RBC on Brexit Vote Implications - June 24th Concordia Healthcare Corp.
Brexit = Negative Implications But Natural Hedges
Limit Exposure to the £
Our view: The vote for Brexit came as a surprise and has negative
implications for CXRX given its UK exposure. However, natural hedges
including expenses and £ denominated debt helps to limit exposure.
We remain unsure as to the path forward but continue to believe the
shares are undervalued regardless of outcome but still expect near term
weakness on the news.
Key points:
• U.K. votes for Brexit, Concordia impacted by weaker pound although
natural hedges limit exposure. CXRX derives approximately 40% of its
revenues from the UK (and ~10% from Europe ex-UK). The business is
naturally hedged as the majority of its international operating expenses
are also incurred in the U.K. Prior to the British referendum, we used a
GBP/USD rate of 1.45x and a EUR/USD rate of 1.15x. We have revised
our exchange rates for the remainder of 2016 to 1.37x GBP/USD and
1.10 EUR/USD. While we acknowledge that FX rates will be volatile, we
believe providing a revised outlook will help investors understand the
exposure to a weaker £ for the company.
• Top-line negatively impacted by ~2% in 2016E, 3.5% in 2017E. We have
revised our forecasts and revenues are now lower by ~$17MM in 2016
and ~$35MM in 2017, Adj. EBITDA is negatively impacted by ~$9MM
in 2016 and ~$20MM in 2017, and Adj. EPS is lower by $0.16 in 2016
and $0.41 in 2017. We have included sensitivity analyses for 2016 and
2017 as well as detail surrounding our revised forecasts for Concordia
in the note.
• Street will need to be more cautious even if constant exchange
guidance remains unchanged. Current 2016 guidance of $1.02-1.06B
revenue, Adj. EBITDA of $610-640MM, Adj. EPS of $6.29-6.77, and yearend
Net Debt/EBITDA of ~5.5x are all based on a constant exchange
rate (CER) of 1.53x GBP/USD. We believe that given the current GBP
weakness, the street will need to adjust its outlook lower even if CER
company guidance remains unchanged.
• Potential Impact on Committee Review Process. We have believed that
the key item holding up the ongoing review process was the outcome of
a Brexit vote as valuations would likely have varied materially depending
on the outcome. With a vote for exit now made, any potential bidder
can finalize a view on valuation and whether a final bid is warranted.
Separately, the CXRX committee can assess if any final bid is satisfactory
or if an alternative path is necessary. We remain unsure as to the path
forward but continue to believe the shares are undervalued regardless
of outcome but still expect near term weakness on the news.
• Price target lowered from $57 to $40 due to lower multiple and slightly
revised estimates. We have lowered our price target from $57 to $40
to reflect a lower multiple of 8.0x on EBITDA (previously 9.0x). The 8.0x
is a ~20% discount to where the group is currently trading; 10.0x 2016
EBITDA.
Investment summary
We believe Concordia will outperform the peer group for the
following reasons:
Inversion crackdown benefits low-tax corporations. The
US is cracking down on corporate inversions (reducing a
corporation's tax rate via a transaction that moves or creates
an organization in a lower-tax jurisdiction), so Canadian
companies like Concordia with lower tax rates (~5%) have an
advantage over their US peers from an earnings and M&A
perspective.
Increased global presence. With the AMCo acquisition,
Concordia now has a platform that it can use to introduce
drugs to new markets. In particular, Concordia could introduce
drugs to emerging markets, where there is a higher percentage
of private payors.
New orphan indications could sustain long-term growth.
The company is pursuing two new orphan indications for
Photofrin, a well characterized product approved in 1996. We
view the new trials as relatively low-risk due to the long-term
safety profile of the drug and believe approvals could sustain
organic growth in the long term.
Integration strategy requires minimal investment. Concordia
has been a selective acquirer of assets. Most of the products it
acquires are mature and require little investment to maintain
compared to the significant expenditures associated with
developing and launching new products. If management can
continue to find assets that meet its standards, the company
should be able to leverage its existing infrastructure to
generate improved returns on those assets.
Target price/base case
Our US$40 price target is based on the average of our EV/
EBITDA valuation and DCF analysis. Applying a 8.0x multiple to
our 2017 Adj. EBITDA forecast of $629MM generates a value
of $39.81. Our DCF value (11.0% WACC and a -2% terminal
growth rate) equates to $39.77. The average of our EV/EBITDA
and DCF values is $39.79, hence our $40 price target. There are
no further acquisitions included in our base case. We assume
that Photofrin is approved for bile duct cancer in 2018.
Upside scenario
Our $63 upside scenario utilizes a 9.0x multiple on 2017E Adj.
EBITDA of $679MM, equating to a value of $60.54. Our DCF
value equates to $64.75. The average of our EV/EBITDA and
DCF values is $62.64, rounded to our $63 upside value. This
scenario utilizes a 2% terminal growth rate and higher multiple
plus incrementally higher EBITDA to reflect stronger organic
growth. We also assume that Photofrin is approved for bile
duct cancer in 2018.
Downside scenario
Our $10 downside scenario utilizes a 6.0x multiple on 2017E
Adj. EBITDA of $579MM, generating a value of $9.89. This
scenario assumes no new approvals for Photofrin and lower
than anticipated demand for the portfolio. We also assume
increased AMCo competition and lower Donnatal demand.
Risks
The company faces a number of risks related to integration/
execution of acquisitions, the inability to identify new
products, Donnatal exposure as a DESI product, clinical trial
failures, unexpected new generic drugs, reliance on third
parties for various operational items such as manufacturing,
price increase pushback, a significant debt load and risks
associated with managing a larger suite of products. However,
the AMCo and Covis deals reduce the overall exposure to
Donnatal. Given Concordia's international exposure to the UK
and EU, the recent Brexit vote and the subsequent effects on
the GBP are a risk to Concordia.
Brexit – Negative Implications But Natural Hedges Limit Exposure to the Pound
U.K. votes for Brexit, Concordia impacted by weaker pound although natural hedges limit
exposure. CXRX derives approximately 40% of its revenues from the UK (and ~10% from
Europe ex-UK). The business is naturally hedged as the majority of its international operating
expenses are also incurred in the U.K. Prior to the British referendum, we used a GBP/USD
rate of 1.45x and a EUR/USD rate of 1.15x. We have revised our exchange rates for the
remainder of 2016 to 1.37x GBP/USD and 1.10 EUR/USD. While we acknowledge that FX
rates will be volatile, we believe providing a revised outlook will help investors understand
the exposure to a weaker £ for the company.
Top-line negatively impacted by ~2% in 2016E, 3.5% in 2017E. We have revised our
forecasts and revenues are now lower by ~$17MM in 2016 and ~$35MM in 2017, Adj.
EBITDA is negatively impacted by ~$9MM in 2016 and ~$20MM in 2017, and Adj. EPS is
lower by $0.16 in 2016 and $0.41 in 2017. We have included sensitivity analyses for 2016 and
2017 in Exhibits 2 and 3, respectively. Exhibit 4 outlines our revised forecasts for Concordia.
Street will need to be more cautious even if constant exchange guidance remains
unchanged. Current 2016 guidance of $1.02-1.06B revenue, Adj. EBITDA of $610-640MM,
Adj. EPS of $6.29-6.77, and year-end Net Debt/EBITDA of ~5.5x are all based on a constant
exchange rate (CER) of 1.53x GBP/USD. We believe that given the current GBP weakness, the
street will need to adjust its outlook lower even if CER company guidance remains
unchanged.
Potential Impact on Committee Review Process. We have believed that the key item holding
up the ongoing review process was the outcome of a Brexit vote as valuations would likely
have varied materially depending on the outcome. With a vote for exit now made, any
potential bidder can finalize a view on valuation and whether a final bid is warranted.
Separately, the CXRX committee can assess if any final bid is satisfactory or if an alternative
path is necessary. We remain unsure as to the path forward but continue to believe the
shares are undervalued regardless of outcome but still expect near term weakness on the
news.
Mixed impact on 2016 and 2017 cash flows. While a weaker Pound and Euro relative to the
USD has a negative impact on top-line and EBITDA, even with the natural hedges that the
business current has in place, the impact on cash-flow in 2016 and 2017 is actually mixed.
While we forecast EBITDA to be $10MM lower in 2016, this is offset by lower cash interest
associated with the pound-denominated debt and pound-denominated contingent
consideration payments that we forecast will be made in H2 2016. Subsequently, overall cash
flow is slightly positive related to the currency impacts caused by the Brexit. In 2017, while
EBITDA is $20MM lower, pound-denominated debt improves the impact on cash-flow
relative to the lower EBITDA.
Valuation
We value Concordia shares by averaging the results of our EV/EBITDA valuation and DCF
analysis.
Applying an 8.0x (prev. 9.0x) multiple to our 2017E EBITDA forecast of $629.4MM (prev.
$649.9MM) generates a value of $39.81 (prev. $56.22). While we had previously utilized the
average of a P/E multiple and our DCF to support our valuation, we believe that given the
company's significant leverage at present, a focus on the levered balance sheet must be
considered with greater weight. The 8.0x multiple is in line with its peer group. Our DCF value
(11.0% WACC and a -2% (prev. 0.5%) terminal growth rate) equates to $39.77 (prev. $57.17).
The average of our EV/EBITDA and DCF values is $39.79, hence our $40 price target. There are no further acquisitions included in our base case. We assume that Photofrin is approved for bile duct cancer in 2018. Our valuation supports an Outperform rating.
Price target impediments
The following are risks to our rating and price target:
The company’s strategy revolves around further M&A activity. The size, location, and other
operational attributes of these assets could make their integration into the rest of the company
a challenge. Management does not have a long track record of integrating assets, so this
remains a risk until a few more deals are completed and successfully integrated.
Although the company's R&D program utilizes a well characterized agent, Photofrin, there is
always clinical/regulatory risk associated with any program and there are no assurances that
the company will be successful in attaining additional approvals. As a commercial entity, the
company faces commercial and legal risks associated with each of its products. The threat of
new entrants is relatively low, as most of its products have either lost patent protection or
compete in highly competitive markets.
The biggest risk but a declining one following the Covis and AMCo deals revolves around
Donnatal. Donnatal is a unique product, as it was approved in 1947 when the FDA was focused
on safety and not efficacy. The product is under review by the FDA and has been since 1975
until a hearing to determine whether it is effective occurs. There are no timelines for when or
if a hearing is to be held, but the product represents ~10% of the company's total revenues and
would impact the valuation if it were not allowed to stay on the market. Continued weakness
in the GBP following the recent Brexit vote could further impact Concordia's international
business. These risks could impact Concordia's ability to meet our price target, valuation, and
rating expectations.