Pfizer Inc (PFE) has just revealed a controversial plan to spinoff its Upjohn unit. As a result, Pfizer will lose its portfolio of drugs that are no longer patent-protected including Viagra, Lipitor and Celebrex. Upjohn will merge with rival Mylan NV (MYL), which sells and distributes the famous EpiPen. The result: a new global pharma company with estimated annual revenue of around $20 billion.
Following the announcement on July 29, Pfizer shares have plunged 12%. In contrast, Mylan is soaring 7%. And now Barclays has revealed that it derives increased confidence in its investment thesis on Mylan from the MYL-PFE deal. That’s when Mylan was already the only overweight name in the company’s US generics segment coverage analyst.
“Our positive thesis was based on the company's diverse geographic footprint, extensive biosimilars portfolio and relatively better quality U.S. Generics portfolio. We believe this deal reaffirms this framework and further strengthens MYL's fundamentals” explains Barclays. It has a $27 price target on MYL- indicating over 35% upside potential from current levels.
According to Barclays, here are three key reasons why the deal benefits Mylan, and why the firm is reiterating its bullish call:
The new company will have 15% exposure to the still challenging US generics market vs. the current 20%. “We favor more balanced growth exposure, which would be further strengthened in the NewCo” explains the firm.
2 Balance Sheet & Cash Flow Improves
With a targeted 2.5x net leverage by the end of 2021, the new company would stand apart from most of its peers, where leverage is pretty material (~5x-6x levered among other U.S. Gx in Barclays’ coverage). Indeed, MYL management has guided to >$4B of FCF in 2020E vs. the firm’s 2019E FCF of $2.0B.
3 Legal risks can be better absorbed
The generics sector currently faces a double whammy of legal risks- namely, price fixing and opioids. “As the risks shift to the NewCo, we believe it would be much better positioned financially to deal with adverse legal outcomes” says the firm.
And an additional bonus point: MYL's long standing governance concerns are likely to diminish with announced management changes. Indeed Mylan CEO Heather Bresch will depart once the deal closes. Instead Pfizer’s Michael Goettler, currently president of the Upjohn business, will take charge at the new company.
Jefferies analyst Jared Holz sees this as a key positive for the deal, noting Mylan had “one of the most out-of-favor management teams in all of health care.”
How to value the new company?
According to Barclays, Mylan now shows upside potential on a range of multiples. “At ~$21, MYL trades at 6.7x 2020E EBITDA, which we believe could form the floor multiple for the NewCo, which we think would be fundamentally stronger, with improved leverage, cash flows, growth and corporate governance” says Barclays.
Applying an EV/EBITDA range of 7.0x-7.5x-8.0 x, the firm reaches a hypothetical valuation range of $23.5-$28.2-$33.1 for MYL, based on its 43% ownership in the new company.
Word on the Street
Overall Mylan shows a Moderate Buy Street consensus. In the last three months, 10 analysts have published MYL Buy ratings, vs just 4 hold ratings. Meanwhile the average analyst price target works out in-line with Barclays’ estimate of $27. Following the deal announcement, analysts reiterated their MYL calls- with most raising their price targets.
In contrast, both Merrill Lynch and Morgan Stanley have downgraded Pfizer. Although both firms approve the deal from a strategic perspective, they cite valuation as the reason behind their increasingly bearish sentiment on Pfizer stock.
Implications for Large Cap Pharma
This deal provides a blueprint for future deals, says Barclays. Although consolidation is inevitable within the generics space to combat industry pressures, balance sheets for most generics companies are stretched.
“The proposed MYL-PFE looks like an innovative deal within large cap pharma and could be a blueprint for Generics companies to acquire the scale & stability required to counter adverse industry developments” writes the firm.