iNova sale the right medicine

23-Nov-2011 iNova sale the right medicine 
22 November 2011 
Tony Boyd 

The $700 million sale of iNova Pharmaceuticals to listed US company Valeant Pharmaceuticals is a rare ray of sunshine for private equity as well as for the local pharma market, which is heading for a very tough year.  At a time when the government is talking up the need to encourage industries of the future, a North American buyer has swooped on a local drug company that oozes talent and has a track record of delivering strong growth in revenue and earnings.  

The sad fact is that there are no trade buyers in Australia for successful drug companies.  Combine that with the temporary closure of the initial public offering market because of market volatility and there are no new investment options emerging for institutions wanting to back local pharma.  

Those that have invested in Sigma Pharmaceuticals and Australian Pharmaceutical Industries have been badly burned over the past three years, with both stocks vastly underperforming the index.  Compare the financial performance of iNova over the past three years with that of Sigma and API and it is easy to see the benefits than can be brought to a company from ownership by private equity.  An exception to the rule of poor performance in the local pharma market is Blackmores.  Its share price performance was four times better than the index over the past three years.  

Archer Capital and Ironbridge Capital bought the iNova business from 3M for an enterprise value of $450 million in December 2006.  Revenue in the first year of ownership was $120 million and earnings before interest, tax, depreciation and amortisation (EBITDA) was $140 million.  Three years later it has revenue of $180 million and EBITDA of $75 million.  That EBITDA number is in excess of the combined EBITDA of Sigma and API in the 2011 fiscal year.  

Under chief executive Andrew Howden, iNova expanded its sales force and made strategic acquisitions to build a large portfolio of drug and skincare products.  Its strategy focused on serving the notoriously finicky and politically powerful privately owned pharmacy market.  These are classic Australian small businesses that hate being steam-rolled by companies that give preference to Coles and Woolworths.  

Pharmacies will come under tremendous financial pressure in 2012 as the first of many blockbuster drugs come off patent.  The big daddy of them all is the Pfizer cholesterol drug Lipitor, a $695 million-a- year drug that comes off patent in the first quarter of next year.  In preparation for that patent change and to avoid being beholden to the country’s full-line drug wholesalers, Pfizer this year launched its own direct distribution through DHL.  However, the pharmacists hate Pfizer’s direct distribution model, as shown by a survey of pharmacists by the Pharmacy Guild of Australia, released this month.  

Some investors say it is wise to avoid any industry that is subject to the heavy hand of government.  The pharmaceutical sector is under pressure because the government wants to save taxpayers about $1.9 billion through reforms to the pharmaceutical benefits scheme (PBS).  However, it is noteworthy that iNova’s sales and profits are not reliant on PBS medicines.  Greg Minton at Archer and Paul Evans at Ironbridge could have sold the iNova business through an IPO but they would have had to swallow a lower price than the 10 times earnings multiple paid by Valeant.  The private equity firms were advised by Greenhill Caliburn and Goldman Sachs.  The Canadian company, which was advised by Merrill Lynch, trades at 14 times earnings in New York and Toronto, so it gets an immediate uplift from the transaction, which includes $75 million of milestone payments on top of the $625 million upfront.  Valeant has a small operation in Australia focused on skincare, cosmetics and dermatology, including the Hamilton sunscreen products and the anti-skin cancer treatment Efudix.  It will use the iNova business as a springboard into Asia.  

The iNova sale, which was first reported by The Australian Financial Review DealBook, marks the latest in a series of successful exits by Archer over the past year.  It sold Rebel Group to Super Retail for $610 million, MYOB to Bain Capital for $1.2 billion and Cellarmasters to Woolworths for $340 million.  Ironbridge, which sold Easternwell to Transfield last year for $40 million, takes the view that the iNova sale has confirmed the quality of management of the company because Valeant wants to retain CEO Howden and his team.  Positive news from private equity is welcome given the disastrous outcome of the Collins Food IPO.  The company issued a profit downgrade less than three months after it was sold to the sharemarket by Pacific Equity Partners.  Its shares are down 47 per cent from the issue price of $2.50 a share.