Tuesday, December 06, 2011

2011 M&A of the Year Nominee: Endo/AMS

It's time for the IN VIVO Blog's Fourth Annual Deal of the Year! competition. This year we're presenting awards in three categories to highlight the most interesting and creative deal making solutions of the year. The categories are: M&A Deal of the Year, Alliance Deal of the Year, and Exit/Financing Deal of the Year. We'll supply the nominations (half a dozen in each category throughout December) and you, the voting public, will decide the winners (by voting early and often, commencing once we've announced all the nominees). Strap yourselves in, it's The Race for the Roger™.

Endo’s $2.9 billion in cash acquisition of American Medical Systems Inc., in June 2011, throws the spotlight on the use of deal-making to go beyond the quick fix. In doing so, Endo had to overcome internal resistance, investor second-guessing, and industry's current preference, it seems, for high-stakes specialization over diversification.

But overcoming obstacles in order to exercise a grand ambition is not the chief reason Endo deserves the DOTY reward. No, the real draw here is management’s adamant vision in the face of a changing reality. Every good company constantly evolves, but only a few complete radical makeovers as rapidly as Endo has. Clearly, external drivers forced Endo’s hand: namely its over-reliance on one therapeutic area, and one medication, Lidoderm, in particular, the ever-riskier reliance on R&D innovation, and the long-term implications of health care reform.

Faced with similar problems, however, many companies, large and small, have huckered down and focused harder on innovation in their core expertise. Others have turned to in-licensing late-stage assets, withdrawing from the R&D-based business model. Endo has taken a third approach – not ditching pharma R&D completely, but moving beyond it to define its strategy not by therapeutic area, but by its customer base, that is, through a “continuum of care” approach that binds it closer to doctors and payers.

Endo was on the finals list for DOTY in 2010 for its HealthTronics acquisition—the first of its major diversification moves--but didn’t win; its return to the polls in 2011 is a testament to management’s perseverance and guts, this time, with a deal that follows similar reasoning on a larger scale and in doing so erases all doubts.

The deal in question thrusts Endo further into urological devices and services, a sector it had little presence in two years ago. Until 2008, Endo derived close to 90% of sales from its pain medication franchise, led by the best-selling topical pain drug Lidoderm. Urology now accounts for $1 billion of its sales, or more than a third of Endo’s total revenues; its key therapeutic areas have expanded to urology and oncology -- and not just drugs but devices and services as well. AMS complements other key acquisitions that Endo has made since ex-J&J executive David Holveck took over as CEO in April 2008: Indevus Pharmaceuticals (2009), HealthTronics, Qualitest (2010), and Penwest (2010).

As such, the company has built a presence in urology that “includes a broad network of partnerships and relationships with the overwhelming majority of US-based urologists,” CFO Alan Levin told analysts at a recent investor forum. The data generated by intensifying relationships is “critical to enhancing the organic growth potential of our urology franchise,” says Holveck. The company furthermore has identified potential cross selling opportunities for several of its product lines – a sticking point, until now, with Wall Street -- and a savvy way to gain more market data. A pilot program now getting underway, for example, trains AMS' men’s health division on selling the Fortesta gel, a newly launched topical testosterone replacement for hypogonadism, which Endo gained from the Indevus deal. The pharma urology reps are getting trained on AMS men’s and women’s health products. Other opportunities for selling synergies include Endocare cryoablation therapy, which came with the HealthTronics acquisition, and AMS’s GreenLight laser for benign prostatic hyperplasia.

If R&D-focused pharmacos are struggling to find the right value in innovation, Holveck says Endo has found the right mix through diversification, both within pharma and beyond it. “Understanding how the continuum of care is given and the products that interrelate with that care,” adds value to the urology practice, he says. And it also reduces event risk, which is implicit in the branded portfolio. Health care reform’s impact is a case in point. Endo estimates it will cut $40 million from the branded pharma business’ top line due to increased discounts to payers, particularly reflecting the higher Medicaid drug rebates. But it should also lead to higher sales on the generics side of the business. And, pointed out Levin, devices have not been greatly affected by health care reform proposals, aside from a 2.5% tax on US revenues, which takes effect in 2013.

For this opportunity, Endo has paid well – the multiple for AMS, itself a spin out from Pfizer, which private equity firm Warburg Pincus acquired in 1999 -- was approximately 14 times trailing EBITDA, the Qualitest multiple slightly less. The process wasn’t at all easy, as Endo’s management is first to admit, and the combination of devices and drugs still leaves Wall Street a bit queasy. But the stock has climbed nearly 50% since Holveck came to the company in April 2008, and although it's just treading water year to date 2011, that’s better than most of the industry. Just as important, Endo is poised to move swiftly in a rapidly changing health care environment.

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