Value Investors Club / MALLINCKRODT PLC (MNK’s 2nd lien notes )

Description

Mallinckrodt (MNK)

Summary: Buy MNK’s 2nd lien notes at 89 cents and unsecured notes at 30 cents.

Background:

MNK is a specialty pharmaceutical business focused on the development, manufacturing, marketing and distribution of

specialty pharmaceutical products and therapies. MNK operates two reporting segments, Specialty Brands (89% of US

revenues) and Specialty Generics. MNK corporate is domiciled in Ireland and the Specialty Brands division operates from

Bedminster, NJ.

Key areas of focus include auto-immune and rare diseases in specialty areas as neurology, rheumatology, nephrology,

pulmonology, and opthamology, as well as immunotherapy and neonatal respiratory care therapies, analgesics and

gastrointestinal products.

MNK filed for chapter 11 relief on October 11, 2020.

Investment recommendation:

Buy 2nd lien 10% notes ($323m face amount) at 89 cents; with $3.3bn of 1st lien debt (levered ~3x), which may be reinstated, and ~$1.7bn face amount of unsecured notes below the 2nd lien notes, it’s unlikely the 2nd lien notes are impaired and are likely to be reinstated.

Buy unsecured notes at 30 cents (note the 4.75% Sr Notes due Apr-23 which only have parent guarantees, not subsidiary guarantees, so they trade ~7 cents); the unsecured notes are trading at a safe discount and are likely the new equity.

Including the $650m CMS legal (unsecured) liability for the Achtar gel and ~$1.6 bn opioid liability, the market value of the unsecured notes implies a 5.3x multiple vs equity multiples ~7-9x.

Assuming the unsecured notes are the new equity, and using conservative EBITDA estimates and multiples, buying the unsecured notes at 30 cents can easily generate >100% return and may be worth par.

Catalysts:

1. Ruling on a formal equity committee by Judge Dorsey, possibly on Dec 22nd, 2020 or early in 2021

2. Clarification on the Restructuring Support Agreement (RSA)

3. Acthar reimbursement stabilization

4. FDA approval of pipeline drugs

Restructuring Support Agreement (RSA):

From the Declaration of Stephen A. Welch, Chief Transformation Officer, in support of the chapter 11 petitions and first day motions (p.42), the RSA has the following provisions:

1. Claims under the Debtors’ Credit Agreement will be reinstated,

2. Debtors’ secured notes (1st lien and 2nd lien) will be reinstated,

3. Unsecured notes will be given 100% of the equity of reorganized Mallinckrodt (subject to dilution of the

warrants issued as part of the Opioid Settlement and the Management Incentive Plan), and new 2nd lien notes (amount to be determined),

4. Holders of general unsecured claims will receive an allocated share of a $100m cash pool, other than trade

creditors who will receive a greater recovery in exchange for providing appropriate post-emergence trade terms.

Cap Table today:

Cap Table, post bankruptcy:

Merits:

• EBITDA ~$1bn and positive FCF ~$600m; even with the CMS hit to Achtar, MNK is not significantly levered

• Buying the unsecured notes (future equity) at 5.3x (including $650m Achtar penalty and $1.6bn opioid liability), leaves 2-4x turns of equity multiple upside

• The $1.6bn opioid settlement, as structured, is evenly spread over 8 years ($200m / year), giving MNK time to function as an ongoing business

• Covid – MNK recently won approval for Canadian tests for an existing drug to treat Covid patients

• MNK is developing new drugs and defending patents with lawsuits; management is operating MNK as “business as usual”

Risks:

• Judge Dorsey appoints an equity committee, threatening to unravel the current RSA and causing a free-fall bankruptcy; Judge Dorsey recently indicated he would try to have an oral ruling for the next omnibus hearing on Dec 22nd at 10am, but a decision may not be issued until after the holidays. Although equity holders are arguing for a formal committee, it is likely they’re simply negotiating for a tip with warrants.

• 1st lien lenders (Aurelius, Silver Point, Eaton Vance, etc…) may litigate to avoid reinstatement; Aurelius reportedly owns ~45% of 10% 1L Notes due Apr-25

• Pharma is an IP & people business, so chapter 11 risks a flight of talent

Timing: If MNK can avoid a prolonged bankruptcy and exit in a timely manner, estate value can be preserved for the benefit of future equity holders instead of drained to bankruptcy professionals.

Considerations:

Achtar rebate litigation: in Mar-20, MNK lost a summary judgement motion and in Jun-20 the company lost its

temporary injunction request in the US District Court of Appeals over the Centers for Medicare and Medicaid Services

(CMS) ruling that Achtar (MNK’s highest revenue drug) violated the Medicaid drug rebate program by mis-reporting the

base date average manufacturer price. The ruling resulted in a $650m retroactive charge and does not include the Dept

of Justice False Claims Act fines. MNK expects the appeals process to conclude in late 2020 or early 2021. The $650m

CMS settlement can be spread out over time. Achtar generated ~$100m of ongoing EBITDA, so the settlement put these

cash flows at risk.

Opioid settlement: The $1.6bn settlement can be spread out evenly over 8 years

MNK main drugs:

Achtar gel (acquired in 2014 for $5.9bn): Injectable drug approved by the US Food & Drug Administration (FDA) not

protect by a patent. The drug is used as a last resort treatment for rheumatoid arthritis (RA), including juvenile RA and

monotherapy. Achtar gel has been criticized for massive price increases; in 2001, a vial cost $50 but it skyrocketed to

$40,000 by 2014.

The Achtar outlook is challenging with trends already being impacted by reimbursement pressures, price and duration in

treatment. Based on market intelligence, Achtar is difficult to replicate on a generic basis and potential competition

(ANIPharma, ~$400m market cap) appears to be a low threat of disruption. Achtar is a very niche drug and is necessary

for complex medical needs. MNK has been investing in clinical studies to grow alternative treatments, including a new

self injector with subscription pricing.

INOMax (acquired in 2015 for $2.3bn): is a gas for inhalation and a vasodilator that improves oxygenation, mostly

focusing on infants. The treatment has certain patents, but Praxair has successfully challenged them in court and is

expected to result in a competitor.

INOMax is a “closed loop” system with a razor / razorblade model and defensive moat. Praxair may bring a competitor in

the near future. Lower birth rates may weigh on future results, but Covid (ventilators) may yield higher volumes.

Therakos (acquired in 2015 for $1.3bn): is an integrated system for lymphoma patients which has a unique process of

separating red and white blood cells and returning reactivated white blood cells. Therakos is one of MNK’s more stable

products although Covid could dampen results due to fewer procedures.

Ofimev (acquired in 2014 for $1.3bn): IV injection of a proprietary acetaminophen formula to manage mild to moderate

pain. This drug faces patent expiration in 2021 and based on analysis of other “patent cliff” drugs, prices may fall by 30-

50% along with ~25% volume declines.

Amitiza (acquired in 2018 for $1.2bn): a leading product in the branded constipation market. Amitza was approved by

the FDA to treat chronic idiopathic. MNK faces generic competition from Endo due to its acquisition of Par

Pharmaceuticals. Amitza faces a challenging outlook due to a generic introduction in 2021 (US only) and soft results from

Covid. While US generic competition may soften results, Amitza posts strong & significant results in Japan.

Terlipressin (pipeline): an MNK pipeline drug (FDA approved in Sep-20, but more data is needed for an NDA) for treating

type 1 hepatorenal syndrome (HRS), an acute, rare and potentially life-threatening condition with no currently approved

therapy in the US. Peak sales are expected ~$300m. Even if the FDA does not approve Terlipressin, MNK could still

monetize its via M&A.

StrataGraft (acquired in 2016 for $116m): regenerative skin tissue for treatment of severe, deep partial thickness burns

– FDA accepted for review in Aug-20. In 2012, the FDA granted StrataGraft orphan product status, conferring seven

years exclusivity. Peak sales expected ~$150m, but it would require training surgeons so could take some time.

Specialty Generics: include a variety of product formulations containing hydrocodone-containing tablets, oxycodone-

containing tablets and several other controlled substances, all of which are significant pain treatment products. This

segment saw material annual declines (-14-18%) from 2015-2018 before stabilizing in 2019. Looking ahead, specialty

generic revenues should decline by ~5-9% per year.

Litigation notes:

Opioid makers and distributors: face over 2,000 lawsuits by states, counties and individuals. Drug manufacturers are

accused of misrepresenting opioid risks and benefits. Distributors (Amerisource Bergen, Cardinal Health and McKesson)

are accused of supplying opioids diverted to illicit markets.

A potential deal by opioid manufacturers Teva, Purdue, J&J, Endo and Mallinckrodt and competitors may cost ~$20-30bn

while several states have discussed $50bn.

J&J’s reported $4bn offer is in-range with market share given branded drug revenue. Teva’s offer of $23bn in drugs is

likely worth less, while plaintiffs may seek extra cash.

Purdue Pharma (oxycontin) filed for chapter 11 bankruptcy and has been seeking a global settlement ~$10-12bn, which

includes contributions from Sackler family members named as defendants. Purdue has paid over $130m in bankruptcy

fees so far.

Achtar CMS: Medicaid has a drug rebate program managed by CMS, in which the rebates are paid directly to the states.

For branded drugs, states receive a base 23.1% rebate and are able to negotiate for further rebates on their own. The

rebate formula says any price increase above inflation is clawed back in next year’s rebates. Even notable price hikes (ie

EpiPen) gained nothing from their 17,000% price increases.

Questcor (former owner of Achtar) invested in additional clinical trials and submitted a new NDA, based on better

science / uses for the drug, and got a new NDA number.

Questcor assumed based on the new NDA, to recapture prior investments in R&D, that it would be able to recalibrate

the base price for AMP and Medicaid so that rebates would be based on a higher sales price.

In 2012, Questcor received a letter from CMS approving the new NDA, and in 2016 CMS recognized the mistake and

began pursuing MNK.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do hold a material investment in the issuer's securities.

Catalyst

Catalysts:

1. Ruling on a formal equity committee by Judge Dorsey, possibly on Dec 22nd, 2020 or early in 2021

2. Clarification on the Restructuring Support Agreement (RSA)

3. Acthar reimbursement stabilization

4. FDA approval of pipeline drugs

show sort by

			2020	2021
Price:	0.41	EPS	0	0
Shares Out. (in M):	84	P/E	0	0
Market Cap (in $M):	34	P/FCF	0	0
Net Debt (in $M):	4,444	EBIT	0	0
TEV (in $M):	5,128	TEV/EBIT	0	0