Crunch time may be approaching for the CEO of Hikma, Said Darwazah. Rumours have circulated recently that Hikma has received an approach from Mylan, an event which, if true, will pose a dilemma for the company’s Board. Hikma has, we believe, been the subject of interest on the part of potential acquirers many times before, but the Darwazah family’s 30% holding in the company effectively means that it cannot be taken over without the agreement of its management. This is no different today, but the rapid recent rise in Hikma’s share price – which has almost doubled over the last year – means that an offer made at a significant premium to the current market cap is going to be hard to refuse. Indeed, Hikma has a duty to its shareholders at large at least to consider such an offer, and only to turn it down if it genuinely believes that the company can do much better on a stand-alone basis.
The question is, then, what is Hikma likely to do left to itself and, is this sufficient for shareholders to prefer to keep the company independent? In general, our view is that shareholders tend to be far too short-term in their outlook, frequently agreeing to takeover bids that give them only a relatively modest gain on their holdings and in the process, killing the entrepreneurial spirit within the company that they have sold. Moreover, shareholders in UK pharma companies have few other alternative investments within the sector, so for the sake of a one-off gain on their holding, they give up on future growth. That said, a big premium to an already expensive share price has got to be tempting, so if Said doesn’t want to sell, he will have to put forward a good case.
In our view, he can do this if he wants to. At Hikma’s recent ‘Meet the management’ event, held in late 2014, it was interesting to note how the focus of the company’s ambitions has swung away from its home markets of MENA and towards the US. The acquisition of Boehringer Ingelheim’s injectables business, Bedford Labs, in May 2014, which followed on from the October 2010 purchase of Baxter’s US injectable assets, has made Hikma the largest injectables company in the US in terms by number of products. The company now has a huge range, including many Bedford drugs that are not currently in production but will be re-launched following tech transfer to other Hikma plants. It also has a strong pipeline, including some first to file opportunities. Of course, competition in the injectables space is likely to increase, as several years of drug shortages have led to a lot of capacity investment that has yet to make much impact on the market but will surely do so over the next few years. Even so, the sheer depth and breadth of Hikma’s portfolio should give it some support.
Unfortunately, but not particularly surprisingly, the company’s analysts were less focused on the opportunities for the injectable business than they were on the risks of regulatory problems, following Hikma’s receipt of a warning letter from the FDA with regard to its facility in Portugal. Assuming that this has the limited impact that the company believes – and it has not impacted Hikma’s ability to supply the US from this plant – these concerns should gradually subside. The US oral solids business has also been booming, driven by product shortages that have enabled Hikma to benefit from massive price rises. In the current year, this should be bolstered by the launch of Mitigare, the company’s licensed colchicine products (colchicine is another good example of a drug where Hikma benefited from a largely exclusive market position, at least for a while, and should be one of only two manufacturers of the licensed version). In addition, we believe that the company has a pipeline of other oral drugs, but with an emphasis on therapies that require some level of trials, such as phenobarbital, where Hikma is currently running a reasonably sizeable clinical trial, presumably with the aim of getting a licence (like colchicine, phenobarbital is so old that it pre-dates the FDA) and then taking 100% of the market at an enhanced price.
When it comes to M&A, Hikma has really only just got started, and it is this more than anything else that makes us believe that the company would be better off remaining in the hands of its current owners for a bit longer. Although Hikma has done a lot of deals in the past, they have almost all been relatively small ones as the company has been constrained by its ability to raise equity, given that the Darwazah family is not ready to dilute its holding. In MENA, Hikma has also been stymied by the lack of suitable targets to buy and by the unrealistic valuation expectations of any putative vendors. It is only very recently that the company has reached the inflexion point at which it can start to do much bigger things, with each successive deal increasing the cash flow available to fund the next one. The Baxter deal was valued at $112m and the BI one at $300m (including milestones) and while we would not expect Hikma to do any deal that wasn’t good value – both the Baxter and Bedford Labs transactions were characterised by low multiples due to the superficial unattractiveness of the assets on offer – it is clearly now well placed to go for larger opportunities. At the management day, the company stated that it was now in a position to do transactions of $1bn+, which is a big step up from where it was only a year or two ago. What to buy remains the question – even with more cash, it is hard to find attractive assets for sale at reasonable prices in the MENA region – but Hikma doesn’t necessarily have to be constrained by the current shape of the business. Being dominated by MENA and injectables doesn’t mean that it can only build out in these areas (or US generics, which is its smallest unit). After all, the two major business areas don’t have that much connection with each other. In MENA, Hikma markets originator products, so it could just as well do so in Europe or the US. It is also starting to sell biosimilars, a business that straddles innovation and injectables.Although its agreement with Celltrion is for MENA only, there are other companies that could provide it with a pipeline for territories outside the region.
Overall, we see plenty of space for Hikma to continue to expand. While not everything that the company has tried has been a success, it has a pretty good track record when it comes to new businesses and markets, so shareholders won’t necessarily take fright if the management takes the company in a new direction. Whereas some years ago, investors were keen to have Hikma as a pure MENA play, more recent events in the region have reminded them that the emerging markets carry high risks as well as high returns and that a portfolio that is more geographically balanced can have its attractions. Consequently, we believe that Said can confidently say a polite ‘no thanks’ to Mylan and its ilk and continue to fly solo for a little longer.