Description

BDY trades at 8X my estimated 2006 fully taxed EPS, 4X EBITDA and 6.5X FCF per share. With 5M shares short, BDY has one of the largest short interest ratios on the NYSE. With the company now current on its financial filings, I believe that we are at a major inflection point in the stock, with 2-3 “bagger” upside potential and very little downside risk. It trades at a significant discount to its fair value by any valuation metric.

I wrote up BDY almost a year ago on VIC (3/21/05) and the stock was then at $9.50 a share. Although the stock is up about 35% since last March, I fully believe BDY is more interesting today than ever before. I would refer you to that write-up as it details BDY’s business and gives a time line of events that helped crush the stock early last year.

On January 27th, BDY finally published its 2004 10K and its restated 10Q from Q3 of 2004. As expected the only problem multiple auditors found was $1M of revenue that should have been booked in Q4 instead of Q3. There was no fraud whatsoever discovered. In other words, BDY went through over a year of significant additional costs and pain for a relatively minor thing. The most interesting thing I discovered from reading through the 10K was the very significant amount of cash BDY generated in 2005.

12/31/04 12/31/05
Cash $76M $65M
Debt $108M $78M
Net debt $32M $13M

Based on these numbers, BDY generated $19M ($1.12 per share) in cash in 2005. I believe we should add another $10M to this number as BDY paid about $10m of cash in 2005 to cover all of their “one time costs” which included all the additional audit and lawyer fees as well as the penalties associated with taking out the convert. So, real cash flow would have been more like $29M in 2005, or $1.70 a share.

On March 3, BDY filed its 10Qs from the first 3 quarters of 05’. Not surprisingly the 1st two quarters of 05’ were quite ugly. Most of that can be attributed to 3 factors: 1) the one-time costs of audits took away $0.05-.10 of earnings each quarter. 2) Management’s attention was clearly focused on resolving the audits and not on growing their business and the business suffered somewhat. 3) Most importantly, there was a change in its wholesaler’s business model. Most drug wholesalers changed their inventory strategy in early 05’. In the past, the wholesalers typically took on 6-8 weeks of inventory. They now take on 2 weeks of inventory, so in the 1st 2 quarters of 05’ revenues declined as wholesalers worked down their inventory before buying more from BDY. This was an issue the whole industry faced not just BDY.

The September 30, 2005 quarter showed a whole different story. The inventory issue was worked through and management was again focused on growing its business. BDY had a quarter that showed $41M in revenue and $0.40 in fully taxed earnings. Once you back out the $1.5M in one time audit costs then fully taxed earnings are closer to $0.44. There are some other costs that I am not backing out but you could easily get to a $0.45+ type number for the September quarter. EBITDA as defined in the lending agreements was approximately $16.5M in the quarter. As I have already stated earlier, cash flow was very strong and a large reason for this is due to amortization from acquisitions. D&A through the first 9 months is running about $7M higher than Capex. Management clearly stated in the Q that the inventory issue is now behind them and the weekly NDC prescription numbers (sales to the retail channel) track very closely to their actual sales figures (sales to drug wholesalers).

Based on the weekly NDC numbers, Q4 (which BDY will report in late April) will be a very strong quarter. I estimate Q4 should look something like this (I have backed out the numerous one time expenses that will probably occur in Q4 as I am trying to show future earnings potential):

Rev - $41.5M
FD EPS - $0.47
EBITDA- $17M

If we annualize my Q4 expectations then BDY is trading at approximately 7.4X EPS and 3.5X EBITDA.

Q1 of 06’ appears to be tracking to be a little bit better than Q4 based on the weekly NDC published data.

So the obvious question is why is a company with a relatively long and successful history, strong balance sheet, and solid cash flow currently trading at these kinds of multiples? I believe there are multiple reasons for the current valuation. BDY just became current on their filings but they won’t file their 10K until late April and will then file their Q1 10Q. The net result is that they won’t really be current until mid-May and that bothers some investors. Their Q3 results were only released a few days ago and there were many moving parts in those results. Investors may be trying to figure out the real numbers and if the Q3 numbers are sustainable.

I believe the real reason the stock is still here is that people believe BDY has a fundamentally flawed business model. I believe this is the reason that 5M shares out of float of maybe 14M are currently short the stock. Many investors have made this argument for more than a year and I think BDY has started to show they will prove their detractors wrong. People believe BDY is too reliant on drugs that have no patent protection. I fully agree that BDY needs to move more products to patent protection and they know that as well. They are working to do that as demonstrated by their recent licensing agreement with Medigene for a drug that treats genital warts and is under protection for another 15 years. BDY took little up front risk with this agreement having to pay about $5M. I assume they won’t see any revenues from this in 06’ but should start to get some benefit in 07’. BDY believes this will be a $40-75M annual revenue drug within 5 years. Their licensing partners, Medigene, are a little more bullish and believe it will be a $100M opportunity within 5 years. In doing continued due diligence on BDY, I spoke with Medigene about BDY. They had many potential US partners to choose from and the reason they chose BDY was their strong relationships with the dermatology community and the outstanding feedback they got about BDY’s sales force. Medigene’s comments underline a very crucial point about BDY. They have a great sales force and are very highly regarded in the dermatology community (I saw this first hand at the recent AAD conference in San Francisco). BDY will continue to leverage their standing in the derm community by acquiring and licensing multiple products as time goes on. They will focus on patented products and get them into their sales funnel with little incremental cost. Very few investors are focused on the great strength of the BDY sales force.

Generic competition has come at this point to the majority of BDY’s brands. They have shown over the years though line extensions and various other methods that they are pretty good at defending their revenues. A good example of this is Adoxa. BDY acquired Adoxa through the Bioglan acquisition in August of 04’. They did a great job of growing Adoxa until generic competition arrived in December 05’. The 1st week that BDY owned Adoxa they did $986k in weekly sales; the week before generic competition they did $1.23M in sales. What has happened since generic competition arrived? In the most recent week Adoxa sales were $1.19M and that compares favorably to an average of 1.17M for the 10 weeks prior to competition. BDY prepared for competition by moving patients to a new strength that did not have generic competition. They also partnered and launched their own generic version as soon as a competing version came to market. The point here is that BDY is always prepared for generic competition and has numerous game plans to be successful against it.

2006 outlook – assumes no acquisitions but does include organic line extensions and product launches

Revenue - $155M
EPS - $1.60
EBITDA - $60M
FCF - $30-35M
FCF/share - $1.75-$2.05

No matter how you slice it BDY is very cheap. Comps typically get at least a 20X EPS multiple implying a $32 price target. I will accept that for now BDY should get a lower multiple until they start getting more revenue from patent protected products but I also believe within a year you will be looking at a company that has multiple products with patent protection. Over the next 12 months I expect BDY to get at least 15X multiple on my $1.60 or trade to $24 a share which is almost double from here. In terms of downside in the stock it is almost impossible to see BDY earning less than $1.10 even if we assume all worst-case scenarios about generic competition. BDY is now trading at 12X worst case EPS and this for a company with excellent cash flow.

Lastly if management cannot find good products to acquire or license I believe they will get very active on their buyback program.

Summary

I have liked BDY for about a year now (again please review my 3/21/05 VIC write up). The upside in the stock is the same - if not better - and the downside has almost been totally removed.

The company is current in its financials and no smoking gun was ever found.

Recent Quarter was very strong and next few quarters should be just as strong

BDY has shown itself very capable of defending against generic competition

Cash flow even during very turbulent times was extremely strong

Known for one of the best sales forces and marketing capabilities in the industry

Catalyst

By end of April - Filing of Q4 2005 and Q1 2006 numbers that will show strong earnings and cash flow

Acquisition or licensing deal

Further growth in weekly NDC numbers

Huge short position