Mallinckrodt has a diverse portfolio of medicinal controlled substances and what makes it a lucrative target is it received over 30 per cent of the US Drug Enforcement Administration (DEA) quota for manufacturing controlled substances in the US last year. A controlled substance is generally a drug or chemical whose manufacture, possession, or use is regulated by a government. The entry barrier in this segment is thus quite high.
A source who is tracking the deal closely said, "The best part of the deal this deal enables Aurobindo break the entry barrier (the manufacturing quota etc) for a niche portfolio that would have taken them 10 years to achieve organically." The deal will include two manufacturing facilities.
Controlled substances constitute around 5 per cent of Aurobindo's US revenues at present, and some think that the acquisition is a strategic fit to grow the same line of business. The controlled substances business in US generates an Ebitda of $40 million for Aurobindo, sources revealed.
Meanwhile, Trump administration's crackdown on opioid addition has led to increased scrutiny of drugmakers who handle such a portfolio.
"There are more than 500 lawsuits which are currently going on in courts against the company due to opioid misuse. There were 42,000 deaths in US alone due to opioid misuse in 2016. Key reasons for this is over subscription and abuse of painkillers. It is a sort of crisis in the US for opioid misuse and government is actively looking to reduce the opioid use and prescription," Edelweiss said.
This raises the risks of legal battles. "The Mallinckrodt portfolio that Aurobindo is looking to buy is a generic one and does not have any branded product. Therefore, there is no promotion by the company, which, in turn, may lead to scrutiny of the drugmaker inducing opioid addiction. Rather, for most of these drugs, there is no substitute and the manufacturing will never stop as they are the only source of pain relief in many terminal illnesses," revealed the source who is working on the deal.
Regulatory challenges, however, have pushed down the valuation of the portfolio. Mallinckrodt had expected to fetch around $2 billion for the generics business when it put it on the block in March 2017.
Sources claim that Aurobindo is likely to lap it up now for $800 million. The portfolio which has an annual sales of around $732 million, this converts to a little more than 1X of sales. Edelweiss, however, claimed that the business has declined by 25 per cent in the last one and a half years, and current margins are around 21.6 per cent.
"Aurobindo has an EBITDA of around $600-650 million, and debt of around $500 million. Post-acquisition (assuming it raises the entire $800 million in debt), the balance sheet is thus not highly leveraged," said the source who also claimed the margins for the portfolio were around 30 per cent or so.
A Mumbai-based analyst who tracks the pharma firm said that while there is room for growth in this niche segment, a lot depends on how Aurobindo builds on the efficiency parameters. "It cannot shift the manufacturing to India as in case of other generics to boost margins immediately. Manufacturing of controlled substances is closely monitored in the US," he added.
As such the US generic business of Aurobindo is facing pricing pressure - the price erosion was around 8 per cent year-on-year for Q4FY18. It is the fifth largest generic pharma company in the US by prescription value dispensed.
Around 5% of Aurobindo's US biz comes from controlled substances
Controlled substances generate an ebitda of $40 mn
It has 16 ANDAs in the controlled substances in the US
Manufacturing of controlled substances is closely monitored by US govt
Mallinckrodt received over 30 per cent USDEA quota for manufacturing controlled substances in 2017
More than 500 law suits going on against Mallinckrodt for opioid misuse
Trump administration crackdown on opioid addiction is likely to raise legal risks
Sources say target portfolio does not have branded drugs, hence legal risks low
Intas Pharma had backed out of the deal early this year
Regulatory fear has eroded valuation of Mallinckrodt's business