year earlier period.

Sans acquisitions of CoolSculpting and regenerative medicines, revenue growth from U.S. Therapeutics would have been 6% Y/Y; total revenue growth would also have been 6%. Q1 2018 results should be more apples-to-apples compared to Q1 2017. In addition to lack of organic growth there are other causes for concern as well.

Allergan Appears To Be Retrenching

Allergan has a reputation as a growth company due to its acquisitive nature. It trades at 10.6x run-rate EBITDA (last three quarters’ EBITDA annualized) which also signals a growth stock. However, signs suggest the company is retrenching. Judge William Bryson invalidated its Restasis patents in October 2017 and Allergan immediately raised its share repurchases. In January the company announced a restructuring that involved laying off 1,000 employees in response to expected revenue declines from loss of exclusivity (“LOE”). Management has educated investors on its vaunted R&D pipeline. If management expected future hits from the pipeline to offset LOE then why would there be a need for layoffs? Allergan expects to save about $400 million from its restructuring efforts, but it also connotes the company is retrenching and is no longer in a growth mode.

Allergan’s Q4 EBITDA of $2.1 billion was up 72% Y/Y. Its EBITDA margin of 49% was much higher than the 32% reported in the year earlier period. Higher margin also came on higher revenue. The company cut R&D and SG&A costs in order to achieve this. R&D expense was $408 million in Q4 2017, down by over $500 million versus the $913 million reported in Q4 2016. This implies management is more focused on protecting its bottom line than investing in the future.

SG&A and R&D was a combined 39% of revenue in Q4, down from 57% in the year earlier period. I applaud management for cutting costs to offset expected LOE. However, it could be difficult to just AGN’s 10.6x trading multiple given that it appears to be battening the hatches.

Major LOE Should Kick In Soon

The Restasis patent loss has been much-talked about. Restasis represents 9% of Allergan’s total revenue and about 12% of its contribution. However, Allergan is still generating revenue and earnings from Restasis. It faces an inter partes review (“IPR”) review from Mylan (MYL) some time in the future. Until it loses the IPR then generic Restasis will likely not reach the market. Management does not expect generic competition from Restasis until Q2 2018. When it finally arrives it could cause an out-sized hit to Allergan’s revenue and earnings.

Mylan and Teva (TEVA) recently launched a generic version of Allergan’s vaginal cream Estrace, which generated Q4 2017 revenue of $102 million. It represents about 2% of Allergan’s total revenue. I expect the generic version to cause a hit to Allergan’s revenue and earnings starting in Q1 2018. Estrace and Restasis represent a combined 11% of total revenue. Whether AGN bulls can stomach a decline in revenue and earnings from known events remains to be seen. I do not believe the loss of Restasis and Estrace is fully-priced in, but we could find out in the first half of this year.

Conclusion

Cost-cutting is exactly what Allergan’s management should be doing. However, its 10.6x EBITDA multiple appears frothy amid the company’s retrenchment and pending LOE. AGN remains a sell.

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