A Smart Move for Endo International?

It's hard to find fault with Endo International PLC (NASDAQ: ENDP  ) . Management has done a great job of unwinding the mistakes of past management and has pursued an aggressive growth-by-M&A strategy that has the company well-positioned for the future and domiciled in low-tax Ireland. Over the past two months management has given investors another two examples of its ability to generate value – settling a large part of its vaginal mesh litigation and announcing another accretive M&A transaction.

Putting mesh largely to rest
Endo International sold vaginal mesh products through its AMS subsidiary and wound up facing the same sort product liability challenges as Johnson & Johnson (NYSE: JNJ  ) , Bard (NYSE: BCR  ) , Boston Scientific (NYSE: BSX  ) and Coloplast as lawyers mobilized patients to file claims. From an initial level of around 8,000 claims, Endo saw the claims balloon to over 20,000 and with speculations on settlements/judgments ranging from $50,000 to over $100,000, Endo was potentially looking at a sizable payout.

At the risk of detouring a bit, I wonder if this claim liability motivated at least part of the company's decision to aggressively pursue M&A targets. Acquiring companies with present-day EBITDA and cash flow could add to the company's wherewithal to pay settlements (or borrow to do so) and offset some of the risk.

As of late April, though, management has largely fenced in this issue. The company announced that it had reached a settlement covering around 20,000 claims for $830 million. At $41,500 per settlement, Endo's outcome was similar to Coloplast's $40,000/claim settlement and clearly well below the worst-case scenario that bears were projecting. By way of comparison, Bard reported 10,400 claims as of February 13, 2014, Boston Scientific has disclosed over 18,000 claims, and Johnson & Johnson has reported nearly 29K claims filed to date.


There are still 2,000 known claims against Endo outside of this settlement, though, and management has set aside $270 million in reserves to address them – those amounts certainly suggest a higher per-claim payout (which seems reasonable given the risks of the trial process), but I would also observe that more claims could still be filed.

A highly accretive generics deal
Just the other day Endo announced yet another generic drug acquisition that should prove highly accretive to the company. The company announced the acquisition of privately held DAVA for $575 million in upfront cash and $25 million in sales-related earnouts. Endo not only bought a generics company for six times trailing EBITDA (including the earnout), below the typical post-synergies multiple of 7x to 8x, but it bought a highly profitable company with a whopping adjusted EBITDA margin of 76%.

Generic methotrexate makes up more than 70% of DAVA's sales, where it holds 30% market share (versus 39% for Roxane, 17% for Mylan, and 12% for Teva according to IMS). Methotrexate has above-average challenges to manufacture, so this should be a solid profit generator. That said, Roxane, Mylan, and Teva have definitely had an impact upon DAVA in the past – DAVA's share spiked to 70% in in the second half of 2012 as Mylan's plunged, but all three of these rivals have seen taken back share from DAVA.

Outside of methotrexate, DAVA also sells amoxicillin and aprazolam among other drugs. The company is looking at five launches in 2015 and has a longer-term pipeline of more than 20 generic drugs. DAVA should add $0.30 to $0.50 a share in earnings for Endo in 2015, or about 7.5% to 12.5% accretion, with minimal integration or synergy risk (DAVA is already very lean, so further cost reductions aren't likely).

The bottom line
With Endo trading at a forward P/E of over 17 and a 2015 EV/EBTIDA of over 10x, this is a good value-adding deal for the company. More to the point, it highlights how management continues to remain on the hunt for low-risk opportunities to broaden the company's product portfolio and add to the earnings and cash flow streams.

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