Cephalon announced today that will pay approximately CHF 622.5m ($590m) to acquire Mepha from the Merckle family. Mepha, which used to be part of ratiopharm (also currently the subject of a sale process), is a branded generic company that is the market leader in Switzerland and also has a sales network across a large number of other branded markets, including Portugal, Poland and Ukraine. Sales in 2009 were reported (by Cephalon) to have been in the region of CHF 400m and we believe that Mepha was expecting to achieve an EBITDA margin of some 15-16% on that, implying that Cephalon will have paid a historic EV/EBITDA multiple (the transaction is debt free) of about 10x. This appears quite modest, but it needs to be borne in mind that Mepha’s earnings are likely to decline in 2010 as a result of changes to the generic pricing regime in Switzerland in 2009. Also, it is likely that the sale process has encouraged Mepha to maximise its short-term reported profits, so the EV/sustainable EBITDA multiple is probably somewhere in the low teens, in our view, particularly when you consider that a meaningful chunk of Mepha’s sales come from contract manufacturing for ratiopharm, which may no longer be required once ratiopharm has been sold.
Leaving aside the numbers, why did Cephalon do this deal? It was hardly the most likely bidder for Mepha: in fact, it was never mentioned at all. Historically, Cephalon has been thought of as a speciality pharma company, with a substantial R&D spend and successful track record of commercialising niche branded products. Now, however, it says that it has an operation that spans brands, branded generics and generics and that Mepha is a natural fit with this. In our view, Cephalon’s claim to be familiar with the generic market is barely credible. Yes, it supplies US generic companies witih Actiq, its fentanyl lollipop, and sells niche branded generics in some European markets, but that hardly makes it a classic generics company. On the contrary, its focus is very much on holding its prices high and using its sales force to generate branded prescriptions from doctors.
Judging by the conference call that Cephalon held following the announcement of the deal, its idea is to use Mepha to sell Cephalon’s products in more territories, to introduce a selected number of Mepha products into Cephalon’s markets (including the US), to cut overlapping costs (mostly Mepha’s Swiss HQ, by the sound of it) and to get some tax benefits. All of these should be achievable, but if Cephalon believes that Mepha’s branded generics can be introduced in the mainstream markets of western Europe (or in the US in any meaningful way), then it is probably set for disappointment. It is no accident that Mepha has focused its efforts entirely on markets that are fully branded and highly priced (and where doctors are receptive to a targetted marketing effort). It has an extremely high Swiss cost base, so its prices need to be set accordingly. Thus. it is very unlikely to be able to compete in markets such as Germany, France or the UK, where a very low COGS is key to success and branding counts for little . It also seems contrary to Cephalon’s existing ethos to compete on price, so we suspect that the focus will be solely on products that have some sort of value-add, possibly supplied by Mepha’s suite of drug-delivery technologies.
Overall, as is the case in so many M&A transactions, we are left wondering whether Cephalon really understands the nature of the business that it is buying. Mepha operates almost entirely in rather peculiar markets (Switzerland being one of them) and it will be interesting to see how Cephalon gets to grips with it after the deal closes. An earnings update is due on February 11th, so we should learn more then about what Cephalon’s expectations are for its new asset.