CEPH Cephalon (MM)

Valeant Pharmaceuticals International’s (VRX) second quarter 2011 earnings of 68 cents per share (excluding special items but including stock based compensation expense) beat the Zacks Consensus Estimate by 3 cents and the year-ago earnings by 8 cents per share.

Bottom-line growth was driven by improved revenues. Adjusted diluted earnings, however, included an extraordinary gain of 6 cents from the sale of investment in Cephalon Inc. (CEPH).

Revenues for the quarter were $609.4 million, marginally above the Zacks Consensus Estimate of $609 million and way ahead of the prior-year figure of $238.8 million. However, revenue included a one-time milestone payment of $40 million received from GlaxoSmithkline (GSK) related to the European launch of Trobalt (known as Potiga in the US).

The improvement in revenues was primarily due to the September 2010 merger of Valeant Pharma with Biovail Corporation. Results for the second quarter of 2010 only reflect legacy Biovail revenues and do not include any revenues from legacy Valeant.

However, excluding the milestone payment, revenue was below the Zacks Consensus Estimate due to tough year-over-year comparisons (Legacy Biovail products were doing very well) as well as weak performance of the Legacy Biovail generic products. Organically (excluding the impact of one-time revenues, acquisitions and foreign exchange), revenues grew 4% over the year-ago quarter.

Quarterly Highlights

Product sales amounted to $530.0 million during the reported quarter, compared with $231.2 million in the prior-year quarter. The increase in revenues was due to robust growth in all segments (specialty pharmaceuticals as well as branded generics) except for US Neurology and Other, which was affected by the availability of generics for Diastat.

Research & development (R&D) expenses amounted to $17.8 million, reflecting a year-over-year decline of 25%. Selling, general & administrative (SG&A) expenses for the second quarter increased 232.0% to $149.7 million.

Outlook

Following the release of second quarter results, Valeant Pharma upped its guidance for 2011. The company expects earnings to come in the range of $2.70 – $3.00 per share in 2011, revised from the previous guidance range of $2.65 – $2.90 per share. The Zacks Consensus Estimate of $2.78 is within the company’s targeted band.

Additionally, the company expects to experience organic growth of at least 8% through 2011 to be driven by strong performance of its businesses in Europe, Latin America, Canada and Australia.

Acquisitions and Deals

In July 2011, Valeant Pharma announced deals that would entrench its already strong presence in the dermatology market in the US. Valeant Pharma intends to acquire the assets of Ortho Dermatologics, a dermatology unit of pharma giant Johnson & Johnson (JNJ), for $345 million in cash. The transaction is expected to close by year end.

Valeant Pharma also announced that it intends to acquire Dermik, a dermatology unit of Sanofi Aventis (SNY), in the US and Canada. The purchase consideration is approximately $425 million for all Dermik assets.

The products of both these divisions will synergize well with Valeant’s dermatology products like Zorivax cream and ointment (herpes), Acanya and Atralin (acne) among others. We believe these acquisitions satisfy Valeant’s aim to become a leading player in the skincare market.

In June 2011, Valeant also acquired rights for Canada, US and Mexico for Elidel cream and Xerese cream from an international specialty pharmaceutical company Meda. Valeant and Meda have also entered into a development agreement for future life cycle management of both Elidel and Xerese.

In an effort to expand its European branded generics business, in May 2011, Valeant announced that it has entered into an agreement to acquire Kaunas, Lithuania-based specialty pharmaceuticals company AB Sanitas for approximately EUR 314 million in cash. The acquisition of the controlling interest is expected to close in the third quarter of this year.

Product Update

In June 2011 Valeant Pharma and partner GlaxoSmithKline announced that Potiga gained FDA approval for use as an adjunctive treatment of partial-onset seizures in patients aged 18 years and above.

Potiga will, however, be classified as a controlled substance under the Controlled Substances Act (CSA) and will not be available until the classification process is completed. Glaxo and Valeant expect to launch the drug by the end of 2011.

Our Recommendation

We have a Neutral recommendation on Valeant Pharmaceuticals. The stock carries a Zacks #3 Rank (Hold rating) in the short run.

Valeant in its current form emerged from the merger of Biovail and Valeant in September 2010.  Overall, we believe the combined Biovail/Valeant entity is a unique company as it offers global reach, a diversified revenue base, a favorable tax structure and limited patent exposure.

Moreover, accretive acquisitions add to the company’s investment thesis. However, the company’s failure to clinch the Cephalon deal was a disappointment. We therefore prefer to remain on the sidelines.

 
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