Description
For a history of the company see previous write-ups.
I believe Endo Pharmaceuticals represents a good value at a current price of roughly $20. While analyst’s estimates are for 2005 EPS of $1.33 and the company will probably guide to a similar number on their 2005 guidance call in the next week or so I believe a more realistic number is $1.50. While “conservative sell side estimates” is oxymoronic all you have to do is look at the company’s last eight quarters to see that it’s true as they have typically beaten estimates by 20-40 percent. At $1.50 the stock is not dirt cheap at 13 times 2005 earnings and 12 times EV/earnings but the stock also has some reasonable growth ahead of it and some modest barriers.
Focus Strategy
Endo Pharmaceuticals has always focused on pain management. When management and buyout firm Kelso LBO’d the firm from Dupont/Merck Pharma the company was basically a grab bag of generic drugs with some strong brands in Percodan and Percocet (long considered the “gold standard” in pain management). Through some smart life-cycle management of Percocet (they have introduced five new formulations in two launches since 2000), the in-licensing of a drug, Lidoderm, that had previously been rejected by the FDA and some generic introductions management has achieved 40 percent compound annual sales growth from 1998-2003. While sales and earnings should be flat in 2004 at $600 million and $1.15 respectively, the company has a solid balance sheet and should end the year with almost $2 per share in cash, a new FDA approved injectable pain drug, DepoDur, that was launched recently and bring them into the hospital surgical suite, an in-licensed migraine drug Frova that has significant competitive advantages, a generic version of JNJ’s blockbuster Duragesic that should be launched in 2006, a FDA approvable letter for a potential blockbuster drug Oxymorphone that could be approved in mid-2006 and a strong pipeline of other pain products. Going forward Endo will rely on both internally developed products and in-licensing to fill their pipeline. Given their focus on pain management they are the “partner of choice” for small drug companies looking to take advantage of a large partner’s distribution capabilities in a focus niche. Given that sales are still relatively small, in-licensing drugs with $200 million in potential sales can still make a significant difference.
I would note that the pain therapy market is a large market even though it is a “niche” pharmaceutical market. The prescription pain market is $16.6 billion with $5.6 billion in prescriptions from opioids and $11 billion from non-opioids. I would also add that the market is mostly generic and has suffered from a lack of innovation for many years and would be much larger if there were more branded sales.
The company has been under a bit of a cloud this year as their primary branded opportunity, Oxymorphone, received an approvable letter but has been forced to perform more clinical trials and management and Kelso have sold a significant amount of stock. While I’ve never been a fan of being on the buying end of insider selling I would note that after the recent secondary management and Kelso’s position will still be 48 percent. With an average cost of $2.50 based on a 1997 investment I have little doubt that I would be reducing my position at current prices as well. In other words, I don’t believe that this is a reflection of any bad news to come. To be honest, in seven years the CEO, Carol Ammon, has gone from having a decent salary and partial ownership in a company taken private at $200 million to amassing $300 million in personal wealth. I think some diversification will help her from being distracted by the stock.
Management
I have been invested in the stock since late 2002 and management has always given very conservative annual guidance. While they don’t give quarterly guidance they have routinely beaten (never missed) sell side analyst estimates by 20-40 percent. I also met with the CEO of Skye Pharma, who Endo is partnering with on three drugs, some months ago. One of the drugs, Propofol IDD-D, is a new version of a drug sold by AstraZeneca that is genericized but still has branded sales of about $200 million. If all sales were branded this means the drug’s market is actually 3-4 times the size or $600-800 million. When I asked the Skye CEO why he said the opportunity was about $300 million when in reality it is closer to $700 million he said, “That is what our partner Endo has told us to say”. This management team is far from promotional and I would say conservative almost to a fault.
As a footnote, last year’s option grants were less than one percent of shares outstanding and total options outstanding (excluding non-dilutive options related to the MBO) are about 2.5 percent of shares outstanding.
Sales
Historically Endo had a small internal specialty sales force of 80 reps that focused on detailing pain specialists and neurologists and had contracted with Ventiv health for 150 reps to sell to community based general physicians. In 2003, with 100 percent growth of Lidoderm and strong sales of Percocet management brought the community based sales force in-house as the economics justified this move. With the launch of DepoDur the company is currently building a small hospital based sales force of about 30 reps, and another 75 reps will be added in Q4 to grow their pain specialty sales force and community based reps for the launch of migraine drug Frova. While this will certainly add some overhead the company will also be able to add another drug to “the bag” of their existing 230 sales reps 75 of these reps having strong relationships with pain specialists and neurologists who treat migraine sufferers. I would add that analysts estimates for increased S,G & A due to the sales force increase are way too high with numbers ranging from $150,000 to $225,000. Management has guided in the past for $140,000 per head but this is the number for the hospital/ specialty reps while the community reps are closer to $75,000. To be conservative I have added $14,000,000 Q3’s annualized S,G & A to get a 2005 number.
Branded Products
Currently Endo’s biggest single product is Lidoderm that is currently experiencing YoY prescription growth of about 55 percent and is expected to realize $300 million in sales this year. Lidoderm is the only drug approved for the treatment of pain associated with shingles although the company believes that greater than 50 percent of prescriptions are off label for diabetic neuropathy, arthritis, migraines and low back pain. One of the benefits of the drug is that it is a topical patch and treats the pain in the location of the patch without getting in to the bloodstream leading to fewer side effects than opioid transdermal patches that do get in to the bloodstream.
Q2 sales were soft as Endo introduced a nine percent price increase at the end of Q1 leading to some distributors buying extra inventory to arbitrage the price increase. Q3 sales of $83 million were normalized to prescriptions and I have little doubt that Lidoderm will be able to reach the $300 million goal for 2004. Q4 sales should come in at about $90-95 million and the product is still growing at about nine percent per quarter. Assuming conservative six percent quarterly growth and a 4-5 percent price increase Lidoderm should do about $430 million in 2005.
Lidoderm also has orphan drug status until March 2006 (this means that no generic competition is allowed before that time) and is patent protected through 2013. I would only add that if somebody tried to introduce a generic Endo could sue under paragraph IV extending the life for at least another thirty months. Having said that, the FDA has been very reticent to allow for generic versions of drugs delivered topically and from what the company has said the FDA doesn’t even have a formal policy for composition of matter patents for topical patches, giving these drugs some superior patent protection. The reason for this is its bio-equivalence cannot be easily measured (if at all since the drug does not get in to the blood) and the FDA has no guidelines for measuring bio-equivalence (essential for getting a generic approved) for a topical skin patch. As the sales force grows I don’t think it is unrealistic to believe this drug could be at $500 million in 2006.
Endo’s second most important product is Percocet long considered the “gold standard” in pain management. Percocet is a combination of oxycodone (similar to codeine) and acetaminophine and the company’s strategy has been to reformulate the drug with different doses of the two active ingredients based on feedback from doctors and patients. Endo’s current formulations of Percocet 5/325 and 7.5/325 (oxycodone/acetaminophine) are currently experiencing generic competition and sales have now eroded to the point that the company believes the damage has largely been done. For reasons that are foreign to me, branded drugs tend to maintain 20 percent share of their pre-generic sales for some time. Because of this and the fact that the current formulation is the third launch of the drug my estimate is that existing branded sales of Percocet should maintain sales volume of about $65 million in 2005. Sales of the older formulations will continue to decline but at a much slower rate. Percocet exited Q3 at run rate sales of $90 million after achieving sales of $215 million in 2003.
The company has been very smart in managing the life cycle of the drug by launching their own generic version of Percocet, known as Endocet, when competition’s generic enters the market. This effectively leads to sales similar to the branded sales until a new formulation is launched. Endocet exited Q2 with run rate sales of about $120 million and when combined with Percocet’s Q2 run rate sales you have $220 million in annual sales. While the price of the generic is discounted, it is not significant in this case because it has only had one generic competitor in Watson until the third quarter (Mallinckrodt entered in Q3) and there is little S,G & A associated with generics leading to healthy margins.
While the company has held their cards close to their vest on the next version of Percocet on the February 5th Q4 conference call Carol Ammon alluded to something new when she said:
“We will continue to manage the lifecycle of Percocet, because we believe it is a very important product with important brand equity. But because of the competitive nature of the product, and the fact that this is covered by an ANDA, we do not disclose what we're working on. But please suffice it to say that -- we believe this is a very important brand and we will manage the lifecycle of it.”
I would also point out that overall company inventory has grown from about $50 million in Q4 2003 to $90 million in Q2 2004 or 100 percent. This $40 million equates to $200 million in sales that the company has attributed to a build-up in Lidoderm related to new packaging. I’m not sure why they would build this much when the drug’s annual run rate is $300 million so suffice it to say that I would speculate that a new formulation of Percocet may be in the pipeline.
Endo recently launched DepoDur (formerly named Depomorphine) and this drug is a sustained release I.V. form of morphine, convenient for single epidural use pre-surgery and also for post-operative relief over a 48-hour period. The benefits are that current forms of I.V. morphine typically only last for 3-4 hours and if a longer lasting dosing is needed an in-dwelling catheter and infusion pump (more expensive for the hospital) is necessary compared with DepoDur’s single injection lasting 48 hours. The sustained release of 48 hours also reduces costs by eliminating the need for oral dosing of another pain-killer that would again increase the hospital’s costs. Endo’s partner Skye Pharma carried out clinical trials with over 1,000 patients in knee, hip and lower abdominal surgery and caesarian section with very positive results. Based on the number of aforementioned surgeries (6,020,000 X one-third x $125) the market opportunity for the drug is expected to be $200-250 million in the U.S. and will be sold by Endo’s specialty hospital based sales force. I have assumed $15 million in sales in 2005/
Recently Endo in-licensed Frova from UK based drug developer Vernalis. Frova is one of many migraine drugs of the triptan class and was previously marketed by Vernalis’ partner Elan. With Elan basically in asset sale/ de-leveraging mode for the last three years they have had little ability to focus on their operations and hired UCB to market the drug. While Frova had achieved run rate sales of $50 million exiting Q1 2004, after being launched in mid-2002, Vernalis was disappointed with the performance and bought the rights to the drug back from Elan for $50 million.
Vernalis was disappointed because of the benefits of Frova when compared to competitive drugs. Frova is marketed at an oral dose of 2.5mg. Frova has a longer duration of action than other triptans by virtue of the therapy’s markedly (three- to fourfold) longer half-life of 26 hours (Maxalt half-life, 2-3 hours; Zomig, 3 hours; Imitrex, 2-3 hours). This reduces the rate of migraine recurrence relative to the other triptans (7-25 percent within 24 hours versus 16-47 percent for other triptans) and is useful for prevention of migraines associated with menstruation that come on slowly but last longer than typical migraines. In September 2002, Vernalis released headline Phase IV data for Frova in the prevention of menstrual associated migraine (MAM). The data were highly positive and demonstrated that Frovatriptan was effective in the prophylactic (preventative) reduction of the incidence, severity and duration of menstruation-associated migraines when compared with placebo. Frova could be approved for this indication in 2006 and if approved it would substantially raise its profile as it would be the first drug approved for this need. On the negative side onset of action of Frova is an issue the sales force must overcome as the belief in the physician community is that onset of Frova is 2-2.5 hours longer than market leading Immitrex. While onset of action is slightly longer (half-an-hour) than most oral triptans, it is really the injectable and nasal forms of competitive drugs that have the fastest onset. While an obvious negative, labeling approval for the prevention of menstrual migraines will largely eliminate this issue.
Frova chose to partner with Endo because of their focus in pain management and relationships with neurologists and with 17 percent of all Rx's for triptans written by neurologists Endo is a logical partner. As previously mentioned Endo will grow its sales force by 75 to support the launch of the drug in late 2004. The migraine market is a substantial opportunity for Endo with 2003 sales of $1.9 billion. I believe the product’s differentiation and therapeutic benefits coupled with Endo’s focused sales force should help them achieve sales of $50 million in 2005 after achieving roughly $40 million in 2004. I would note that Lidoderm is already prescribed off-label by pain specialists and neurologists for migraine.
The company paid a reasonable price for Frova of $30 million up-front and $15 million in each of 2005 and 2006. Endo pays no sales or profit royalty unless Frova is approved for the MAM indication mentioned above, leading to a sales royalty of 20 percent and another milestone payment of $40 million. Endo also loaned the company $50 million at five percent over five years (through 2009) although $20 million of the MAM milestone would have to be re-paid to Endo if approved in 2006. Essentially, Endo paid one-times sales to acquire this drug, although the $50 million loan will dilute the returns. It is interesting to note that management confirmed that Frova has 9.5 percent share of migraine scrips in Germany (versus the current 2 percent in the U.S.) leading me to believe that there is ample opportunity to grow the drug through better detailing by a more committed sales force.
Oxymorphone is potentially Endo’s largest drug and is internally developed. The drug will compete in the $3.6 billion strong opioid market and be used to treat moderate-to-severe pain. The primary competitor in this market is Oxycontin that had 2003 sales of an estimated (Purdue the company that owns the drug is private) $2 billion. Oxymorphone has clinical and safety benefits over Oxycontin in that it achieves similar efficacy to Oxycontin at half the milligram dose (less opioid in the bloodstream) and has a time-release formulation that prevents abuse. Endo has partnered with drug delivery company Penwest to develop Oxymorphone. Penwest’s TimerX time-release technology is made of xanthan and locust bean gum making it slowly erode in liquid allowing for better time release. The other benefit is that this makes it hard to crush and inject or snort. While not the typical way to take drug therapy this is the way that Oxycontin is used abusively.
Late last year the drug received an approvable letter but in the end was not approved because of some confusion with data in one of the 12 phase II/III clinical trials. The company is currently recruiting and will conduct the trial over three-months and re-submit the data in late-2005 or early 2006 with the hope of receiving approval in 2006 based on the six-month review time related to a FDA pre-reviewed re-submission. While the approvable letter and request for more trials is concerning I have spoken to the former IR person at Ligand, a company that released an oral opioid in 2003. He said that basically the FDA has very high hurdles when it comes to approving opioids and if you look at the track record there aren’t many in the last five years that have been approved the first time through. Because of the abuse problems they want to make sure that the applicant has all the t’s crossed and i’s dotted before approval. The exception might have been Endo since they are more prudent given these drugs are crucial to their franchise and although it didn’t happen I am quite confident that the approvable letter will move to approved next year.
Generic Products
Currently their most important generic product is Endocet and I have discussed its role previously so I will forego any more detail.
Their second most important generic is Morphine Sulphate extended release (MSER). Endo introduced this product in 1999 and because it is a little harder to develop and manufacture the company had the generic market to itself until late 2003 when Mallinckrodt entered the market. While pricing has eroded (estimates are down 25 percent) because of this competition the drug is still performing well as prescriptions have continued to grow at a 12 percent pace. Previously mentioned Ligand introduced a single daily dosage form (Endo’s is twice daily) of MSER in 2003 and it appears that this grew the whole market for the drug. While currently running at $80 million in sales, another small new entrant recently came in to the market and I have forecast a very conservative 40 percent drop in sales next year.
Generic Oxycontin is their most important pipeline generic. Endo had filed a paragraph IV ANDA to produce generic Oxycontin and was sued by Purdue Pharma, the manufacturer of Oxycontin. After the required 30-month stay the case went to trial with Endo prevailing. Purdue filed an appeal and the two companies went before the court on November 2nd with an outcome expected in early-to-mid 2005. While Endo could have launched generic Oxycontin at risk based on the district court’s decision they would be open to damage awards if Purdue won the appeal. Endo made the prudent decision and decided not to launch prior to the outcome of the appeal. I would note that the large Israeli specialty pharma company, Teva, felt confident enough in the district court’s decision that they did launch the one 80 mg strength they have approval for.
The three dosages that Endo filed on had combined sales of $1.3 billion in 2003 and if Endo wins the appeal they will have six months of exclusivity (the only generic approved) on the drug. Assuming a 20 percent price discount, 50 percent generic erosion over six months and some modest S, G & A the drug should produce about 70 cents in EPS over the six months and another 20 cents after new generics enter the market after the six month exclusivity ends. My understanding is that in the appeal the burden is on Purdue to prove that the district court judge made an error in his determination regarding patent law. While commentary was mixed coming out of the appeal, the majority seems to believe that the appeals judges failed to find an error in the judgement.
The last pipeline generic is a generic form of JNJ’s pain patch Duragesic that is estimated to have U.S. sales of $1.3 billion in 2004. Endo in-licensed the product from Noven Pharmaceuticals earlier this year and they will face competition from Mylan, Eon, Par/Abrika, Stada and Watson either at launch or shortly after in early 2005. With some stiff competition estimates are that price discounts will be 60 percent soon after launch leading to a generic market of $410 million. While science is not a differentiator in generics dollars are and Noven/Endo’s Dot Matrix patches have significantly less site detatchment than competitive patches ultimately reducing the cost of a prescription. The incidence is 3 percent for Noven’s patch, 9 percent for Watson’s patch and an estimated 25 percent for generic Duragesic. While there are patient benefits to lower site detachment the real benefit is cost saving to the drug plans since more patches falling off means more patches consumed and higher cost per prescription for the payor.
Endo paid $8 million to in-license this product and will pay another $5-10 million based on the number of competitors upon final approval by the FDA. While not disclosed, my guess is that they will split the profits after Noven pays for manufacturing. Given the competition I have assumed $70 million in sales. I would also note that with generic oxycontin Endo was required to file a risk management program (RMP) with the FDA that outlined how they would reduce the risk of abuse with a generic – a request that had not been necessary with a generic schedule II drug in the past. This will be likely with generic Duragesic as well that should limit price competition (RMP’s cost money and affect margins) and could delay entry of some competitors in to the market.
Catalyst
Potential for new Percocet
Less competition on generic Duragesic
Other drug in-licensing