Is Mylan a Good Buy?

As branded drugs have become more complicated and global growth has become more important to generic franchises, scale matters more than ever. That's a definite check mark in the plus column for Mylan (NASDAQ: MYL  ) , as it is among the largest generic drug makers in the world and one of the few with the scale and capability to operate not only efficiently, but to crack the code on hard-to-manufacture generics.

Wall Street is definitely keen on the shares right now. The stock has risen almost 80% over the last year, and more than 140% over the last two years, as investors have gotten excited about the potential for generic Lidoderm, Copaxone, and Advair, as well as the potential for additional value-creating M&A deals.

Agila looks like a good deal
In buying Agila for a maximum consideration of $1.75 billion, Mylan is vaulting itself into the attractive generic injectables market. This is a market where Hospira, Novartis (NYSE: NVS  ) , and Fresenius have already established double-digit market shares, but where the lack of competition is such that companies often achieve 40% to 60% market share in particular drugs. There are also significant barriers to entry for this market, which supports and sustains healthy gross margins for the players. With growth in the high single to low double-digits (and IMS forecasting 13% growth from 2012 to 2017), it's an altogether appealing market and one where Mylan could do well for itself over time.

Does Mylan need additional emerging market deals?
One of the perks to the Agila deal has to be the exposure it brings to emerging markets, with only about 40% of revenue coming from the U.S. and about 25% from Brazil. Mylan currently generates nearly 70% of its revenue from North America and Europe (excluding the Specialty business), and I would argue that it needs to build up its exposure to faster-growing areas like Latin America, Asia, Eastern Europe, and the Mideast.

Mylan has openly talked of seeking additional deals, and I estimate that the company could likely spend $1.5 billion (if not more) in the pursuit of added growth, geographic exposure, and formulation capabilities (Mylan has no particularly strong presence in areas like creams or gels). The downside to that idea is that valuations are pretty steep right now. Aspen Pharmacare, Hikma, Gedeon Richter, and Krka all have pretty robust valuations, even relative to their above-average growth prospects. This could be an issue for future competitiveness, as rivals like Novartis, Sanofi, and Actavis may be able to establish at least modest economic moats in these markets.

I also am not expecting Mylan to be able to work a tax inversion deal in the near future. Some of Mylan's rivals, including Actavis (NYSE: ACT  ) have been able to dramatically lower their tax rate by acquiring foreign businesses and redomiciling overseas. Given the need for non-US shareholders to own 20% of the combined company, it may be challenging for Mylan to find a deal that is both large enough and attractively priced to allow such a move.

Waiting on important pipeline developments
Mylan has three major pipeline opportunities with largely binary outcomes (Copaxone, Lidoderm, and Advair). The company is expecting to hear from the FDA this year on its generic versions of Copaxone and Lidoderm. Copaxone in particular could be a significant win for Mylan, with up to $300 million in potential revenue even assuming that Novartis enters the generic Copaxone market as well.

Advair is not likely to be relevant until the second half of 2016, but the sales potential could more than $500 million. Novartis and Actavis are also reportedly in the mix, but Advair is a challenging drug for generic development, due both to the drug itself and the administration pathway (the need for a special inhaler). Mylan acquired inhaler technology from Pfizer some time ago, and this could prove to be a key factor in getting to market and establishing strong share.

How fast can it grow?
Mylan is solidly in the top tier of generic drug markers alongside companies like Teva, Novartis, and Actavis, and I believe the company will be able to successfully exploit the growing demand for generic pharmaceuticals, particularly in the injectables space where Novartis has a strong presence but Teva and Actavis do not.

I'm looking for long-term revenue growth (absent large deals) above 6%, with scale and product mix improvements (including injectables and biosimilars) leading to better margins and FCF growth at double the rate of revenue growth. Unfortunately, that does not discount back to a particularly compelling fair value unless you completely ignore debt. Likewise, an 11x multiple to 2014 EBITDA (11x matching the three-year EBITDA growth analysts are currently projecting) just gets the fair value over $50.

The bottom line
It's hard to be bullish on Mylan when the valuation already appears stretched. I do expect Mylan to succeed with its three big-name generic pipeline candidates, and I'm also confident that the company will maintain its leading Epipen franchise (a major portion of its Specialty business). While I cannot dismiss the prospects of Mylan successfully executing further value-creating deals, nor the possibility that the market will reward the stock further for approvals of Copaxone, Lidoderm, and Advair, it seems like a lot of strong performance is already taken for granted.

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