Endo Pharmaceuticals (
) is a specialty drug company, with a focus on a few specific
areas, namely pain management, urology, and endocrinology. Pain
management is the company's forte, led by Lidoderm, a lidocaine
medicated patch that is prescribed for a wide variety of
pain-related problems. Lidoderm gained traction after orally
ingested pain killers such as Vioxx (
) faced well-publicized safety concerns in the mid-2000's. Today,
Lidoderm accounts for well over 50% of Endo's total sales, bringing
in $763 million dollars last year.
Another 16% of sales is generated by the Opana franchise. Opana
is orally ingested and is used to treat severe pain symptoms. It is
used much like morphine. The third major drug marketed by Endo is
Percocet, the well-known painkiller for less severe pain
indications. Percocet accounts for about 9% of Endo's total.
While far and away dominated by its pain franchises, the company
in early 2009 purchased Indevus, which specializes in urology
(bladder and urinary tract) and endocrinology (endocrine system).
Currently, the products here account for a rather small portion of
sales, about 4-5%.
Let's look at Endo through the filters of growth potential,
competitive position, and financial strength. Growth potential is a
negative here. Endo faces a common problem in the branded drug
industry - patent expiration and the inevitable generic competition
that follows. Both Lidoderm and Opana, collectively almost 70% of
revenues, have patent cliffs upcoming. Lidoderm has theoretical
patent protection up until 2015, but already faces a patent
challenge from Watson Labs (
). Opana has seen similar challenges, and its patent protections
expire before 2013.
The most likely outcome of these challenges are settlements. For
example, Endo recently settled generic challenges to Opana from
), which allow Endo to continue selling the drug until 2012, longer
than would have been possible had they lost the challenge, but also
before the patents expire.
MagicDiligence expects similar settlements related to Lidoderm.
It seems reasonable to assume that generic versions of both
Lidoderm patch and Opana will hit the market in the 2012-2013 time
frame, meaning that Endo will need to replace 60% or more of their
sales in the next 3 years. That certainly does not bode well for
long-term growth potential.
How Endo will replace those revenues is still in question. The
Indevus purchase gives the company a wider market to address, but
those sales will have to ramp up fast. The pipeline has had recent
problems. Aveed, a long-acting testosterone injection, and Fortesta
(testosterone gel), both acquired in 2009, received FDA inquiry
letters last December, which will at best postpone their approval.
On the pain side, Endo continues to work its strategy of buying the
rights to late-stage drugs that improve on existing treatments.
While this strategy usually improves the likelihood of approval and
limits R&D spending, it also limits the duration of patent
All told, Endo will likely see solid growth into 2012, at which
time generic competition could eat as much as half of current
revenues. This uncertainty will keep the valuation high on an
earnings yield basis.
The other two factors, competitive position and financial
health, are positives. Endo, like all branded pharmaceuticals,
enjoys strong regulatory barriers to entry through patent
protection. This keeps competitors out for a period of time and
allows the firm to charge high prices for their drugs. Another
competitive advantage is Endo's large 800-person sales staff that
focuses on the niche of pain management. This sales department is
considered one of the most productive in the industry, and should
be an important factor in quickly growing sales of acquired
Financial health is fine. The balance sheet has $734 million in
cash vs. $322 million in long-term debt. Operating margins are over
25% and stand to improve as Opana and, to a lesser extent, Lidoderm
experience volume gains. Free cash flow is outstanding, averaging
almost 30% of sales over the past 5 years. This cash flow will help
the company acquire new compounds to plug their upcoming sales
Right now, Endo trades at a trailing, MFI-adjusted earnings
yield of 15%. Against expected 2010 results, that figure is 16.2%.
That looks too cheap for the profitability just mentioned. Going
through a cash flow analysis, I come up with a fair value between
$27-$32, depending on how long they can push back generic
competition of Lidoderm, and what kind of replacements they can
find. So there appears to be upside from the current price around
$24... but not a tremendous amount. Therefore, while MagicDiligence
has a positive rating, Endo doesn't quite make
status. This doesn't assign any value to the potential of a bigger
pharma player gobbling up the company, either.
: Steve owns no position in any stocks discussed in this
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