Description

Pitch:

Consensus views Endo as a pharma asset in secular decline. We view Endo as the next successful specialty pharma roll-up (i.e the next VRX - Valeant Pharmaceuticals).  Since Mike Pearson took over VRX in 2008 it has been a ~10 bagger.  The ENDP CEO, Rajiv Desilva, was the Mike Pearson “disciple” for the last decade and is highly likely to succeed in the transformation of ENDP as a result.  Furthermore, his incentive package strongly aligns management with shareholders. 

In a base case we get to a price target of ~$96 based on $7.66 cash EPS in 2015 and a 13x multiple (the approximate current Valeant multiple on run-rate fully synergized earnings), or 25% upside.  Our 2014 cash EPS estimate is $5.44 and an additional year of executing the value accretive roll-up strategy + our revenue assumptions for the existing core business takes 2016 cash EPS to $10.18, or an additional ~33% EPS growth for those willing to look out an additional year.  We view this as a multi-year investment and bet on the ENDP CEO to replicate the VRX strategy at ENDP and transform the business into a collection of improved assets and growth profiles. 

Our base case 2015 revenue of $4,006 (includes $97mm from the Boca Pharmacal acquisition which closed on 2/3/2014, $221mm from the closed Paladin Labs acquisition which closed on 2/28/2014, and $750mm of additional revenue from M&A in each of 2014 and 2015) is 56% higher vs. consensus of $2,586, and our base case 2015 cash EPS of $7.66 is 98% higher vs. consensus of $3.88.

Business Description:

Endo International plc (“Endo”) is a healthcare company focused on pain-related branded pharmaceuticals (~53% of 2013 revs), pain-related and diversified generic pharmaceuticals (~28% of 2013 revs), and urological devices (~19% of 2013 revs). The company is the result of a failed revenue synergy-based roll-up strategy by prior management, who spent >$5bn on M&A from 2009 – 2011.

Rajiv Desilva, previously a Partner at McKinsey (1995 – 2003), exec at Novartis (2003 – 2008), and President and COO at Valeant (2009 – 2013), joined Endo in March 2013 as President and CEO. Rajiv has since restructured Endo’s senior management team.

Investment Merits:

• Valeant has proven that the efficiency-driven pharma roll-up strategy works.
• Valeant has consistently deployed significant amounts of capital over a multi-year period at unlevered ROICs ~20%.
• Valeant’s stock has been more than a “10 bagger” since Mike Pearson became CEO in 2008.
• We believe the same structural advantages that allow VRX to buy companies at high unlevered ROICs (post synergies and efficiencies) also exist at ENDP
• We believe that new CEO Rajiv Desilva is the right person to apply the strategy at Endo.
• The efficiency-driven pharma roll-up strategy is easy to elucidate, but exceptionally difficult to execute -- we believe that Rajiv has strong odds of successfully executing the strategy at Endo. Rajiv has been the Mike Pearson (current Valeant CEO) disciple for over a decade at both McKinsey and Valeant, where he was keenly focused on M&A, specifically integration (the most dangerous part of a roll-up strategy).
• Post patent cliff and asset sales, residual Endo will comprise an attractive collection of growing assets.
• After the H2 2013 / 2014 patent cliff, we believe that Endo will comprise a reasonable set of assets with positive organic growth: flattish branded business, low-double-digit growth generics business, and low-single-digit growth devices business.
• Rajiv has clearly outlined his aspiration to acquire growing branded drugs and bring overall growth to the branded segment. If Rajiv is successful, he will have three divisions with clear multi-year organic growth runways.
• Management incentives.
• Rajiv is incentivized to drive shareholder returns. Many of the compensation principles applied by Valeant have been incorporated in Rajiv’s agreement at Endo: Rajiv will earn over $50mm if he can 2x Endo’s share price from its current level.

 For more background information the VRX accretive M&A strategy please review the VRX investor presentation materials.  In particular, the documents that highlight his historic deal IRR and hit rates.  

Price Target and Upside

• We get to a price target of ~$96 based on $7.66 cash EPS in 2015 and a 13x multiple (the approximate current Valeant multiple on run-rate fully synergized earnings).
  • Our model assumes 2015 revenue of $4,006, overall EBITA margin of 45% (including fully synergized acquisitions), interest expense of $333mm (incremental acquisitions are debt-funded), a tax rate of 15% (Endo’s tax rate should decline as a result of the Paladin Labs acquisition), and 164mm diluted shares outstanding (pro forma for the stock component of the Paladin Labs acquisition).
  • Modeling specifics.  We assume Endo acquires $750mm in revenue (on top of recently announced Boca and Paladin acquisitions) in both 2014 and 2015 and that these revenue streams come in at 60% EBITDA margins, which is roughly in-line with the VRX economic M&A model.  The 2016 assumption also utilizes these inputs.

Risks

• Product liability litigation.
• Endo is currently a defendant in a product liability litigation process regarding vaginal mesh products in the Women’s Health segment of its AMS business (urological devices). These issues stem from an FDA Public Health Notification Update in July 2011.
• Endo is one of several manufacturers hit with these mesh suits.
• Patent cliff.
• ~80% of Endo’s 2012 branded pharmaceuticals revenue may genericize over 2013 and 2014. This represents 45% of Endo’s total 2012 revenue and roughly 60% of EBIT.
• M&A/Execution risk.
• Rajiv says all the right things with regard to M&A, and is very credible based on his track record at Valeant. That said, he only recently closed his first two deals at Endo, limiting the level of conviction one can have in him as a primary capital allocator.

Disclosure:

We and our affiliates are long Endo (ENDP) and may long/buy additional shares or sell some or all of our shares, at any time.  We have no obligation to inform anybody of any changes in our views of ENDP. This is not a recommendation to buy or sell shares.  Our research should not be taken for certainty.  Please conduct your own research and reach your own conclusion.

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