Can Allergan's Growth Continue?

In the world of Big Pharma, growth is a precious commodity these days. Allergan (NYSE: AGN  ) is a noteworthy exception, though, as the company continues to see strong demand for cornerstone products like Botox an Restasis, as well as its facial aesthetics line. Allergan's pipeline is somewhat more limited than an investor might normally prefer, but the company has been active in pursuing follow-on indications for existing drugs and has had a higher than normal "hit" rate for its pipeline. Though there are frustratingly few true bargains in the pharma space today, Allergan continues to look at least as though it will remain a solid holding.

Botox still the big dog
Botox is a good example of how Allergan works on already-approved products to find new applications and markets. Botox is probably still best known for its cosmetic applications (reducing lines/wrinkles), but it is also approved for applications like migraine and overactive bladder.

The buildup in overactive bladder has been slow, as Botox has had trouble gaining mindshare against Astellas (Myrbetriq and Vesicare) and Pfizer (NYSE: PFE  ) due to reimbursement issues. Reimbursement started improving in 2013, though, and Botox's profile in the market has improved to a point where Medtronic mentioned it as a competitive issue for its Interstim device in overactive bladder.

Allergan appears to also be slowly improving acceptance and demand for Botox in the migraine market. Generic topiramate and sumatriptan (Imitrex) still make up a large part of the market, but it is one of the relatively few branded drugs (including Pfizer's Relpax) actively marketed for migraine right now.

Even in its core aesthetic markets, Botox continues to do well. It would appear that Merz is gaining share with Xeomin mostly at the expense of Valeant (NYSE: VRX  ) , and that Botox is holding its own. Looking a bit ahead, trials in indications like premature ejaculation and depression could further expand the sales potential of what is already an exceptionally profitable drug for Allergan.

Looking to sustain Restasis
One of the biggest uncertainties around Allergan in 2013 (and stretching now into 2014) is the fate of Restasis, the company's dry eye drug that produces about 17% of its total product revenue. The company's initial patent is expiring soon and Actavis has filed for a generic version. It is unclear whether the Actavis filing will past muster, though, and Allergan is still hopeful that Restasis X could make it to market and preserve a meaningful portion of this franchise. Further down the road, AGN-195263 could become a viable treatment for evaporative dry eye/blepharitis, and it is worth noting that developing effective dry eye treatments has proven difficult for would-be challengers like Shire and Valeant's Bausch & Lomb.

Holding or growing existing markets, and looking for new opportunities
As indicated above with Botox, Allergan is always looking to maintain or build its existing franchises. Botox holds solid share in aesthetics despite competing with Valeant, and the same has been true in the dermal filler market. Likewise in the OTC artificial tears market – Allergan competes with well-known eye care franchises like Johnson & Johnson, Novartis, and Valeant, but continues to hold its own with a product that contributes a meaningful (5%-plus) portion of revenue.

None of this should be taken to mean that Allergan isn't also looking to enter new therapeutic areas. The company's anti-VEGF compound DARPin isn't a sure thing by any stretch, but the company will be releasing more Phase II data later this year. A launch before 2017 is probably not likely, but it is possible that DARPin will require fewer injections than existing wet AMD treatments and could offer blockbuster potential.

Buy, or be bought?
Unlike Valeant or Actavis, it may be challenging for Allergan to launch a tax inversion deal. Management has been consistent about targeting deals that augment the company's growth profile, and that's not a low hurdle given the company's good present day growth prospects. Moreover, with the rules for tax inversion deals calling for target company shareholders to own 20% of the combined company, there aren't many targets left for Allergan.

I don't believe Allergan is an imminent takeover target, but I wouldn't rule out the possibility. Companies with existing eye care and/or aesthetic businesses like Johnson & Johnson and Valeant could certainly realize synergies from such a deal, and Allergan's above-average growth would be attractive to Valeant, Pfizer, and many other pharmaceutical companies.

The bottom line
As I am looking for Allergan to grow revenue at a 6% long-term rate and free cash flow at an even faster rate (around 9%), Allergan is one of the best growth prospects in the large-cap pharmaceutical space. The shares do not trade at much of a discount to fair value, but the company's growth and healthy balance sheet (which it can use to acquire smaller companies in aesthetics, eye care, dermatology, urology, and so on) do seem to offer more opportunities for upside than slower-growing Big Pharma names trading at or around fair value.

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