Biotech Values

[DewDiligence]

MRX – Here’s an analysis by S&P that’s apropos
to the discussion on salesforce efficiency.

http://www.businessweek.com/investor/content/aug2007/pi20070820_574123.htm

>>
Medicis Has an Earnings Glow

by Herman Saftlas
August 20, 2007

S&P ranks Medicis Pharmaceutical a strong buy, thanks in part to an expanding dermatological product line, including a new treatment to compete with Botox

Medicis Pharmaceutical ( MRX ) is the largest independent dermatological company in the U.S., focusing primarily on the anti-acne and dermal filler sections of the market. We believe that the company, under the leadership of founder, Chairman, and Chief Executive Jonah Shacknai, has been able to reinvent itself with the development of a new portfolio of popular aesthetic dermatological products such as Solodyn and Ziana acne treatments, and Restylane and Perlane hyaluronic acid-based dermal fillers. These products have more than compensated for dwindling sales of its older, off-patent Dynacin, Plexion, and Triaz lines.

During the fourth quarter of this year, we expect Medicis to file a new drug application with the Food & Drug Administration for Reloxin, a botulinum toxin dermal filler that's expected to compete with Allergan's $1.1 billion Botox drug.

Strong Performance

During the second quarter of 2007, Medicis generated operating earnings per share (EPS) of 28¢, vs. 24¢ in the same period a year earlier, exceeding our estimate by 3¢. Revenues in the quarter climbed 28%, reflecting growth in key Solodyn and Ziana acne lines and also benefiting from the launch of Perlane dermal filler. We also think Restylane sales have weathered the early 2007 launch of Allergan's competing Juvederm dermal filler.

Medicis' business is highly profitable, with a second-quarter gross margin of 87.1%. The company also raised its full-year 2007 EPS guidance by 7¢, to $1.19.

We have Standard & Poor's highest investment recommendation of 5-STARS, or strong buy, on Medicis. We view the shares as attractively valued vs. peers, with a p-e-to-growth ratio of 1.0 and a price-to-sales ratio of 3.3, based on our 2007 projections.

Growth Strategy

Medicis' growth strategy centers on expanding the market share of existing dermatology products, introducing new products, making synergistic acquisitions, and forming collaborative partnerships. Medicis focuses on treating acne, acne-related conditions, fungal infections, skin discoloration, and inflammatory and hyperproliferative skin diseases, such as psoriasis and topical dermatitis.

Principal prescription pharmaceuticals include acne treatments such Solodyn, a once-daily oral form of minocyline antibiotic; Ziana, a once-daily gel acne treatment; Dynacin, an oral antibiotic to treat moderate to severe acne; Triaz, a topical formulation to treat all forms of acne; and Plexion, a topical treatment for rosacea (a chronic skin condition causing inflammation and redness of the face) and acne-related conditions.

Non-acne products include dermal fillers such as Restylane, a hyaluronic acid-based injectable gel for the treatment of fine lines and wrinkles, shaping facial contours and correcting deep facial folds; Perlane, a dermal filler implanted into the skin to correct or moderate severe facial folds and wrinkles; Loprox, a broad-spectrum topical anti-fungal treatment; and Omnicef, an oral antibiotic for skin infections. Prescription lines also include Buphenyl, an adjunctive therapy for hyperammonemia in patients with urea cycle disorder.

Manufacturing and R&D

Medicis outsources all of its manufacturing needs. Patheon manufactures the capsule form of Dynacin, and Par Pharmaceutical (PRX) manufactures the tablet form. Plexion and Triaz are manufactured by Contract Pharmaceuticals. Loprox cream and gel are manufactured by Aventis, and Vanos, Loprox TS (topical suspension), and Loprox shampoo are made by Patheon. Omnicef, which is co-promoted with Abbott Laboratories (ABT), is manufactured by Abbott. Restylane is manufactured by Q-Med.

Acne and acne-related dermatological products accounted for 45% of net revenues in 2006; non-acne dermatological products, 45%; and non-dermatological products, 10%. Products are distributed primarily through drug wholesalers such as McKesson (MCK) (57% of net revenues in 2006) and Cardinal Health (CAH) (19%).

Research and development spending totaled about $162 million in 2006, including $125 million related to a development and distribution agreement with Ipsen for the development of Reloxin.

Expanding Markets, Product Line

Medicis believes that annual U.S. pharmaceutical sales in the dermatological market exceed $5 billion. According to the American Society for Aesthetic Plastic Surgery, nearly 11.5 million surgical and non-surgical cosmetic procedures were performed in the U.S. during 2006, including approximately 9.3 million non-surgical cosmetic procedures. The overall global aesthetic market is expected to expand at a compound annual rate of 13% over the next five years, according to Medical Insight, an industry trade association.

Some 60 million people in the U.S. are believed to have active acne, with about one-third of that total suffering from more severe scar-forming acne. Yet only about 10% to 12% of the latter total use medicinal treatments.

We estimate global sales of dermal fillers at about $600 million in 2006, doubling to $1.2 billion in 2010, and exceeding $1.5 billion by 2012. Key drivers for this market, in our view, include strong demographic trends in aging baby boomers, greater awareness of the cosmetic benefits of filler products, and technological advances that create safer and more effective therapies. Medicis believes that its Restylane and Perlane products address a market encompassing perhaps as many as 25 to 30 million Americans.

Botulinum treatments such as Botox are also highly popular. We believe that more than 12 million procedures will probably be performed annually within a few years. Botox sales were estimated at more than $1.1 billion in 2007.

Solodyn: Fuel for Growth

…We forecast revenues for 2007 of about $455 million, up from a reclassified $349 million in 2006. The gain should be led by an expansion in key anti-acne and dermal filler franchises.

We believe the company's largest-selling prescription acne product, Solodyn, should continue to fuel above-average growth. Based on recent weekly prescription data, sales of Solodyn are currently annualizing at about $200 million, which we believe is impressive for a product on the market for a little over one year.

Premium priced relative to older competitors at about $360 per prescription, Solodyn sales will benefit, we think, from the company's recent introduction of a Smartcard program aimed at helping patients and pharmacists to adjudicate managed care co-pays, resulting in savings to the patient. More than 10,000 persons have joined this program, with more than 90% of enrollees filling their prescriptions within five days.

Consumer Advertising Push

The acne franchise was recently enlarged with the launch of Ziana. While initial uptake of the product has been somewhat short of our expectations, we think volume will pick up in the second half of the year and come in near the $40 million mark for full-year 2007.

With respect to the dermal filler line, we think the company's key Restylane franchise is performing well despite having to compete with Allergan's Juvederm hyaluronic acid dermal filler, which came on the market in early 2007. By our analysis, Restylane's popularity and customer loyalty have not been significantly impaired by the competition, which has resulted in stronger growth for the overall dermal filler market. In that sense, Restylane has benefited with the rising tide lifting all ships. Medicis' latest dermal filler is Perlane, a thicker and denser formulation of Restylane, which is injected deep into the skin to correct moderate to severe facial folds and wrinkles such as nasolabial folds.

Even though they're prescription products, we view Restylane and Perlane more like consumer products, and as such, we think they should benefit materially from a major ongoing direct-to-consumer TV and print media advertising campaign. Medicis noted recently that it had already received many thousands of hits on its dedicated RestylaneTV.com site. We project combined sales of Restylane and Perlane of close to $140 million this year, up from Restylane sales of $118 million in 2006.

With Allergan now competing with Medicis in the hyaluronic acid-based dermal filler space, we also see Medicis preparing a competing product to Allergan's popular Botox botulinum toxin dermal filler line (estimated sales of $1.1 billion in 2007). This product is Reloxin, which was purchased from French drugmaker Ipsen in March, 2006. The purchase price was $90.1 million in cash, plus an additional $103.5 million contingent on the successful completion of various clinical and regulatory milestones. The deal calls for royalties of 30% on Reloxin sales to be paid to Ipsen.

Price Target: $42

We expect the company to file a new drug application with the FDA for Reloxin during the fourth quarter. Assuming about a 12-month review process, we think the product could be on the market by late 2008 or early 2009. We project Reloxin sales in the $150 million to $200 million range by 2011. [This depends in part on whether MNT’s PureTox is also on the market.]

We foresee a modest expansion in gross margins in 2007, reflecting increased sales and a more profitable product mix. We expect selling, general, and administrative (SG&A) costs as a percentage of revenues to decrease, and for research and development spending to decline. We look for the effective tax rate to rise to 36%, from 32% in 2006. We estimate operating EPS of $1.20 in 2007 (after about 20¢ in projected stock-option expense), excluding business development milestones or contract payments. For 2008, we forecast operating EPS of $1.60.

Medicis shares were recently trading at 17.2 times our 2008 EPS estimate of $1.60, and about 2.8 times our 2008 revenue forecast of $530 million. Our projected price-earnings (p-e) multiple reflects a modest premium to peers in the specialty pharmaceutical sector. But on a p-e to projected three-year growth-rate basis, the shares had a price-earnings to growth (PEG) ratio of 1.0, which is a discount to the comparable 1.3 PEG that we estimate for the overall specialty drug industry. [I think PEG is a stupid metric, but that’s another matter.]

In our discounted free cash-flow model, we assume a beta of 0.8 for the stock, a risk-free interest rate of 5.2%, and an equity risk premium of 5.5%, to derive a current weighted average cost of equity of 9.6%. Our current and terminal weighted average cost of capital is 8.5%, and we assume a terminal growth rate of 2%. Based on our DCF analysis, we calculate an intrinsic value of about $42 per share.

Corporate Governance

Our view of the company's corporate governance is generally favorable. Medicis' board has only one inside director, company founder and CEO Shacknai, and no affiliated outsiders. In addition, both the nominating and compensation committees are comprised solely of independent outside directors.

On the negative side, we believe board independence is somewhat compromised by the dual roles of the CEO and chairman of the board. Another negative we see is a poison pill anti-takeover provision in place. In addition, shareholders are not allowed to call special meetings, and the board may change corporate bylaws without shareholder approval.

Risks to our recommendation and target price, in our view, include the instability of the discretionary cosmetic pharmaceuticals business, especially with respect to higher-end, expensive treatments. Medicis also faces formidable competition from the much larger Allergan in its principal aesthetic franchises. The company is also subject to risks associated with the development and regulatory approval of new products [duh].

We view Medicis as an attractive specialty pharmaceutical company with expanding positions in rapidly growing aesthetic drug markets. We believe the company has arranged a compelling lineup of new high-margined products that will propel robust EPS growth over the coming years. We also see the company as an attractive takeover candidate given its strong cash-flow generation and solid growth prospects.
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