By Dimitrios Apostolopoulos (University of Warwick), Chris Leung (University of Warwick) and Ilya Korzinkin (UCL) - Date: 07/09/2019
Acquirer: Pfizer
Target: Mylan
Announcement date: 29/07/2019
Pfizer Advisors: Goldman Sachs, Guggenheim Securities
Target Advisors: Centerview Partners, PJT Partners
Overview of the deal
Coming at a precarious period in healthcare where big drugmakers are feeling the pressure of patent protection losses and lower-priced rivals, Mylan has unveiled a new long-promised strategic revamp through a 1-for-1 all stock merger with Pfizer’s off-patent medical unit, Upjohn. Where Mylan has foreseen its market value deteriorate by a third in 2019 alone, both businesses are banking on the merger to reignite declining sales through a combination of “Mylan’s growth assets” with “Upjohn’s growth markets” as cited by Pfizer CEO Albert Bourla. The merger would accelerate Mylan’s strategy of bolstering operational scale and commercial capability, and in the process creating a generics company that is substantially larger than competitors in the region.
Pfizer’s rationale for spinning off Upjohn, which generated 22% of the pharmaceutical giant’s Q2’19 revenue, stems from its longstanding effort to split core operations into 3 distinct units – innovative medicines, consumer healthcare and lower margin generic drugs. Pfizer and GlaxoSmithKline (LSE/NYSE: GSK) announced back in December 2018 that they would merge consumer healthcare businesses, meaning once the Upjohn-Mylan deal is completed, this would allow Pfizer to focus on advancing its considerably more profitable innovative drugs division that includes cancer treatment Ibrance and pneumonia vaccine Prevnar. For a change, Pfizer is getting smaller, losing its crown as the world’s largest drug maker by market share. Simultaneously, the move could also spark a potential trend for similar deals as more pharmaceutical companies look to reposition themselves higher up the value chain in innovative medicines, steering away from lower-cost generics.
With Pfizer’s shareholders owning 57% of the resulting entity, the deal is set to be structured as a reverse Morris trust, where Pfizer will separate Upjohn in a tax-free spinoff, then combined with Mylan.
Company Details (Pfizer)
Pfizer is a research based global biopharmaceutical company engaged in the discovery, development and manufacturing of “Innovative Health” and “Essential Health” products. Key products include blockbuster drugs Lipitor, Lyrica, Viagra, Celebrex and Xanax.
- Founded in: 1849
- CEO: Albert Bourla
- Number of employees: 92,400 (2018)
- Market Cap: $230.46bn -EV: $264.68bn
- LTM Revenue: $53.64bn -LTM EBITDA: $22.56bn
- LTM EV/Revenue: 4.93x -LTM EV/EBITDA: 11.73x
Company Details (Mylan)
Mylan is a global generic pharmaceuticals provider with a growing diverse portfolio of over 7,500 products including prescription generic, branded generic, brand-name and biosimilar, similar as well as OTC remedies.
- Founded in: 1961
- CEO: Heather Bresch
- Number of employees: 35,000 (2015)
- Market Cap: $10.72bn -EV: $23.68bn
- LTM Revenue: $11.29bn -LTM EBITDA: $3.55bn
- LTM EV/Revenue: 2.10x -LTM EV/EBITDA: 6.67x
Projections and Assumptions
Short-term consequences
A series of high profile systemic and internal issues that the merger may not be able to rectify have plagued Mylan. The company is among many drug makers embroiled in lawsuits seeking to hold them responsible for the continuing opioid epidemic, with forecasts of total liability still uncertain due to its scale and complexity. Additionally, Mylan’s infamous emergency allergy kit has also been experiencing a stark decline in sales since the company came under serious criticism for steep price hikes of over 400% back in 2016.
Yet, Upjohn has also been experiencing complications of its own with Pfizer’s off-patent business coming under industry-wide pricing pressure from cheaper competitors. The coupled effect of Lyrica’s Loss of Exclusivity (L.O.E.), which is an epilepsy and fibromyalgia medication, on June 30th, underlines the pressure placed on Upjohn’s performance expectations, with forecasted YOY revenue declines for FY19 and FY20. This comes on top of the fact that Upjohn’s Lipitor, Norvasc, Celebrex and Viagra are all experiencing declining revenue, and is a trend expected to persist at the newly formed company.
Two negatives certainly don’t make a positive when it comes to mergers and acquisitions, and for all the proposed merger’s pitfalls, a key point was reiterated and reinforced at the conference call held by the two companies: the competence of the new company, both in making drugs and in the ability to market the new joint array of drug products. Mylan possesses a diverse portfolio of medications across key therapeutic areas such as central nervous system, anaesthesia, infectious disease and cardiovascular that will help maintain a robust pipeline. Concurrently, Upjohn brings trusted iconic brands, and more importantly offers proven commercialisation capabilities to China and emerging markets. It is no doubt that the NewCo will be a significantly strengthened giant with Upjohn’s business expected to contribute $7.5 – 8 bn in revenue, on top of the $12 - $12.5 bn from Mylan’s side to generate revenues that will easily surpass its closest rival, Teva Pharmaceuticals. Pro forma 2020 adjusted EBITDA is also anticipated to fall within the range of $7.5 - $8 bn, including phased synergies of $1 bn annually by 2023.
Such forward progression is also aided by the management shuffle that sees “one of the most out-of-favour management teams in all of healthcare”, namely Heather Bresch, retire. Jefferies healthcare strategist Jared Holz blames Mylan’s management for a “fairly significant discount” in the company’s valuation.
Announcement of the merger sent Pfizer’s stock slipping 3.8% to $41.45, while Mylan’s rocketed 12.6% to $20.78.
“Slamming bad things together is unlikely to solve the systemic issues,” – Ken Cacciatore, Cowen managing director and senior healthcare research analyst
Long term upsides
The transaction strategically cleans up the business and creates a pure- play innovation- focused ‘Pfizer innovative’, with the core business segment of the company acting as the main beneficiary of the merger. Core earnings are estimated to be $40bn top line with a 30% pre- tax margin. By projected earnings, Pfizer innovative is expected to come in between $2.20-2.30 EPS, compared to the current 2.16. Management expects the company to become a top tier growth business with 7% YOY top line growth projected from 2020 to 2025. This also presents a substantial margin leverage opportunity for the business, as now it is free to invest heavily into R&D and SG&A.
Pfizer’s shareholders will reap most of the benefits of the transaction due to the ‘Reverse Morris Trust’ nature as mentioned prior. Where all legal requirements of a strategic spin-off to another company is met, the result is a tax-free entity. However, Mylan shareholders, on the other hand, will still feel the burden of taxes, who incidentally, own less of the NewCo than Pfizer.
If Mylan- Upjohn achieves successful integration, there could be revenue synergies present from portfolio consolidation and self- cannibalisation, as well as better execution of Mylan’s portfolio development strategy, with Pfizer bringing its expertise to develop some smaller, niche brands for example. Over time, Mylan can further broaden its selection of products in new markets, using UpJohn’s geographically vast distribution infrastructure, making the company less dependent on lagging and volatile developed markets.
Should Mylan manage to refinance its $13bn long- term debt using UpJohn’s relatively robust balance sheet as solid footing and alleviate the combined company’s $25bn debt load by the promised $1bn of cost- related synergies by 2023, the NewCo could theoretically use its reduced cost profile to manufacture EpiPens and other generics at a profit again. This can thus fill the wider market shortage, with the same applying to some generic drugs that have been abandoned due to high manufacturing costs. Should shortage- reducing generic drugs become a focus again, the merger would be creating the world’s largest generics provider, with over $50bn combined EV. The potentially reduced cost profile also putting the NewCo in a favourable position to face the potential headwind of tight pharmaceutical price controls being implemented in the US market, one of the hottest debate talking points in the 2020 election cycle.
Risk and uncertainties
Much uncertainty has been attributed to the structure of the NewCo, with many of Pfizer’s shareholders questioning why so much control has been given to Mylan. Mylan Chairman Robert Coury becoming the executive chairman of the NewCo, and Mylan is naming eight board members, and Pfizer just three. This comes amidst the Mylan management competency controversies, especially with only a third of the company sales in the long term projected to be coming from generic drugs, and the rest from biosimilars, which the Mylan- led board has less expertise in marketing and developing. Furthermore, it is unclear whether just being on US soil with that type of board composition, management disclosure standards will realistically change and whether the company will still receive the cash flows needed to adequately deal with remaining outstanding price – fixing settlements.
Furthermore, it is still unknown precisely what synergy opportunities will there be for the off- patent franchise, as well as what assets from PP&E will be included in the transaction nor what the composition of the combined pro- forma portfolio will contain. UpJohn’s off patents like Viagra can potentially clash with Mulan’s generic patents applications, despite management reassuring that portfolio concentration is very limited. It is also still unclear what the pro rata leverage profile will be like for the NewCo, especially how the $12bn payment from a new debt issue by Pfizer will be distributed. With Pfizer’s credit rating lowered from A+ to AA-, rating agencies have expressed concern over how robust the combined debt structure of the NewCo may be, and if Mylan can realistically refinance its debt.
On the Eastern Front, China presents a growing pain for the NewCo, as a national tender system evolving for purchase and distribution of off- patent drugs is hurting many generic drugs, that in any case have already a sizeable amount of OTC competition, with the biggest hit expecting to come in 2H2019. Only time will tell how the Chinese story unfolds, however management was clear to point out that there are still some clearly identifiable and favourable by- volume positive trends in the remaining EM side of the business. With China only constituting of 12% of the company’s business by sales volume, it is seen as a manageable threat by the board, however remains a sizeable problem should the tender situation worsen. Especially with the 2026-2028 patent expiration cycle looming on the horizon, and substantially more pressure loaded on the Emerging Markets side of the portfolio to outperform, only time will tell if the NewCo will be up to the task to perform on expected multiples.
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