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Even though it is a large med-tech company with a market cap over $37 billion, Baxter International (NYSE: BAX ) just doesn't seem to garner all that much investor interest, or at least not as much as peers/rivals like Biogen Idec (NASDAQ: BIIB ) , Novo Nordisk (NYSE: NVO ) , CareFusion (NYSE: CFN ) , and Hospira (NYSE: HSP ) . Institutions pay attention, though, and investors may be in a good position to benefit from their skepticism. While the Street is wrapped up in trying to guess just how much business Baxter will lose in its hemophilia and specialty pharmaceuticals businesses to competition, it looks as though the market may be missing the forest for the trees.
Hemophilia Under Threat, But Not Likely To Collapse
The biggest near-term risk to Baxter comes from Biogen Idec's impending launch of Elocate in the U.S.. Elocate is a long-acting recombinant Factor VIII protein that allows hemophilia patients to control their condition with fewer injections (from an average of about 100/yr to 50) and it is going straight at a business that generates more than $2 billion a year in high-margin revenue for Baxter.
Looking at how sell-side analysts have been altering their models, it would seem as though many expect Baxter to lose almost half of its market share. I think that is excessive. For starters, doctors are slow to shift hemophilia patients from treatments that are working (Baxter's Recombinate is over 20 years old and still has more than 4% of the U.S. hemophilia A market). Along those lines, I would point out that almost half of Baxter's Advate users (a more modern rFVIII treatment) are on a once-every-three-days schedule and wouldn't see all that much incremental benefit to Elocate. Likewise, patients who have had issues in the past with inhibitors may be hesitant to switch.
There's also the matter of Baxter's own long-acting rFVIII protein (BAX 855) to consider. The company should be out with pivotal data in the second half of 2014 and may be in position to launch just 15 months after Biogen Idec. What's more, I believe Baxter's transgenic mouse model does reduce development risk.
When it is all said and done, I believe Baxter's expectation of 20% or so share loss will be closer to the mark than a 50% loss. There are longer-term threats, as Novo Nordisk and CSL are also working on long-acting versions, but this is not an easy market in which to shift market share and I believe Baxter's wider hemophilia program (which includes new products like Rixubis and OBI-1) is in better shape than the Street currently credits.
Medical Still Offers Sticky Markets And Good Margins
Baxter's Fluid Systems business (a segment that generates close to 20% of total revenue) is in an interesting place. Companies in this space have given and taken share just as much on the basis of the FDA/product issues (Baxter's Colleague recall and then Hospira's pump issues) as any competitive factors. Still, all three of these companies have more than 25% share in a market that tends to generate solid cash flow from year to year.
Neither CareFusion nor Hospira appear to be letting up, but everybody in this space seems to be looking elsewhere for their long-term growth. CareFusion has been at the center of M&A speculation for some time, and recently announced the acquisition of Vital Signs from General Electric. Hospira meanwhile has been getting more and more involved in the biosimilars market and maintaining its significant market position in injectable drugs.
Outside of Fluid Systems, Baxter is looking at some challenges and doubts in its Medical Products division. Integrating Gambro in a smooth and expedient fashion is going to be critical if Baxter is going to generate a worthwhile return on what was a rather large acquisition in a slower-growth market. In particular, Baxter really needs to leverage Gambro's higher-growth acute care products. I believe they can, but the Streets needs convincing.
Baxter also has to face impending competition to two meaningful parts of its Specialty Pharmaceuticals business. Piramal is expected to launch a generic form of desflurane that will challenge what I estimate to be more than $200 million a year in branded sales of Suprane for Baxter. Likewise, generic competition is coming for Endoxan (cyclophosphamide), a product that I estimate contributes at least $300 million to Baxter, and could ultimately cut a third to half of Baxter's sales.
On The Other Hand...
Competition is a fact of life in med-tech and it is not as though Baxter is new to this. Baxter has long faced competitors like Novo Nordisk in its hemophilia business and rivals like Grifols and CSL in its biotherapeutics business, to say nothing of the aforementioned CareFusion and Hospira in pumps and infusion sets.
Baxter also just isn't sitting on its rear waiting to lose momentum. Management is still optimistic about the potential for HyQvia (a longer-acting immunoglobulin product), has a growing vaccine business with a deep pipeline, and has been investing resources into developing biosimilars and licensing new oncology drugs. History suggests these won't all work out, but I believe the core operations in hemophilia, biotherapeutics, renal care, and infusion will continue to generate more than enough cash flow to grow the business and reinvest in new pipeline opportunities.
The Bottom Line
I'm looking for Baxter to grow its top line at a long-term rate of 5%, with free cash flow growing at a faster rate of 8% due to synergies with Gambro and ongoing investments in pharmaceuticals and biologicals. Discounting that cash flow back, I believe Baxter shares are worth about $75 today. Although that level of undervaluation doesn't suggest Baxter is a quick double-bagger, Baxter is a quality company that is not often on sale. I believe patient investors can take advantage of the Street's current skepticism and fear and add shares in a very solid company.
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