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The Pros and Cons of Owning Mylan

Posted on: September 10, 2008 - Email Article - Printable Version

Allen Lutz

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Mylan Inc [MYL: 10.4799, +0.6199 (+6.29%)] announced on Monday 9/08/08 their plans to retain their specialty business Dey Inc. instead of selling it in a bidding process they expected to end by December. Last year Mylan bought Merck KGaa generics division in October for $7 billion in cash. Dey Inc, a specialty business focused on respiratory and allergy drugs was part of that deal. In February of this year, Mylan announced they were planning to sell Dey because their big drug Perforomist was not reaching targeted sales figures.

During Mylan’s 1st quarter conference call, executives said the bidding process was proceeding as scheduled and they planned to have the business sold by the end of the year. Some thought King Pharmaceuticals [KG: 10.79, -0.03 (-0.28%)] was in a position to buy the struggling Dey, but after King made a $1.4 billion bid for Alpharma that rumor was put to rest. Mylan is also issuing $500 million in convertible notes to institutional investors due in 2015 which adds to the company’s already considerable debt of $4.9 billion.

In an article that came out after the market closed on Monday, Mylan Vice Chairman and CEO Robert J. Coury stated, “After carefully analyzing all the options regarding Dey, it became clear that retaining the business was truly in the best interest of all stakeholders.” This euphemistic language really means no one was willing to buy Dey. Mylan reaffirmed full year 2008-2010 guidance of $0.47-$0.53 in 2008, $0.90-$1.10 in 2009 and $1.50-$1.70 in 2010. Management also said they expect Dey to contribute positively to earnings this year. Hey, that sounds pretty good. Reaffirmed earnings and a positive impact to EPS for Dey; but something sounds fishy. Read on.

A little over a month ago CEO Coury said the company was looking to sell Dey to pay down debt, after the company reported weaker than expected sales of Perforomist, its treatment for chronic obstructive pulmonary disease. A month later we are now expected to believe this company will contribute positively to earnings? Later in the release the truth comes out. The following was taken directly from Mylan’s news release.

The Press Release

In addition to excluding one-time costs associated with the realignment of the Dey business, the company’s reaffirmed financial guidance continues to exclude the following items:

Purchase accounting related charges, including amortization of intangibles and the inventory basis step-up;
integration and other non-recurring expenses;
the non-cash goodwill impairment charge related to the Specialty Segment that was recorded in the first quarter of 2008; and
recognition of previously deferred revenues related to the sale of our rights to Bystolic.

The Takeaway

Mylan was forced to take a $385 non-cash goodwill impairment loss on Dey in the 1st quarter that significantly affected earnings. Shares of Mylan were also down 11% on the news. According to Mylan’s most recent 10-Q, Dey still has $325 million in goodwill. Now the company says Dey will contribute positively to earnings if we exclude the goodwill impairment charge, amortization of intangibles and integration expenses. It is likely at least one of these “one-time costs” will appear in an earnings transcript within the next few quarters. Saying Dey will contribute positively to earnings with those types of asterisks is like saying Fannie Mae or Freddie Mac will be able to be profitable going forward, but excluding mortgage related losses. Here are the pros and cons of owning Mylan Inc.

Pros

1. Industry Trend

The year over year increase in healthcare costs has significantly outpaced wage increases over the past 10 years. An increased generic utilization rate has helped mitigate costs and should continue as a record number of generics enter the market in 2008.

2. Global Position

Merck’s generic division and the Matrix segment give Mylan a global presence which should position the company well going forward.

3. Duragesic Prescription Trends

According to a Cowen and Company report, Mylan has 55% of the Duragesic market after competitor Watson recalled one of its lots of the drug. This is up from 44.1% in September. Analysts expect Duragesic to earn revenues of $250 million in 2008.

4. Guidance is Achievable

Mylan lowered FY 2008 EPS guidance to $0.40-$0.50 in May after the first quarter and then raised and narrowed guidance after the second quarter to $0.47-$.53. After they issued the $500 million in new notes they reaffirmed these numbers.

5. Takeover Target

For large cap pharmaceutical companies Mylan presents an attractive investment opportunity. Cash cows like Novartis [NVS: 48.39, -0.59 (-1.20%)] and Pfizer [PFE: 17.92, -0.24 (-1.32%)] could make a bid as Mylan’s share price continues to depreciate.

Cons

1. Poor Management

Management has not been concerned with shareholder value for years by continually misleading investors about the state of the company. That is why shares have depreciated about 5% over the past 10 years. According to FiercePharma.com CEO Robert Coury received total compensation of $8.4 million during fiscal 2007, which was only nine months due to the company changing its fiscal year.

2. Inability to find a buyer for Dey

The inability to find a buyer for Dey suggests it is worth significantly less than any bidder was willing to pay. Instead of being able to sell a weak franchise that does not fit within Mylan’s core competencies and pay down debt, the company is forced to keep a failing business and issue additional debt.

3. Valuation

3. On a strict EV/EBITDA, Mylan trades at a significant premium to Teva [TEVA: 42.01, -0.81 (-1.89%)], Barr [BRL: 0.00, 0.00 (0.00%)] and Watson Pharmaceuticals [WPI: 24.79, -0.40 (-1.59%)]. According to Yahoo! Finance Mylan’s EV/EBITDA is 14.1x’s versus Teva’s 12.0x, Barr’s 12.9x’s and Watson’s 6.9x’s. With the new debt issuance they aren’t cheap!

4. Highly Leveraged

Mylan has about $4.5 billion in debt versus a market cap of $3.6 billion. The financial burden that a leverage ratio creates will make it difficult for Mylan going forward.

5. Takeover Bid is Holding on Hope

Reports suggest Pfizer [PFE: 17.92, -0.24 (-1.32%)] and Novartis [NVS: 48.39, -0.59 (-1.20%)], who hold $27 billion and $16 billion in cash respectively could make a bid for Mylan. M&A activity has been strong in Healthcare, but holding and waiting for a takeover is never a strong investment rationale.