Tuesday, June 27, 2006

On the Road Again....To Zagreb??? Barr Labs

Well, it's a big, wonderful world out there and a xenophobic focus on the domestic opportunity set just does not provide sufficient perspective for successful investors, whether individual or corporate. Ergo, Barr's brave international move.

Barr Labs (BRL) today announced a potentially transformational bid for Pliva d.d.for $2.2 billion.Pliva has over $600 million in sales in Europe. The combined company, according to management's conference call this morning, will have nearly $2.5 billion in sales with EBITDA in excess of $875 million and net income greater than $550 million. Barr, which has been essentially a U.S. company, suddenly will find itself selling in about 30 countries. Germany is the largest base, but there is sales force in Poland, in Russia and across all of Europe...a very diverse group of countries with a very diverse set of regulations that Pliva has experienced and thrived in.

Founded in 1921, Pliva is today the largest pharmaceutical company in Croatia and by sales, the largest in Central and Eastern Europe. Since April 1996, Pliva's shares have been listed on the London Stock Exchange, a first for a Central and Eastern European manufacturing company.Healthcare is central to Pliva and the company produces a wide range of quality pharmaceutical, animal health and agrochemical products. Pliva also produces a range of food and beverage items and a line of cosmetics and personal hygiene products.Pliva's best selling product is its patented oral antibiotic, azithromycin, which Pliva markets in Central and Eastern Europe under the brand name Sumamed. Pliva's azithromycin has also been licensed to Pfizer, marketed as Zithromax in the United States and elsewhere. Pliva also produces and markets drugs under license from a number of multinational pharmaceutical companies.

Barr becomes a leader in bio-generics, a capability that is embryonic because of the lack of regulatory structure in the States, but a capability that can be highly useful in Europe. But with Barr's penchant and skill for the important regulatory side of generic drug development, and this is the primary skill for generics operating in the U.S., the company should develop some valuable legal and regulatory expertise in crossing the pond with this skillset. The company gains some valuable sterile injectable drug manufacturing facilities in Brno, Czechoslovakia and in Krakow, Poland. In India, there is a bioequivalence laboratory, another significant capability for the future. In addition, transfer of some manufacturing to other countries should result in a lower tax burden for Barr.

The significant manufacturing and research capabilities should greatly increase the amount of research and cthe number of submissions that the company will be able to make for approval. These are very low cost facilities relative to the U.S. based facilities that the company operates. The company currently offers about 150 different dosage forms of some 75 different generic pharmaceuticals. As well, Barr has had a proprietary pharma strategy largely concentrated in women's healthcare with SEASONALE extended cycle oral comprehensives, Plan B emergency contraceptive, and ParaGuard Intrauterine contraceptive device, A total of 19 proprietary products are manufactured and distributed.

The combined company will have over 150 projects under development and will be marketing a current portfolio of about 120 products.The combined company has 65 ANDA's (Abbreviated New Drug Applications...used for generic approval) in front of the FDA.

Some of the Pliva products seem quite plain vanilla relative to other generics, but given their low cost structure, have significant margins.

The financials are not very clear. Pliva is being acquired for twice sales, which seems remarkably low relative to other generic deals in the States. The company claims that the deal is neutral to slightly accretive to its internal (not Street estimates) for 2007. Additive for 2008. The company expects some $50 million in cost savings in 2008 followed by $100 million in 2009.

Though the actual acquisition will follow a timeline requiring several approvals, Hart Scott Rodino approvals July/August, August/Sept Croation Agency Supervision approval, then the tender offer. The transaction will not be complete prior to October.

Despite the uncertainty that surrounds this new twist in Barr's strategy, the valuation for BRL is quite reasonable. EV/EBIT on a TTM basis is about 10.5 times. Return on invested capital for TTM was 18.4%. Long term debt is miniscule at about 1% of capital. However, the acquisition will be financed largely with about $2 billion in incremental debt both short and long term. Management indicated that it is working through those details.

Until I have a chance to work through some financials, I don't have sufficient comfort with the numbers and the assumptions. But strategically, I suspect the deal makes a great deal of sense for Barr. There is a lot of integration risk in deals of this scale. Barr has been a poor performer this year with a YTD decline of about 22%. Returns on capital have been sinusoidal ranging between 11% and 30% in the last five years. Free cash flow generation has been strong, especially in recent years with last year totalling over $300 million. About $80 million in net share buybacks occured last year. There is a $300 million buyback authorized since 2004.

Disclaimer: Neither I, my family, or clients have a current position in Barr Labs or Pliva.


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