Monday, April 30, 2012

I admit it: I don't "get" the generics business.

On one hand, I see the appeal of the generics business - there's ALOT of profit to be made by undercutting traditional pharma companies in off-patent drugs. Who doesn't like the idea of winning 30% of pharm.'s revenue with an investment of 1% of pharm.'s revenue?

On the other hand, any generics company really has only one variable to compete on: cost. (Who wants to compete solely on cost? Not me.)

By definition, the generic chemicals manufactured are identical, so there is no competing on product performance, and presumably every generic company's cost to manufacturer a particular chemical is roughly the same (though the difference in labor costs between, say Dr. Reddy's in India, and Teva (Israel and USA) isn't insignificant.)

So why would one generic company pay a premium to acquire another, as Watson did to acquire Actavis last week? At 14X EBITDA, the deal doesn't work on a purely financial basis, unless the combined operating margin roughly doubles (requiring a $1.2B improvement in operating margin, on $8B in annual revenue. That ain't happening.)

Watson will be acquiring Actavis manufacturing assets, which adds a mild amount of strategic value, but it seems to me that the only two ways that this deal ends up being rewarding for Watson is 1) if success in the generics business is entirely based on scale, or 2) the greater fool theory takes hold.

So with generics M&A occurring roughly monthly and big boys like Pfizer stomping into generics, I need someone to correct me, or otherwise explain this industry to me, because I just don't see an investment rationale, or why risk capital would chase this industry, other than to lock-in a modest annual ROIA.

(And it's not like I'm the only one not questioning the wisdom of generics investment - Deutsche Bank is taking a ~$375M hit on their investment in Actavis, as a result of the Watson-Actavis deal.)

Help, anybody?

btw: I think the manufacturing challenges inherent in bio-similars makes this subset of the generics industry much different than the chemical generics discussed above.

No comments:

Post a Comment