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Posted on 9th March 2016

Oh My: Mylan, Meda and muddle

Mylan’s announcement last month that it has agreed to buy Meda for $9.9bn was greeted with a distinct lack of enthusiasm by the stock market, which marked the company’s shares down 18% the following day. This was a reversal from the recent norm in the US, where almost any acquisition done by any pharma company has sent its share price up. So why not in this case, when Mylan says that the deal will be earnings accretive from day one? First of all, because it looks extremely expensive. The SEK 165/share that Mylan is offering corresponds to a 92% premium to the stock price the day before the announcement, and although Meda’s shareholders were hardly likely to accept an offer lower than the one that Mylan made in April 2014 (SEK 145/share) the fact that Mylan was prepared to up its bid just to get a deal done smacks of desperation. The overall valuation of the proposed deal, at 12.9x EBITDA, may look quite conservative compared to other deals in the sector, but plunging stock markets globally and a much tougher debt market in the US have led to expectations that deal values will fall. Moreover, Meda is not in any sense a growth stock and nor does it have any particularly compelling products (other than, perhaps, the European rights to Mylan’s epinephrine autoinjector, Epipen), so while it makes Mylan bigger, it does very little for its top line growth prospects.

In our view, it is the last point that is the most pertinent. Mylan’s last big deal, for Abbott’s developed markets business, saw it taking over a set of declining assets in Canada, Europe and Japan. Meda, which mainly operates in Europe and the US. is not actually in decline, but nor is it growing very fast, thanks to a broad base of elderly (but very stable) products topped by a small number of more newly-launched drugs. As with Abbott, ‘synergies’ (for which mostly read redundancies, as there are only limited top-line synergies) should boost the bottom line for a few years, supporting Mylan’s EPS target, but in the longer term, Meda is likely to prove a drag on earnings growth. In addition, this deal appears to be driven more by management’s fear that Mylan itself may be subjected to another hostile bid (after Teva’s aborted effort last year) than by any real industrial logic behind the combination. Mylan says that it has wanted to get into OTC for a long time, but why? It’s a totally different type of business, driven by consumer advertising, and only offers genuine synergies with a prescription generic business in those markets where pharmacists can be incentivised by product bundling. We also note that Mylan’s FY 2015 results, released at the same time as it announced the Meda deal, showed European revenues excluding Abbott rising at only 3% on a constant-currency basis, with the Abbott products managing 1%. This is with the full Abbott sales force still retained, but we doubt that these reps will all be kept over the longer term. Meda, meanwhile, has a three-year plan that assumes 3% pa top line growth, so even if Mylan can do a bit better with Meda’s business than its current management, the overall outlook is stil extremely dull.

Meanwhile, it is worth considering what is going to happen behind the scenes. Heather Bresch said on the analysts’ conference call that followed the Meda announcement that the combined company will have 2,000 products and that Mylan’s supply chain is ‘unprecedented’. While she presumably meant this to be a positive statement, the reality is that the company now does indeed have a level of complexity that is certainly unprecedented in its own history, if not in the pharma industry as a whole. This, too, is a reason why investors should be cautious about the impact on Mylan of its latest planned deal. Meda was a rabid acquirer of assets and a reluctant disposer of them, with the result that its portfolio is a total mish-mash of prescription drugs, OTC, semi-ethicals (products prescribed but not reimbursed) and galenics. All of these are supplied by seven factories spread around the world as well as an extensive network of contract manufacturers. It is highly doubtful that Meda has really yet integrated Rottapharm, which it bought in late 2014, while Mylan has certainly not finished integrating Abbott, so throwing the two together is going to take a huge amount of time and effort even assuming that Mylan holds off any other big acquisitions in the near term. Of course, Mylan is not alone in facing this issue: Teva’s planned purchase of Actavis is also going to be a massive headache for the people who actually have to make it happen.

In recent years, supply chains have gone from being a totally ignored part of most companies’ operations to centre stage, as action by regulators has shut down plants and led to product shortages and declines in earnings. The more products a company is dealing with, the harder it is to make sure that production is in step with demand and that every plant in the network (including those owned by the third party suppliers on which all generic companies depend) is in full compliance with regulators’ quality standards. A change in ownership inevitably results in new reporting lines and often a new way of doing things and it doesn’t take much to create chaos. Mylan’s own 2013 acquisition of Strides’ injectables business, Agila, showed this quite clearly, when Mylan seemingly failed to spot the problems that Strides was having with the FDA even before the deal was done. Pharmaceuticals are produced in campaigns and lead times can be months, so dealing with stockouts is rarely quick, even if the afflicted markets are deemed important enough for production to care (and the bigger a company is, the less that anyone will care about smaller markets or products). The looming impact of the EU’s Falsified Medicines Directive makes the whole business of supply chain integration even worse, as companies now have relatively little time to make sure that all their suppliers will be able to provide the tamper-proof packaging and required unique 2D barcode for every pack that they sell. Without this, products will have to be withdrawn from the market.

Companies like to show KPIs to analysts and investors but one that is almost never seen is the level of on-time and in-full delivery between production and the marketing subsidiaries (or third parties, for those companies that also supply externally). Firms are rarely fully honest with shareholders about supply chain problems unless they are so major that they can’t be hidden, but an inability to supply can lead to late launches, reduced sales, higher costs and reputational loss. With the US customer base being so concentrated, maintaining supply here is clearly critical, so other regions are likely to play second fiddle where plants are manufacturing both for US and ex-US territories. Given that the US also takes very high volumes of a restricted number of product presentations while Europe generally requires much shorter runs of a much broader variety of presentations and packs, as well as relying more on outsourcing, the biggest strain on supply chain is likely to come here. Mylan’s efforts to in-source more products, started after it bought Merck Generics way back in 2007, have not been painless and dealing with the sheer diversity of the Abbott and Meda product ranges (particularly the latter) is going to present a tremendous challenge to Mylan’s self-described ‘best in class’ supply chain. It’s easy to put up a glossy PowerPoint slide showing how everything fits together, but the reality on the ground is likely to be much more messy, not only for Mylan but for all those companies driven by M&A.

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