Endo Health Solutions’ (ENDP) new CEO is executing on his strategy, as expected, and most of the Street likes what it sees. Endo announced on Wednesday a number of initiatives to both cut costs and drive long-term accretion, including the sale of two business assets, a workforce reduction, and the expectations for small to mid-sized acquisitions. We’ve followed ENDP as a turnaround story since last year and wrote in February that Rajiv De Silva’s hiring as CEO meant good things for the struggling company (his leadership at Valeant (VRX) has rewarded shareholders). Yesterday’s news was the first official glimpse at De Silva’s plans, a divest and acquire strategy that we believe holds promise (we speculated on this in early April).
Alongside its strategic announcement, Endo lowered guidance for 2013 significantly, largely a result of the FDA’s recent decision to allow generic forms of Endo’s painkiller Opana ER to come to market despite that these older formulations lack abuse deterrent qualities. Under its former management team, Endo lowered 2013 EPS guidance at the end of the first quarter to $4.40-$4.70 on $2.8B-$2.95B in revenue; on Wednesday, guidance was yet again lowered to $2.65B-$2.8B and adjusted EPS of $4.10-$4.40. Given the shakeup at Endo under new leadership, this seems like the final reset (standard affair when new management steps in – a “free reset” of the bar), and the Street has taken both guidance and the go-forward strategy to heart. Already on Thursday morning a few Wall Street analysts have come out in support of the specialty pharmaceutical company with at least one aggressive target based on management’s plans for the company: Leerink Swan upgraded ENDP from Market Perform to Outperform and increased its price target from $37 to $48. Given that most of the street had left ENDP for dead over the last year, analysts coming back around on the name is a major vote in favor of the strategy. Nevertheless, it’s all about execution from here, and although Endo’s plan will take time, the news flow from updates as divestitures and acquisitions materialize should generate interest in the name into next year.
Cuts and divestitures… Perhaps most glaring at first glance is Endo’s plan to cut its workforce by 15%, approximately 700 jobs worldwide as part of an expected $325M reduction in operating expenses. The company anticipates that it will realize $150M in savings yet this year and will achieve the full run-rate by mid-2014. Endo also plans to put urology-focused products/services business Healthtronics up for sale. We suspect the sale could bring in upwards of $400M given that the company was purchased in 2010 for $260M and Endo has since added a number of assets to the business. In addition, the company will explore options with its early-stage pharmaceutical discovery branch. Endo also plans to decentralize decision-making to improve efficiency among its individual business arms, a departure from the top-down approach that hampered Endo in the past. De Silva has already begun subbing in leadership of his own choosing who in turn have restructured underneath. We expected De Silva to bring in his own teams, and the fact that we’re seeing a strong focus on new leadership at all levels of the company speaks volumes to the path that Endo was on before this changing of the guard. Bear in mind that Endo’s Board was under pressure from large investors early this year to make changes at the top, which they clearly did with the hiring of the former Valeant exec. As a result, Endo climbed from a low of $26 late last year to a high of $38.32 in 2013. De Silva said on Wednesday’s evening conference call, “we are moving to integrate and empower business units to decentralized decision-making and well-defined accountabilities. Our goal is to retain, augment and develop top talent with both strategic and operational expertise.” Read PropThink’s previous column regarding De Silva’s history building shareholder value at Valeant to understand why we see his leadership as so crucial to Endo.
But investors’ primary concern in the last two years has been the patent cliff on Lidoderm and the generic threat to Opana, both of which are just around the corner. These certainly aren’t new to the Endo story, and we believe that expectations have been tempered appropriately. The FDA’s decision on Opana had little effect on the shares as value for branded Opana was already being factored out of the stock. Lidoderm will face generic competition in September, thus Endo is accounting for this pressure in its 2013 guidance. De Silva even went so far as to say, “we like to beat our numbers, so we’d like to be at the top end of that range if we can, but that the full range represents where we believe the realistic outcome could be.”
…to support acquisitions and organic growth. Interestingly, it appears De Silva is less intent on reducing debt than in improving Endo’s ability to leverage capital for acquisitions alongside organic growth. Endo had $340M in cash as of March 31 and over $3B in long-term debt. It’s ugly at first glance, but keep in mind that Endo generates strong cash flow: more than $700M in operating cash flow each in the last two years — this was, in fact, the impetus for our assertion that ENDP was undervalued based on its free cash flow late last year. Management believes that they can continue to deliver strong cash flow while taking on more debt if need be, particularly, said De Silva, considering the favorable borrowing landscape. Small acquisitions are a key part of De Silva’s plan going forward, specifically with deals in the “$250 million to $500 million range.” PropThink’s Premium subscribers will be aware of our interest in BioDelivery Sciences (BDSI) as both a standalone business, but also for the potential of an Endo takeout; the two are partnered on BEMA Buprenorphine, which, as an analgesic, would make a nice fit with Endo’s pain business. After Wednesday’s conference call however, a BDSI buyout seems less likely given De Silva’s focus on licensing or owning new products/businesses, although the company is clearly excited about BEMA Buprenorphine.
When asked what kind of multiples he’ll be looking for in potential deals, De Silva responded, “What I can tell you that it is not so much the multiple that are going to will be driven by, but rather a view on what kind of IRR I can generate. I want to be substantially above our cost of capital. Cash payback period will be an important metric for us and we’ll also like to do deals that are immediately accretive.” CFO Alan Levin added, “And I think that generally implies deals that have some attractive additional revenues that help to diversify our top line and our cash flows, and as we’ve said before, opportunities where we could see our shareholders benefit from synergies either on the cost base or upside in revenues.” Management, it appears, are well aware that investors are focused on earnings, and the combination of accretive acquisitions and cost reductions should drive EPS numbers if execution goes as planned.
After finally seeing the official strategy from Endo, we remain interested in the specialty pharma company as a long-term holding. The stock trades at just under 9x forward earnings (adjusted), slightly below other specialty pharmaceuticals (given Endo’s “fresh turnaround” status) around 12-13x. With the potential for bottom line growth, acquisition and divestiture announcements, and long-term P/E multiple expansion towards industry averages, ENDP remains an attractive holding. Clearly, the markets seem to agree; ENDP climbed up 3.5% on the strategy reveal.