From the start of this decade to present day, Depomed’s journey from a royalty based Biotechnology Company; to one of the “top 5 opioid producers” has had many twists and turns. Over the last 7 years Depomed has flawlessly utilized their acuform extended release patent, to transform themselves from a middling microcap biotech, into a billion dollar specialty pharmaceutical. This transformation is not without controversy though, controversy that Depomed has not handled well.
When looking at Depomed today, most would assume Nucynta is their crown jewel asset. But in what becomes a reoccurring theme in the Depomed story, those who assume that, are misinformed.
Depomed has been able to leverage their most important asset, an extended release patent, called acuform to build a portfolio of drugs, licenses, and royalties. A portfolio vastly undervalued in today’s marketplace.
Association #1 Price Gougers
For most of the decade prescription drug prices have soared. As these prices continued climbing, many opportunistic companies went on acquisition sprees. Fueled by cheap debt, pharmaceutical mergers and acquisitions reached a fever pitch by 2015. The market, no matter the size or the terms of the deal, continuously rewarded these opportunistic companies. Depomed entered the fray in January 2015, when they outbid Horizon Pharmaceutical for the drug Nucynta, an painkiller owned by Janssen. Depomed funded the 1.05 billion dollar purchase with cash on hand, along with raising roughly half through a $575 million through a debt offering. Considering Janssen was already paying Depomed royalties for the drug, it seemed to be perfect fit for Depomed’s portfolio.
With their familiarity of the drug and a revamped sales, Depomed forecasted that they could grow annual Nucynta revenues from $166 million in 2014, to $500 million by 2018. With the ultimate goal of getting revenues to 1 billion per year before patent expiration in 2025. Depomed picked the one of the worst times to finally get aggressive with some of there targets, heading into the summer of 2015
With not even one quarter of sales completed, after the close of the Nucynta transaction, Depomed was hit with an unsolicited takeover offer from Horizon Pharmacueticals. The offer’s headline number promised a nice premium for Depomed shareholders, but in reality, the offer was made with a volatile currency, which was 100% HZNP shares, no cash.
Depomed wisely rejected the offer, claiming a transaction including only Horizon shares and no considerable cash contributions, was unfair to the Depomed shareholders. Over the course of the summer of 2015, between Hilary Clinton’s campaign against high drug prices, and the tumbling of once giant Valeant pharmaceuticals, no companies in the sector were immune to collateral damage. Horizon, which was seen as a serial price gouger itself, saw its share price collapse by 50%. Within 90 days of their final offer of $33 dollars a share for Depomed, the all stock offer of .95 shares of Horizon’s stock, was already worth sub $20 per share to Depomed holders. Depomed remained associated with the tumbling price gougers for the rest of 2015, and traded in tandem with HZNP, even though they had successfully launched Nucynta. By the end of the year, only 1% of all Depomed shareholders agreed to even tender their shares to Horizon. The bid was dropped eventually, after a legal ruling.
While Depomed’s stock traded in tandem with these related companies, the similarities with them was far from exact . Companies like Valeant, Horizon, Endo, Concordia, and Mallinkrodt, would often acquire other drug makers, with legacy drugs, with short shelf lives and high revenue streams. Most of these aquistions were made rarely with cash on hand, either stock was issued, or debt was raised. The most important factor in making these transactions work, was the ability for these companies to continue to be able to raise the price of acquired drugs as they saw fit. That all came to a halt in 2015, when the government raised concerns about drug prices, and continue to pressure companies into capping drug price increases. Now all of these assets are no longer what they were worth when they were purchased, which of course, when purchased with borrowed money, becomes a default risk. Declining revenues and writing down multiple assets, while paying interest on those assets, is the main reason why VRX, CXRX, and ENDP are in the positions they are in. Even today, VRX fell below $10 per share, due to lack of sufficent bids for Inova.
Depomed’s only similarity, is that they borrowed half of the funds to pay for Nucynta, the rest was funded with cash on hand. So while Depomed has increased the price of Nucynta to be on par with other painkillers, there’s almost no chance that the government who is trying to clean up the opioid epidemic (see association #2) are going to make opioid’s cheaper for the public to get their hands on. Last quarter Depomed hit a record $124 million in revenue, with growth of 33% over 2015, meanwhile most. Of the above companies mentioned, saw their revenues decline, in 2016. Depomed’s wrap on the debt situation appears to be very tight, they prepaid with cash on hand, 100m last April, and have announced they will prepay another 100m this week. In just 2 years they have already paid back 35% of the debt used to buy nucynta. In contrast VRX just paid down some of there near term Debt, by issuing more debt. At this point one can make an argument, that Depomed could sell Nucynta at a 50% markdown, and the stock would still be undervalued, due to the other drugs that they own.
Association #2: Epidemic Contributors.
Depomed’s top selling drug is, at the root of it, a schedule II opioid, there is no denying that. Senators have sent letters in the past week, to who they believe are the top 5 opioid makers, asking about there sales practices. This is where once again, Depomed’s stock price has shown they are assumed guilty by association.
If you read the letter, in addressing the 5 drugmakers (Depo, Insy, JNJ, MYL, and Purdue) outside of just naming Depomed as a producer of opioid’s, Depomed the company is never cited, or mentioned once in examples of transgressions. The letter also asks for all sales documents from Depomed, relating to opioids dating back to 2012. If the senator had done the research, they would discover, Depomed had none 2012. The city of Chicago brought a very similar lawsuit against 6 opioid makers back in November 2015. One week later, that lawsuit was re-submitted with Depomed being the sole defendant dropped without prejudice. The reason why this is, due to the purchase agreement with Johnson and Johnson, it was agreed upon that JnJ would assume all legal responsibly and liability for Nucynta for 2015 and before.
This leaves us with Depomed only having 2016 as the sole full year of selling Nucynta. Depomed’s share of the opioid market in 2016 totaled .37%. Our friends at zerohedge have rightly pointed out, the largest producer of opioids in this country is Mallinkrodt, who was left off this list of the top 5 makers. Now I cannot speak for Depomed here, but if I spent 1 billion dollars on something in 2015, that I KNEW had sales practices investigations by anyone (Chicago) and the company I was buying it from, told me they would assume the damages. I certainly would make sure I would not repeat those same sales questionable practices.
So it is our belief that this investigation, will ultimately end up like the misguided Chicago one of 2015, but also will provide a platform for Depomed to differentiate themselves chemically and criminally from the other companies listed.
Conclusion
In totality, Depomed remains a company in transition. Starboard has hand picked a new CEO, and board members, because they feel the company is undervalued. They bought the stock last year with the same notion, and benefitted, as the stock soared from 14 to 27 within 5 months. But as they made clear when they announced their 9% stake, their goal wasnt to trade Depomed, their intention was to make sure shareholders would no longer be ignored by entrenched executives. We share this sentiment, look no further then Depomed’s performance from the day Starboard agreed to a standstill in November 2016. With Starboard handcuffed, until 3/15/2017, the near 90% gain in Depomed shares from April to November had completely vanished by 3/15/2017, only confirming their opinion of management. Depomed’s ability to communicate its strengths and differences to the public has been porous. They have revamped the salesforce, now they must revamp public perception. There are many segments of value to be had in the 700m market cap, between there intellectual property, rising revenues, weakening competition, debt control and the phase III asset cebranopadol which they received in 2015 from a settlement with Endo. For acquisition purposes, we will exclude the convertiable debt, which Horizon also did in their merger presentation as well, notating that Depomed would pay that back on their own by 2021. We refrain from giving short-term price targets, but it is our belief that an acquirer can be handsomely rewarded, by paying up to 2billion (Market cap + secured debt — cash) for Depomed’s shares. For now, the common shares are trading like a distressed company, in a distressed sector, but when you peel back the layers, you’ll find a healthy company, in a distressed sector. Depomed’s shares can get cheaper, but as long as the market cap is <1billion we believe Depomed shares are undervalued.
