Description

Akorn equity:  This is a wacky stub equity story about a generic drug maker.  Today it is a penny stock with a Q on the end of it… But it reached $57 per share in June 2015, and later received at $4.7B buyout offer at $34 per share in April 2017 from Fresenius (FRE GY).  That deal was terminated a year later over alleged bad practices in their labs for quality control, safety and cleanliness, including some questionable data items in their drug trails (but no accounting issues were ever alleged).  This all happened just as business performance entered a period of decline mainly from pricing pressures. 

It began a two year decline… Lawsuits and appeals ensued, and Fresenius spent 9 months fighting to walk away from the acquisition.  A judge ultimately backed Fresenius’s exit in late 2018.  They parted with a super-bitter taste in their mouth, and presumably, with some spite, tipped the FDA on their discovery of lax lab processes..

After the Fresenius deal was terminated, in early 2019, the company disclosed FDA warnings about it’s “aseptic and sterilization practices” at its Decatur, IL & Somerset, NJ facilities.  This initiated yet another sharp leg down and the stock hit the $3s.  The loss of confidence coincided with weakening results across the generic drug patch, putting Akorn squarely in the penalty box and on a course for bankruptcy.

Management’s heads rolled and the new management, led by CEO Doug Boothe, is well regarded in the industry and by investors throughout the capital structure.  Sales have slipped from a peak over $1.1B to around $700m and company forecasted adj EBITDA over the next 5 years starts at $188m in 2020 (not fully covid adjusted), rising to $240m in 2021, and to $345m by 2024.    

During the past year and a half, they talked with potential buyout partners about selling the company, but it was against a weakening operational backdrop, and they didn’t find a deal.  Reported suitors included Baxter, Perrigo, et al.  In a first attempt, 22 companies signed confidentiality agreements.

Then in 2020, they tried more seriously to auction the company for the benefit of the lenders, with whom there was a standstill agreement in place, in an ultimately doomed process led by PJT that suffered from particularly bad timing relative to the onset of covid.  It failed to produce bids to cover their liabilities despite broad interest.  There were 37 interested parties who signed confidentiality agreements, reduced to 7 for second round bidding, and then to two for final bids.  The bad timing was the process culminated in late March 2020, just as covid madness was upon us causing major uncertainty and before people got new processes worked out for working from home/zoom/etc.  I believe this timing caused lowball bids out of an abundance of caution from the initial shock of such dramatic changes, and this isn’t representative of the value of the assets.

They filed bankruptcy on May 21, 2020 with $871m of secured claims including accrued which had been under a standstill agreement.  Another ~$100m of unsecureds need to be worked through plus throw in the usual egregious fees and a $30m DIP facility, and anything over ~$1.025B for the assets starts accruing to the equity.  Maybe that number needs to be a bit higher for some covid funding needs, but it’s in the ballpark and some more conservative $1.3B numbers being thrown around seem high.  After bk, the stock subsequently bopped down to around 9 cents in early June, and since has risen along with the emergence of new potential financing and a new sale process to around 32 cents, a $42m mkt cap with 133.2m shares outstanding.

So far, the best they’ve seen is a stalking horse credit bid for $900m placed early in the process and intended to stoke a further marketing process to be conducted inside Ch 11.  This has informally been revised to $1.05B, apparently non-binding and all paid in the value of claims (so wampum). 

Meantime, there are interests working on fundraising transactions with potential backstops, reportedly from Stonehill or Whitebox, and talk of forming an equity committee.  The debt is a Term Loan which has traded up from 70 in early May, to 96 currently on optimism over a business turnaround and a reinvigorated sale process.  The idea is to go back and re-do a 363 asset sale process untainted by covid outbreak timing, attaining reasonable credit for tangible progress on business stabilization and rebounding cash flows, and without taint from past FDA warnings, on which new management has taken proper corrective steps.  

7x adj ebitda on $188m this year (nomalized, $133m covid revised on July 2nd) gets you to $1.3B, or well over $2 per share for the equity.  6x on 2021’s $240m (covid revised $211m) would be $1.4B or $3.11 per share ($1.80 per share covid revised).  So, things don’t have to get too hot for this equity to be a multi-bagger.  We’d just need to see reasonable and normalized bidding.  The current equity level implies 5.6x, which seems low given new management, and an interesting pipeline, in an improved pricing environ. 

Having enough time for a proper auction will be key to attract bids that are clear of the FDA taint and the covid period.  If so, we could expect to see bids approaching $1.75B+… which would be more inline with industry transactions for specialized niche players, and would put the equity upwards of $5.  There is risk here that the judge could take the expedient path and favor the credit bid, however weak, and wipe out the equity.  The current plan has bids due Aug 3rd and a sale hearing on Aug 20th.  But I expect there will be some near term action to elongate.  

Though the operating trends were downward for 2017-19, there are real reasons to be optimistic.  New management is considered operationally top notch, and has begun a plan which stabilized the business, improved quality and compliance systems, tightened discretionary spending and procurement activities, and is already seeing improvement in key performance metrics including improved product availability, lower backorders, and reduced ‘failure to supply’ penalties.  All the operational fixes are focused on free cash flow generation and bolstering their new product pipeline.  They have largely completed cGMP (good mfg process) related enhancements to fully address the FDA warning, with related expenses expected to significantly diminish in 2020.

Akorn has assets worth buying.  Their specialty generics business has over 200 products and focuses on a specific niche of difficult to manufacture items with alternate dosage forms (think injectables, ophthalmics, nasal sprays, liquids, etc) which have higher barriers to entry and generally lower competition due to a limited number of scale manufacturers in this niche.  It is a diversified portfolio well insulated from single product vulnerabilities, with no product comprising over 10% of revenues.  They have four manufacturing facilities, two R&D sites, a distribution center, and 2,180 employees.

Here’s some of the products they make:

The pipeline has 20+ active development projects, and 50+ pipeline products overall.  They are prioritizing high-value products where their ophthalmic capabilities allow for more complex drugs.  There are 35 ANDAs (21 generics, 14 Brand) addressing large market opportunities, and they occasionally receive good news from the FDA.  In 2019 there were 5 approvals, including for Azelastine Hydrochloride, a nasal spray.   R&D resources used on remediation contributed to reduced spending in 2019, but the targeted investment is ~4.5% of sales per year or about $40m+ annually.  

FDA approvals should accelerate once they receive an all-clear from follow-up FDA inspections, expected in time, which would be a clear sign to buyers that they can confidently bid.  New management has changed the compliance culture, brought in new personnel, filed a corrective action plan, established a dedicated data integrity team, and has expanded ongoing development of compliance related KPIs.  Furthermore, they have implemented improvements across the network, not just at the location which received FDA observation. 

The substantial majority of cGMP fixes are complete, including equipment validation, aseptic practices, contamination control, test methods, product stability, investigations, and data integrity audits.  Third party verification activities began in early 2020, and the few outstanding items are expected to be closed out this year.   During this period, other Akorn facilities have passed FDA inspection with satisfactory outcomes, and in Decatur 100% of the observation items and 96% of the warning items have been addressed, while in Somerset it’s 92% of the observation items and 87% of the warning items (as of mid April).  Clearly, they are getting close to lifting of the ‘official action indicated’ status, which would pave the way for an acceleration of new product approvals, as well as assure potential buyers.  The company has taken remediation seriously and spent $111m, between 2018-2020.

They are open during covid and positioned to handle it well considering on a normal day many in their labs go to work dressed in PPE like this:

They saw a spike in sales at the beginning of covid in late Q1, which normalized once inventory levels in various channels were adjusted.  Though forecasts under covid contain inherent uncertainty, these 5 year company forecasts were at least made after the covid period began and were as of April 15th.  Take the 2020 numbers with a grain of salt because in Q2 they suffered as demand was reduced by fewer hospital visits and restricted patient access to ophthalmology practices, leading the company to revise the 2020 and 2021 estimates on July 2nd. 

Company’s 5 year forecast – filed on April 22nd:

So, the gambit here is a new sale process to find a reasonable bid on untainted assets, rather than the bids which had been due on March 27th amid the covid scramble.

Further info was filed on July 2nd with an updated 2020 forecast for covid effects… April-May was the low point and a rebound is already in progress:

This covid impacted filing brings 2020 adj ebitda down to $133m from $188m, acknowledging the temporary closure of many optometrist offices.  But the process for a 363 sale will likely outlast much of the expected covid period and acceptable bids should realistically be based on a normalized environ.  Hope we’ll see that again soon.

There is one additional way to win here with an obscure tax angle… The PPP has provisions to allow companies that file bankruptcy during the pandemic period, under certain circumstances, to seek a refund of their last three years of tax payments.  I put zero value on this and am not looking into the PPP angle.  But if it comes to pass could be worth an additional dollar per share to the equity based on $131.9m of 2017-2019 tax payments (though I’m sure the PPP provision wasn’t intended for companies liquidating their assets).

The situation presents an interesting option-like equity opportunity, based on a reasonable likelihood of a revised bid process.

Catalyst

Catalysts:

-          FDA: Follow-up inspections from the FDA providing buyers with an all-clear

-          Sales: New product introductions and approvals

-          Time: from the Judge, to run a proper auction

-          Rebounding results from the covid related temporary closure of ophthalmic practices and fewer hospital visits

-          Continued operational progress

-          Run off, in 2020, of significant remediation spending

Risks:

-          Funding: The DIP may not suffice, and they might need more funding, particularly in light of the covid reduced estimates

-          Time:  The judge doesn’t have to give them enough time for a proper auction.  If she favors the Term Loan holders credit bid, the equity could be bagel-ized.