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Perrigo Co. PLC said on Aug. 9 that spinning out or selling its prescription pharmaceuticals will allow the generics business to better capitalize on its unique portfolio, while the company focuses on its over-the-counter medicines, but the value of this proposition isn't immediately clear outside of Perrigo.

The company announced alongside its second quarter earnings that it completed a previously disclosed strategic portfolio review and determined that the best strategy going forward would be to remove the topical generics from Perrigo's broader portfolio (see sidebar for more on the OTC-only strategy). The decision comes two years after the company was pressured by certain investors to divest the prescription pharma business and at a time when Perrigo's own generics and the broader generics industry are challenged to increase revenues.

Other major generic pharma players have reported big declines in sales during this and the past few earnings seasons as drug pricing pressures mount in the US – even for low-cost copies of high-cost branded prescription medicines. (Also see "Generic Manufacturers Try To Up Their Game As US Pressure Persists" - Scrip, 16 Jun, 2017.)

Most recently, Mylan NV said on Aug. 8 that its second quarter North American sales fell 22% year-over-year, forcing the company to explore its own strategic alternatives. (Also see "Mylan To Explore Strategic Options, Claiming Investors Have Failed To Appreciate The Value " - Scrip, 8 Aug, 2018.) A week earlier, Teva Pharmaceutical Industries Ltd., which is facing pricing and competitive pressures in both its generics and its branded drug portfolios, said North American generics sales plunged 29% in the second quarter. (Also see "Teva Braces For A Bigger Hit As Price Competition Intensifies For Copaxone" - Scrip, 2 Aug, 2018.)

Differentiated Products, Undifferentiated Pressures

Perrigo believes it has a differentiated generics portfolio dominated by topical treatments, including creams, foams, mousses, gels, liquids and inhalable products. However, that mix of medicines did not give the Irish-domiciled company immunity from pricing pressures in the US as net sales of its generics declined 13.2% year-over-year in the second quarter.

"Reported net sales in the quarter were $209m compared to $240m last year. New product sales of $8m were more than offset by lower net sales of existing products of $35m, due primarily to price erosion," Chief Operating Officer Ron Winowiecki said during the company's earnings conference call. "Compared to the same quarter last year, price erosion was approximately 11%, which was greater than expected."

Both pricing pressure and fewer anticipated product launches in 2018 led Perrigo to lower its full-year earnings guidance to $4.8bn-$4.9bn in reported net sales versus prior guidance of $5bn-$5.1bn. Sales guidance for consumer health care in the Americas was unchanged at about $2.44bn, but the company lowered guidance for its international consumer health care business to $1.52bn versus $1.59bn previously, and dropped its prescription pharma guidance to $880m from $1.03bn.

Perrigo received its fourth complete response letter (CRL) from the US FDA in May related to the abbreviated new drug application (ANDA) for its copy of Teva'sProAir (albuterol sulfate) metered dose inhaler.  

The company also disclosed during its earnings call that several authorized generics, which were expected under previously signed agreements with partners to launch in 2018, will not hit the market this year.

And, in yet another blow to the prescription pharma business, Perrigo said when reporting second quarter earnings that it does not expect to re-launch the scopolamine transdermal patch – an anti-nausea medication – in 2018. The company launched scopolamine in late 2017, but disclosed in its first quarter earnings report that there was a supply disruption, which apparently will not be remedied this year.

As Pressure Mounts, Does Rx Value Drop?

Given the prescription pharma business's various challenges – declining sales, ongoing generic drug pricing pressure, and multiple delayed product launches – analysts questioned the value of Perrigo's generics as a standalone business in the eyes of investors or potential buyers. The company expects to complete a sale or spin out of the prescription business in the second half of 2019.

Jefferies analyst David Steinberg said in an Aug. 9 note that Perrigo's insistence that separating its consumer OTC and prescription generics businesses would increase internal focus on each set of products "seems to run counter to prior commentary that there are meaningful synergies between the two businesses in terms of product development/regulatory, supply chain and manufacturing."

"To that end, management now believes that its consumer and generics businesses are sufficiently different in terms of distribution and portfolio management and have already begun the process of separating R&D, marketing and distribution functions," Steinberg wrote. "Importantly, new CEO Uwe Roehrhoff stated that there is no meaningful impact from dis-synergies, with advantages outweighing potential separation issues post the internal analysis."

The company has given mixed messages about the importance of keeping its prescription pharma business in-house, insisting in 2016 when pressured by investors to sell that the generics portfolio was an important part of Perrigo. (Also see "Perrigo's Rx Business Looks Ready To Sell, Says Hedge Fund Investor" - Scrip, 12 Sep, 2016.) Morningstar analysts said that year that the company's prescription generics were among the most attractive assets in its portfolio. (Also see "Perrigo Puts Tysabri On Block, Generic Topicals Under Microscope" - Scrip, 11 Nov, 2016.)

But investor Starboard Value LP gained five seats on Perrigo's board of directors under a settlement with the company in early 2017, making it appear that a sale of the prescription generics was more likely. (Also see "Starboard Agreement Tilts Perrigo Toward Rx Generics Sale" - Pink Sheet, 7 Feb, 2017.) A management shakeup followed the Starboard agreement. (Also see "Starboard-Driven Perrigo Sees CEO Depart After CFO" - Scrip, 6 Jun, 2017.)

Roehrhoff took the helm in January of this year. (Also see "Perrigo Taps CEO With Global Operations Expertise At Pharma Packaging Firm" - Pink Sheet, 8 Jan, 2018.) And in March the company's prescription generics appeared – at least in the eyes of analysts – to be a vital part of Perrigo's combined portfolio going forward. (Also see "Perrigo Finding Balance As Three-Legged Stool With Two Consumer Units, Rx Division " - Pink Sheet, 5 Mar, 2018.)

Roehrhoff insisted during the Aug. 9 earnings call that the decision to split off the prescription generics business was not because of its recent financial performance, but because of the company's strategic review showing that more value could be squeezed out of the assets in an entity entirely focused on that business.

He noted that "the benefit of managing this business separately with a focused team that can address the needs of an agile market environment with a strong focus on product development and a clear integration between R&D, technology management and operation, will benefit the growth of this business."

High Margins Aside, Buyers And Investors May Be Wary

"While we understand the theory that a standalone consumer business should potentially garner improved valuation metrics we aren’t convinced yet," Jefferies' Steinberg said in his Aug. 9 note. "It’s hard to believe there aren’t some synergies [between the OTC and prescription businesses], particularly on the manufacturing side. Moreover, Perrigo's generics unit is not a typical 'commodity' business. In fact, it has far higher margins (~40% vs ~20%) than either of the consumer divisions."

Perrigo reported adjusted operating margins in the second quarter of 39.4% for its prescription pharma business, 15.2% for its international consumer health care segment, and 20.4% for OTC products sold in the Americas.

"Although the prescription segment has maintained fairly healthy profitability – which has hovered near a 40% adjusted operating margin for this and the last few quarters – the lack of visibility into ongoing pricing pressure and uncertainty of complex product launches like ProAir raise some doubt about the price management could ultimately receive for this business," Morningstar analyst Michael Waterhouse wrote on Aug. 9.

"Perrigo likely has decent odds of finding a buyer for this niche topicals business, but industry pressure has led several generic drug manufacturers to consider selling underperforming assets," Waterhouse added.

That means there could be a lot of competition to find buyers for revenue-generating assets with declining sales. It also means investors could have a lukewarm response to receiving shares in a spin-off company or buying into an initial public offering for the separated entity.

Perrigo investors did not have an enthusiastic response to the company's plan to separate its prescription generics from its OTC brands. Perrigo closed down 10.6% at $70.03 per share on Aug. 9.

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