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Little has gone right for Lannett Company (LCI) since it announced in early November -- just weeks ahead of completing its purchase of fellow generic drugmaker Kremers Urban Pharmaceuticals -- that Kremers was losing a key customer that accounted for nearly a fifth of its annual sales. Despite the change in circumstances, it closed the $1.23 billion acquisition on Nov. 30.
Just how ugly have things gotten for Lannett since then? This ugly: Its market cap has been slashed by more than half during the first three months of 2016. But after all the carnage, could Lannett finally be a stock to buy again?
Questions about earnings
Investors' worries about Lannett's earnings resulted in the sell-off of its stock. The company added fuel to the fire recently when it lowered full-year sales guidance by $30 million -- a decrease of around 5%.
Lannett's more pessimistic outlook reflected a double-whammy. First, the company said that it, like others in the industry, was "experiencing softness in the generic drug market" overall. Second, several products that it expected to launch in the first half of this year will be delayed.
So how bad are the earnings issues? Net income for the first six months of fiscal 2016 was down 41% compared to the prior year period. That's definitely not good, but an exceptionally strong second quarter in fiscal 2015 made the year-over-year comparisons challenging from the outset.
The real question relates to what happens going forward. The loss of Kremers' (unnamed) major customer hurt, to the tune of about $87 million in revenue a year. However, Lannett says it has already replaced 30% of that lost revenue. Even more promising, the company announced recently that it was "in the process of reestablishing business relations" with the customer.
Also, Lannett fully expects that the product launches that were planned for the first half of 2016 will move forward early in the second half. Assuming that happens, it could be looking at more of an earnings delay instead of an earnings disaster.
Eating the elephant
However, at the heart of concerns about future earnings lies one big question: Can Lannett make the Kremers acquisition work? Lannett financed most of the $1.23 billion deal by taking on debt.
The numbers seem to work for Lannett. Operational synergies are expected to save $40 million in the first 12 months and increase to around $65 million per year of savings by 2020. With the added earnings that Kremers should bring in, combined with a nice tax credit resulting from the buyout, the deal doesn't look bad from a purely financial standpoint.
Some, however, might doubt that Lannett's management team is up to the task. While it's true that company doesn't have a track record in pulling off acquisitions of this magnitude, the person leading the charge does. Michael Bogda, Lannett's president, oversaw two large acquisition integrations while he served as executive vice president at Teva Pharmaceuticals (TEVA 0.16%). He's done it before, so I don't see why he can't make the Kremers acquisition work for Lannett.
Value play?
Lannett is currently trading at less than six times forward earnings, which puts it into value stock territory. But is it a value trap?
If you think Lannett's earnings are going to fall off a cliff, perhaps due to a disastrous integration of Kremer's, then its stock is cheap for a reason. If you think that earnings will probably pick up as new products launch, and that the Kremers acquisition will likely go relatively well, the stock is cheap only for a season. I'd go with the latter scenario.
I also think that Lannett could be for sale itself at some point, and its president's old firm is a likely future suitor. Teva hasn't been shy about scooping up other drugmakers in the past, and its M&A pace doesn't appear to be slowing down. The Israel-based company recently won European approval for its acquisition of Allergan's generics business, and it closed on its purchase of Mexican pharmaceutical company Rimsa in early March. Teva still has nearly $7 billion on hand that it could use to keep its buying spree going.
But would Lannett put itself on the market anytime soon? Probably not. I suspect the company's management team will want to prove that they made a smart move with the Kremers deal first. They also undoubtedly believe that the stock is highly undervalued right now. But once the ship has been righted, I wouldn't be surprised for Lannett to be open to a sale -- to Teva or another large player in the generics market.
Lannett's stock could languish for a while longer, but I think its rebound is just a matter of time. In my view, investors with a long-term focus aren't going to be able to buy this generic drugmaker at such an attractive price for too much longer.
