Description

Amneal Pharmaceuticals, Inc. (“AMRX” or the “Company”) is a pharmaceutical company that develops, manufactures, markets and distributes high-value generic and to a lesser extent, branded drugs.

I recommend purchasing AMRX’s stock, which I believe can double over the next two to three years.  While AMRX has a somewhat ignominious history as a public company, the Company now enjoys a number of attractive characteristics.  First, its management, whose family owns over half the Company, is highly aligned with public shareholders and since re-taking the reins in August 2019, has managed the business well.  Second, the Company’s core generics business has turned the corner in a challenging environment and appears poised for further top-line growth and margin expansion amid the continued launch of high-value products.  Third, the Company has upside from its relatively small specialty business as well as international expansion of its generics segment.  Finally, it is statistically cheap even on 1-year forward metrics, not to mention medium-term financials that benefit from the preceding sources of upside.

Background

AMRX was founded in 2002 by brothers Chirag and Chintu Patel, five years after they immigrated to the United States from India.  Over the next 15 years, the business grew substantially as a private company focused on U.S. generics, recording over $1,000 million of revenue and approximately $340 million of EBITDA in FY 2017.  In May 2018, AMRX went public by acquiring Impax Laboratories, Inc. (“IPXL”) for approximately $1,650 million (9.8x LTM EBITDA before synergies) and thereby creating the fifth largest generics company in the United States.  Pursuant to the deal, pre-existing AMRX shareholders (largely the Patel family) obtained 75% of the combined company, with IPXL shareholders acquiring the remaining 25%.  Moreover, in connection with the transaction, pre-existing AMRX shareholders took some chips off the table by selling approximately 15% of the Company’s pro forma shares to TPG and Fidelity for $855 million or $18.25 per share, implying a combined enterprise value of approximately $7,100 million (9.6x 2018E EBITDA based on deal proxy projections).

Following the IPXL transaction and after briefly reaching a high of around $24.00, AMRX’s stock imploded.  New management, which had limited history at AMRX, spooked the market with a series of guide-downs primarily related to generics, and the stock hit a low of just above $2.00 in August 2019.  By then, the Patels—who had witnessed the value of their family’s stake in AMRX drop by more than $2.5 billion in just over a year—decided they had seen enough.  Accordingly, in August 2019, Chirag and Chintu returned to the business and were named co-CEOs effective immediately.

Since returning to AMRX, the Patels have successfully embarked on a turnaround plan.  Among other steps, they sought to repair generic gross margins, which had fallen from 50% to nearly 30% over the 18 months preceding their return and have steadily risen since.  In addition, they committed to rebuild the Company’s base generics business while also launching approximately 15 complex generics in two years, a goal that they remain on track to meet.  They also aimed to invest in the specialty franchise acquired from IPXL and have already taken a series of steps in that regard.  

Notwithstanding the Company’s progress over the past 18 months—as further evidenced by strong FY 2020 results and better than expected FY 2021 guidance—AMRX’s stock sits at under $5.00.  This is approximately 80% below the post-IPXL transaction high and nearly 75% below where Fidelity and TPG (an astute healthcare investor) purchased nearly $1 billion of stock.  For reasons further described below, Amneal is no Shamneal, and its current price seems too cheap.

Capital Structure

Below is AMRX’s capital structure.

Business Overview

AMRX operates across three segments: (i) Generics, (ii) Specialty and (iii) AvKARE.

Generics (~67% of FY 2020 revenue, ~64% of FY 2020 pre-corporate EBITDA)

In its Generics segment, AMRX focuses on products in the United States with substantial barriers-to-entry resulting from complex drug formulations or legal or regulatory challenges.  The segment includes approximately 250 product families across therapeutic classes.  As a result, no single product family accounts for more than 15% of segment revenue although levothyroxine sodium and diclofenac gel have been material in recent years.

Significantly, AMRX has a large, high-quality pipeline, particularly for a company of its size.  By its estimates, 60% of the Company’s generic pipeline consists of what are believed to be potential first-to-file, first-to-market and other high-value products.  This includes 104 pending abbreviated new drug applications with an aggregate addressable market value of approximately $47 billion (see chart below) as well as 93 additional generic product candidates (80% of which are non-oral solids) with an aggregate addressable market of approximately $26 billion.

Illustrating the quality of its pipeline, AMRX has already announced numerous complex generic approvals since late 2019.  These include, among others, generic Carafate (first generic Sucralfate Oral Suspension, launched in December 2019), EluRyng (first generic NuvaRing, launched in December 2019), generic Butrans (launched in April 2020), generic Lidocaine Patch (approved in August 2020), generic Zovirax (approved in November 2020) and generic Ortho Evra (approved in February 2021, with 180 days of exclusivity).  In addition, before August 2021, it expects to launch an additional five complex products, and thereafter, it aims to launch six to seven complex generics per year.

AMRX’s Pending ANDAs

Specialty (~18% of FY 2020 revenue, ~30% of FY 2020 pre-corporate EBITDA)

In its Specialty segment, AMRX has a small portfolio of products, with Rytary, Unithroid and Zomig accounting for about 75% of FY 2020 revenue.  Both Rytary (Parkinson’s Disease treatment with patent protection through 2028) and Unithroid (branded levothyroxine sodium for hypothyroidism) grew double digits in 2020 and are expected to grow at a similar clip in 2021.  Zomig, however, will lose patent protection in May 2021 and therefore experience substantial revenue attrition.  AMRX hopes to offset some of this revenue loss by capturing the majority of the product’s generic market share.

Beyond marketed products, AMRX has several medium-term pipeline opportunities.  First, AMRX is in Phase 3 trials for IPX203, an investigational extended-release formulation of Carbidopa-Levodopa in advanced Parkinson’s Disease patients.  Data is expected to read out in Q3 2021, with a potential for launch in 2023.  I believe that if approved, the drug could generate on the order of $100 million of annual revenue and over $50 million of annual EBITDA.  Second, AMRX is in Phase 1/2 trials for K127, an orphan drug candidate for the treatment of myasthenia gravis (a rare autoimmune neuromuscular disease).  Finally, as a result of its pending acquisition of Kashiv Specialty Pharmaceuticals, LLC (“Kashiv”), AMRX will acquire two additional Phase 1/2 candidates.

AvKARE (~15% of FY 2020 revenue, ~6% of FY 2020 pre-corporate EBITDA)

In its AvKARE segment, AMRX provides drugs, medical and surgical products and services primarily to governmental agencies, with a focus on the Department of Defense and the Department of Veterans Affairs.  AMRX acquired a 65.1% stake in this business in January 2020 at an implied enterprise value of approximately $340 million (5.4x LTM EBITDA) and views it as an attractive, growth opportunity with moat-like characteristics.

Key Considerations

Below are the four key considerations underpinning my bull thesis.

1. Strong, Incentivized Management

The Patel family owns over 50% of AMRX and is thereby highly aligned with public shareholders.  Moreover, since Chirag and Chintu Patel have returned to the Company, they have consistently delivered on their promises.  And while AMRX’s related party transactions have been extensive, the Patels have done nothing to suggest that they are stripping, or will strip, value from the Company.

2. Rebound in Generics

I believe that AMRX’s generics business turned a corner in FY 2020 and is poised to continue growing revenue and EBITDA.  Two considerations underlie this optimism: (i) margin growth and (ii) pipeline execution. 

With respect to margins, amid pressure in the U.S. generics market, AMRX was caught flat-footed in 2018 and early 2019.  While peers cut costs and managed product portfolios in response to accelerating price deflation, AMRX did little, likely in part because of the distractions associated with the IPXL merger and new management’s lack of familiarity with the base AMRX business.  Accordingly, segment adjusted gross margins collapsed from 50% to nearly 30%.  However, the Patels have taken a series of actions to reverse this trend, focusing on fixing internal inefficiencies and improving product mix.  Although I do not believe that adjusted gross margins can return to 50%, they should exceed 40%, implying substantial upside from current levels.

The margin expansion opportunity will in part come from the continued launch of high-priced complex generics.  As highlighted above, the Company has a robust pipeline and is on track to hit its target of launching 15 complex generics from late 2019 to 2021.  With a goal of six to seven complex generics per year thereafter, AMRX should be well placed to continue to offset the natural erosion of its base business stemming from price deflation.

3. Optionality

I think that AMRX has several sources of optionality, including (i) international expansion of its generics business and (ii) organic and inorganic growth of its specialty business.

Regarding international expansion, AMRX has partnered with Fosun International Limited (its top shareholder outside of the Patel family) to penetrate the Chinese market.  It is additionally exploring partnerships for other countries.

AMRX’s specialty business is currently small, but with the Company’s financial position greatly improved, it should be able to continue acquiring pipeline assets at relatively low cost.  A template can be found in the recent Kashiv deal, for which the Company is set to make cash payments of $100 million (excluding potential royalties and contingent consideration) and acquire $15 million of EBITDA as well as generic and specialty pipeline assets.  Furthermore, although the success of the Company’s existing small pipeline is far from certain, it does have several shots on goal in the medium term.

4. Valuation

My valuation of AMRX is laid out in the next section.  However, even without ascribing much value to any of the preceding factors, I still think that AMRX is cheap.  In my view, the Company is worth approximately 9.0x 1-year forward EBITDA, which would imply nearly 50% upside in the stock based on the midpoint of the Company’s FY 2021 EBITDA guidance.  To those who view 9.0x as an unreasonable premium to that of larger generic peers such as Teva Pharmaceutical Industries Limited (“TEVA”), I think that there are two key distinctions.  First, I believe that AMRX’s potential legal liabilities related to opioids and alleged antitrust violations will prove relatively low.  Second, AMRX, unlike many of its peers, is expecting to grow EBITDA by a material percentage.  As a result, a 9.0x multiple on forward EBITDA still translates into a high single digit percentage levered free cash flow yield.

Valuation

Below are my financial projections for AMRX.  While my estimates imply continued growth, they are notably far short of what IPXL and AMRX were projecting at the time of their merger.

Based on my projections, I see approximately 100% upside in AMRX’s stock.  These numbers do not explicitly take into account potential opioid or antitrust liabilities as I do not view such liabilities as material.

Risks

The largest risks to the thesis are (i) a deterioration in the U.S. generics industry, (ii) a deterioration in AMRX’s generics business, (iii) pipeline failures, including a negative Phase 3 read-out for IPX203 and (iv) material opioid and antitrust liabilities.

Catalyst

There is no specific catalyst here although the stock will likely trade up on continued strong business performance, further complex generic approvals and a positive Phase 3 read-out for IPX203.