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This ASX healthcare stock is set to be a major US player

Nicholas Grove  |  06 Jul 2016Text size  Decrease  Increase  |  

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ASX-listed generic drug manufacturer Mayne Pharma Group (ASX: MYX) last week announced it will acquire a portfolio of products from pharmaceutical giants Teva and Allergan for US$652 million.

Mayne Pharma expects the acquisition of the 37 US Food and Drug Administration (FDA) approved products, as well as another five that are awaiting approval from the FDA, to propel the company into the top 25 retail generic drug companies in the US.

It also expects the deal to transform it into the number two player in the US generic oral contraceptives market.

UBS analysts believe the key acquisition marks a transition for Mayne Pharma into to a "meaningful US generics player".

Morningstar equity analyst Chris Kallos agrees, saying that the acquisition is a "company-changing" deal which stacks up from both a financial and strategic perspective.

"It is an opportunistic transaction, diversifying Mayne's therapeutic areas in the generic space with approved/US FDA pending generic products. These products can also leverage off Mayne's core capabilities in formulations of both potent substances and extended release formats," Kallos says.

"Moreover, the deal is consistent with Mayne's strategy of targeting niche markets which can sustain between two and three players.

"The deal is especially timely given the company's expansion of manufacturing capacity at Grenville in the US."

Kallos also expects the acquired drug portfolio to generate EBITDA (earnings before interest, tax, depreciation and amortisation) margin in the high 40s--well above the 30 per cent generated by Mayne Pharma's existing operations.

Mayne Pharma is funding the acquisition via an extension of its existing debt facility, a fully underwritten $601-million 1-for-1.725 accelerated non-renounceable entitlement offer and a $287 million placement.

The entitlement issue's $1.28 offer price is well below Morningstar's recently upgraded $1.90 fair value estimate, Kallos says.

High uncertainty, no moat

But despite his positive view on the deal, Kallos is retaining his no-moat and high uncertainty ratings on the stock, given Mayne Pharma's relatively short operating history as an integrated generic drug manufacturer.

"We consider the multiple sources of risk to justify a high uncertainty rating on the stock," he says.

"These include: delays in regulatory approvals for Mayne's new drug pipeline; patent and exclusive licence expiries; product recalls (less relevant to generics); and timely integration of acquisitions."

Kallos also points out that Mayne's exposure to currency risk is high, given 70 per cent of its revenue is generated in the US.

He also explains why he believes Mayne Pharma doesn't possess an economic moat.

"Sources of competitive advantage for generic drug manufacturers ... typically include economies of scale and vertical integration, combined with unique formulation skills, complex generics expertise and broad geographic reach," Kallos explains.

"In the absence of patent protection afforded to innovative drug developers, these factors represent comparable barriers to entry.

"Mayne Pharma's transformational acquisition of Metrics in 2012 potentially combines several of these aspects, including good manufacturing practices and compliant commercial manufacturing operations accredited to handle high-potency substances in both Australia and the US.

"However, we believe these strengths lack the complexity needed to command strong pricing power.

"Furthermore, we are concerned by the integration of these technologies because the company has only existed in its current form for a short time."

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Nicholas Grove is a Morningstar journalist.

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