Description

Disclaimer: Not investment advice

Opportunity Overview

The purpose of this writeup is to argue that if your investment mandate allows investments in smaller, more illiquid companies, or if you are trading a PA, AYTU (Aytu Biopharma) is a very compelling long. Despite a ~$35mn fully diluted market capitalization and trading on average only ~$60,000 of volume a day, this stock has multi-bagger potential if management can continue to execute and shares re-rate to a more reasonable multiple.

At current prices the company is trading at just 1.3x TTM adjusted EBITDA. What is unique about this idea is that although there is some complexity, the risk reward profile is skewed very favorably for current prospective investors. There is inherent downside protection in the current EBITDA multiple as well as a net-cash balance sheet with net-cash representing ~25% of the current EV on a fully diluted basis. 

The upside case is that despite the current multiple suggesting deteriorating fundamentals, the company is actually seeing profitability growth and margin expansion driven by their commercial Rx segment, and specifically, their ADHD product portfolio within this segment which is experiencing rapid revenue growth (38.6% TTM growth YoY, 49.0% growth YoY in most recent quarter) due to the strength of their generic Adderall product offering and value-add to ADHD patients.  

Some brief TTM stats for this Rx segment to illustrate the discrepancy between the market multiple and the perceived quality of the segment:

• TTM Revenue of $73.9mn / TTM Adj. EBITDA of $17.1mn

• Gross margin of 70%+ (74% in most recent quarter)

• GAAP EBIT margin of 9.9%

• Adj. EBITDA margin of 23.1%

The current valuation is quite interesting when considering that, as seen in the above AYTU financial metrics, commercial pharmaceutical businesses can be very profitable, high margin businesses with minimal capital intensity – AYTU has zero capital expenditures. 

There are a multitude of reasons that may explain why this investment opportunity exists at such a cheap valuation:

• Shares are down 99% over the last 4 years due to a failed merger in 2020, an ensuing reverse stock split and several dilutive equity raises. 

• In addition to the “good co” ADHD product portfolio the company has also had other business segments related to consumer health and clinical development that historically were unprofitable and a use of cash. Over the last year management has wound down these segments almost completely to focus solely on the Rx segment. 

• The decline in their pediatric portfolio has lowered overall Rx segment revenue, which masks the strong growth in their ADHD product portfolio. The company expects to recover much of this decline going forward. 

• Possible market skepticism of the stickiness and magnitude of ADHD product portfolio growth given the significant Adderall shortage over the last year boosting sales of generics. Upon deeper diligence work on the shortage and AYTU’s business model, we believe this would be an incorrect perspective on the cause of AYTU’s ADHD portfolio success. 

• A strange fiscal year reporting scheme, as AYTU’s FY runs 2 quarters ahead of the calendar year. (For ex., AYTU reported 3Q 2024 results for the quarter ended March 31st, 2024). 

Capitalization:

Warrant Table

• Note – have excluded some warrants from calculation of FDSO as seen above as their strike prices are significantly above the current share price, and thus the cash received on exercise is far greater than the impact on FDSO. 

History / Opportunity Setup

1. Oct. 2022 – Significant Business Model Shift – Emphasis on Profitability

AYTU was founded by Josh Disbrow in 2015 and achieved NASDAQ listing in 2017. As mentioned above, AYTU has a messy history with several failed business ventures. In the interest of brevity will glaze over this as the go-forward business is drastically different. 

Prior to October 2022, AYTU operated through 3 segments:

1. Rx – the sale of prescription pharmaceutical products, including Adderall generics and pediatric products, to wholesalers and pharmacies.

2. Consumer Health – sale of OTC medicines and personal care products related to hair loss, urological health, allergies, etc. primarily through e-commerce platforms. This segment was acquired in Feb. 2020. 

3. Clinical Development Portfolio (AR101) – AYTU acquired the global rights to development and commercialization of AR101 in Apr. 2021, a drug used to treat Vascular Ehlers-Danlos Syndrome. 

Although the Rx segment has been consistently profitable, the consumer health and clinical development segments had historically been unprofitable and a use of cash. In October 2022 AYTU announced the strategic goal of emphasizing profitability, initially starting with the indefinite suspension of all clinical development (AR101). 

In June 2023, the Company announced the institution of a new strategic mandate focusing its business solely on its Rx Segment, in an effort to drive long-term stockholder value. AYTU noted that “The Company has generated positive adjusted EBITDA for fiscal 2023 and for seven of the last reported eight quarters for Rx, excluding the Consumer Health Segment and pipeline R&D. This concentration on the Rx Segment will result in discontinuing the Consumer Health Segment altogether.” 

2. Sep. 2023 – Inflection in Financials

In Sept. 2023, AYTU reported FY 2023 results causing the share price to immediately rally ~80%. 

The previously discussed winddown of the consumer health and clinical development segments resulted in an earnings release displaying to the market the resulting financial inflection and underlying strength of the Rx business. Some headline metrics from this release showcasing the margin and profitability improvement:

“FY 2023 Commercial Highlights (12 months ending June 30, 2023)”

• Total net revenue was $107.4 million, an increase of 11% from $96.7 million in net revenue in FY 2022.

• Net revenue from the Company’s Rx segment was $73.8 million during FY 2023 compared to $61.1 million in FY 2022.

• Consumer Health revenue during FY 2023 was $33.6 million, a decrease of 5% compared to FY 2022.

• Gross margins improved to 62% in FY 2023 compared to 54% in FY 2022.

• Net loss during FY 2023 was $17.1 million, or $5.11 per share, compared to $108.8 million, or $74.01 per share, in FY 2022. Of this $17.1 million net loss, $9.8 million was attributable to the Consumer Health Segment, $2.6 million was attributable to the now suspended pipeline R&D, and $4.7 million was attributable to the Rx Segment.

• Total Adjusted EBITDA was a positive $3.2 million in FY 2023 compared to a negative $21.5 million in the year-ago period.

• Total Adjusted EBITDA for the Rx Segment was a positive $9.4 million in FY 2023 compared to a negative $5.5 million in the year-ago period.

3. Current Operations – Rx Business

It is clear from the previously discussed FY’23 release as well as the subsequent releases that the go-forward business will comprise solely of the Rx segment. So, what is the Rx segment business model?

ADHD Portfolio

Through the first 3 quarters of AYTU’s FY’24, ADHD products have represented the vast majority of Rx segment revenue at ~85%+ of total segment revenue. This revenue is generated from the sale of two Adderall generics, Adzenys and Cotempla, to pharmaceutical wholesalers and pharmacies. 

Adderall Shortage

The macro backdrop of the strong growth in AYTU’s ADHD products has been the public, ongoing shortage of Adderall and Adderall generics for ADHD. The FDA declared a nationwide shortage of immediate release amphetamines in October 2022, including Adderall and Adderall IR but also a variety of generics such as Ritalin, Vyvanse, and Focalin. Part of the issue stems from increased demand for these drugs - use of prescription stimulants rose 46% from 2012 to 2021, partly driven by the pandemic-era trends of remote work and telehealth causing 1) a large increase in the number of adults having trouble focusing at home amongst kids, pets, etc. and 2) a large increase in the ease and variety of online methods available to procure ADHD medication. Strain on the supply of stimulants has been exacerbated by DEA quotas on drug manufacturers as well as worker shortages, supply chain issues, etc. 

While most sources claim this shortage has largely eased at present, a quick search will still yield several results suggesting that a large demographic of ADHD patients are still facing difficulty in securing their prescriptions. While meeting with AYTU management, they acknowledge that the shortage has been a driver of growth in past periods but deny that the 49% YoY growth over the last six months has been driven by the shortage. Management claims that the company has been seeing strong organic growth due to the strength of their ADHD platform and product offering in the marketplace. 

AYTUs value-proposition and business model is as follows:

Bioequivalence 

Current FDA regulations require any approved generic to contain 80-125% of the reference drugs formulation. Management claims this causes many patients who use generics to be dissatisfied as the effects of the generics are noticeably different from what they are used to. AYTU claims their generic ADHD stimulants are very similar to brand-name Adderall and further that their formulation results in a much smoother patient experience than the oftentimes overpowering stimulant dose effect of other IR brand name and generic formulations. 

Availability

AYTU has developed a platform called Rx Connect that is essentially a network of pharmacies and prescribers that all carry AYTU manufactured Adderall generics. This ensures that any doctor who prescribes an AYTU generic can be assured that the patient will have no issue finding availability, which is currently a large issue for patients. In the case a patient is not near a Rx Connect network pharmacy, expedited shipping is available. 

$50 Co-pay Guarantee

A common pain point of ADHD patients is the uncertainty of coverage for various generics, resulting in unexpectedly high co-pays and billing volatility. AYTU guarantees a maximum $50 co-pay to patients with commercial insurance regardless of plan, deductible status, etc. which also attracts prescribers / patients to AYTU manufactured generics. AYTU essentially takes payors out of the mix for patients and underwrites the prescription themselves. Insurance providers then re-imburse the wholesale distributors / pharmacies AYTU sells to. 

On average AYTU realizes a positive margin on this gross to net spread which allows them to underwrite this $50 max payment guarantee. AYTU’s A/R balance represents the revenue from sales to pharmacies and wholesalers, and the offsetting accrued liabilities account on the balance sheet represents the ongoing liability of AYTU’s subsidies and discounts to patients to achieve the $50 Co-Pay guarantee. AYTU still takes on re-imbursement risk as if wholesalers / pharmacies are not reimbursed, AYTU has to account for it by decreasing their net receivables balance to account for the charge-back. AYTU collects receivables on a shorter timeline than the patient prescription life, which management says results in the A/R balance generally being smaller than the accrued liabilities balance at any given point. 

Pediatric Portfolio

AYTU’s pediatric portfolio consists of two fluoride supplements, Poly-Vi-Flor and Tri-Vi-Flor, for infants and children with fluoride deficiency, and Karbinal ER, an extended-release antihistamine for allergy conditions. 

This segment generated $25.4mn in revenue for FY’23 which has now declined ~60-65%+ through the first three quarters of FY’24. This is due to payor changes from PBMs discontinuing their coverage of AYTU’s pediatric products. As of the most recent transcript, management has seen stabilization in this business and are seeing some growth midway through the fourth quarter amidst positive payor changes. Over time they believe they can recover a meaningful percentage of this revenue. This is also a higher margin segment than AYTU’s ADHD products. 

4. Go-Forward Outlook

• Management expects the consumer segment to be almost entirely wound down by the summer. FY’25 will display a tidy, smaller organization, focusing solely on the Rx segment. 

• Sales force growth – the current size of AYTU’s sales force is only 40 salespeople that call on all large Adderall and Concerta prescribers. Management is actively focused on growing the sales force as the business scales. 

• Management originally leased a manufacturing facility in Arizona, however recently passed through the necessary approval required to shift manufacturing to a contract manufacturing organization (CMO). As this facility was much larger than AYTU needed, management expects this change to result in further expense reductions and margin improvements. Management says that by the end of June all production at the Arizona facility will have ceased, with some further minimal wind-down costs expected. 

• AYTU has a $15mn term note that they currently pay just under 16% on (variable interest loan). This comes due in Jan 2025. AYTU is in the works of refinancing this and believe they can get a much better rate on refinancing on the strength of their profitability / cash flow improvements. They expect this refinancing to be done by early fall. 

• Management has placed a pause on pursuit of any acquisitions and state that they want to build their cash position to an extremely comfortable level before thinking about further inorganic growth. Their number one priority currently is EBITDA / FCF. CapEx is also expected to be minimal in the future – the biggest future capital expenditure is outfitting sales reps with the necessary technology and IT infrastructure. 

Valuation 

• Above are some ball-park estimates for the upcoming quarter. AYTU’s FY Q4 tends to seasonally be a strong quarter for them, while FY Q3 (most recent) is seasonally their weakest quarter due to patient’s insurance deductibles resetting at the beginning of the calendar year, which lowers AYTU’s margins.

•  Valuation is somewhat of a superficial exercise as AYTU trades at less than 3x our estimate of FY'24 GAAP EBITDA on a fully diluted basis. Even if excluding warrant dilution and subsequent cash on exercise, AYTU would trade at less than 2x FY'24 projected GAAP EBITDA. Another metric mentioned above to triangulate valuation is that AYTU trades at 1.3x TTM Adj. EBITDA. 

• Generic pharma comps trade at much higher multiples. Desktop research suggests 8-12x as a rough median EBITDA multiple. As investors wake up to the new business model focusing only on the Rx segment, margins continue to expand, and the ADHD platform continues to grow, AYTU could see substantial upside upon rerating to a more reasonable multiple. 

• FCF is lumpy as AYTU has had some working capital investments and costs related to the winddown of the consumer segment, but it is evident that FCF generation has improved significantly in recent quarters compared to the old business model in FY’23. In 4Q’23 (FY), AYTU generated $7mn+ in FFO and $9mn+ in FCF which is indicative of the potential of the business in future quarters on a normalized basis. 

Risks and Mitigants:

1. Further dilution in the event of a future equity raise. 

   1. AYTU currently has a cash balance of ~$20mn and are seeing strong profitability. Management has also placed a pause on any acquisitions until cash builds up considerably. It appears very unlikely that AYTU would have a reason to go to market for an equity issuance in the near future

2. ADHD shortage improving

   1. While the shortage may be largely over, the TAM of patients affected is still much higher than current AYTU penetration. AYTU only has less than 1% share of the generic Adderall market, and there is a long runway for growth. The company’s recent results suggest that their Rx connect platform and patient reception to their generics have allowed them to take some market share irrespective of the shortage. Management also claims that they are not seeing many of their patients return to brand-name Adderall even after supply becomes available, as they are happy with the effects of the generics. 

Closing Thoughts

The turnaround story following AYTU’s decision to focus solely on the Rx segment is compelling and the financials have certainly been improving. Risk adjusted, seems like you’re getting a decent business at a great price here.

Catalyst

• Continued ADHD Portfolio Growth
• Margin improvement upon complete winddown of Consumer Health segment
• FCF build-up over time
• Multiple re-rating inline with other generic pharmaceutical manufacturers