VRX, ENDP, HZNP, and MNK – A Comparison of US Pricing Risks

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Richard Evans / Scott Hinds / Ryan Baum / Hardy Evans

203.901.1631 /.1632 / .1627

richard@ / hinds@ / baum@ / hevans@ssrllc.com


March 28, 2016

VRX, ENDP, HZNP, and MNK – A Comparison of US Pricing Risks

  • Formulary managers (e.g. ESRX, CVS, UNH) have only recently begun to give full and careful attention to VRX, and to other specialty pharma companies having aggressive US pricing and reimbursement practices (e.g. ENDP, HZNP, MNK)
  • Formulary managers apply pressure by using credible threats to shift volume away from substitutable products. To gauge susceptibility, we identified each company’s substitutable US Rx sales as a percent of global sales, then estimated the total sales and gross profits at risk if prices for the companies’ substitutable products were forced down to the level of the relevant alternatives
  • HZNP has the greatest percentage of sales at risk; if its products’ prices are forced to the level of relevant substitutes, global sales would fall by as much as 68%. VRX’s global sales would fall by as much as 17%, ENDP’s by 12%, and MNK’s by 10%
  • If we reduce 2016 consensus EBITDA by an amount equal to the gross profits at risk, then EBITDA / debt service ratios fall from 2.2x to 1.6x at VRX, from 2.7x to 2.3x at ENDP, and from 4.4x to 3.7x at MNK. Because HZNP’s gross profits at risk exceed 2016 consensus EBITDA, its EBITDA / debt service ratio falls to a negative value; however HZNP has a relatively small 2016 debt service obligation ($68M)
  • To state risks in terms that match debt covenants, we also calculated EBITDA/interest coverage ratios. Ignoring HZNP, only at VRX can feasible pricing pressures reduce EBITDA / interest ratios below the critical 3.0x threshold. If the prices of VRX’s substitutable products are forced to the level of substitutes (removing $1.8B in sales and $1.4B in gross profits), VRX’s 2016 EBITDA / interest ratio would be approximately 2.6x. If we solve for the amount of pricing pressure required to lower EBITDA / interest to the critical 3.0x level, we find that VRX can only stand to lose roughly $950M in 2016 sales ($730M in gross margin) to pricing pressure. Notably, this level of sales and gross profit pressure can be delivered simply by forcing prices of VRX’s A-rated products to the level of A-rated alternatives
  • VRX is most at risk, because feasible pricing pressures exceed levels that would cause the company to violate its debt covenants, and because underlying US volumes are weak. HZNP follows – feasible pricing pressures are sufficient to eliminate 2016 EBITDA; however debt is modest, and underlying volume growth is quite strong. ENDP is next most at risk – feasible pricing pressures could reduce EBITDA by 14%, but are unlikely to push interest coverage ratios into or even near technical default levels. ENDP’s underlying US volumes are weak, meaning risks would build over time if US pricing power is lost. MNK is least at risk; like ENDP, MNK has 14% of EBITDA at risk to US pricing pressures; unlike ENDP, MNK benefits from even less debt, and higher mix contributions to US revenue

Where we’re BULLISH: Biopharma companies with undervalued pipelines (e.g. AMGN, BMY, GILD, SHPG, VRTX); Biopharma companies with pending major product approvals (e.g. ABBV, ACAD, ADMA, ALIOF, BIIB, CHMA, CLVS, CPRX, CTIC, GILD, ICPT, JAZZ, LLY, LPCN, MRK, NVO, OCUL, PTCT, SRPT, TEVA, ZSPH); SNY on sales potential for Praluent (alirocumab); CNC, MOH and WCG on bullish prospects for Medicaid HMOs; and, DVA and FMS for the likely gross margin effects of generic forms of Epogen

Where we’re BEARISH: PBMs facing loss of generic dispensing margin as the AWP pricing benchmark is replaced (e.g. ESRX); Drug Retail as dispensing margins are pressured by narrowing retail networks and replacement of AWP (e.g. WBA, CVS); Research Tools & Services companies as growth expectations and valuations are too high in an environment of falling biopharma R&D spend (e.g. CRL, Q, ICLR); and, suppliers of capital equipment to hospitals on the likelihood hospitals over-invested in capital equipment before the roll-out of the Affordable Care Act (e.g. ISRG, EKTAY, HAE)

We believe VRX’s US Rx price / volume trends were more extreme than is generally appreciated, with VRX being heavily reliant on US Rx net pricing gains to offset negative volumes[1]. And, we believe VRX was able to achieve US pricing gains in large part because the products whose prices were being inflated were at least somewhat off-radar from the perspective of large payors

As VRX grew through acquisition and price inflation, the company’s aggregate impact on the typical payor’s drug spend became quite large; by 3Q14 VRX was the 5th largest contributor to market-wide US Rx net price inflation, and ranked as the single largest driver of market-wide US Rx net price inflation in two subsequent quarters. This, and high-profile controversies over VRX’s aggressive tactics for seeking reimbursement (e.g. Philidor), have resulted in payors now giving very careful attention to VRX’s pricing and reimbursement practices – and to the practices of companies who operate similarly

These payors can be expected to apply pricing pressure, in proportion to the presence or absence of substitutes. Companies with large percentages of sales in products easily substituted by alternatives made elsewhere will see greater pricing pressure, and vice versa

Three-quarters of VRX, ENDP, and HZNP US Rx net sales come from products that payors have the option of excluding from formulary. For MNK, we estimate that roughly 23% of US Rx net sales can be excluded

To establish a measure of how substitutable the companies’ US Rx portfolios are, we placed each product into one of three categories:

  1. A-rated substitutes are available (pharmacists can substitute a generic alternative for the company’s product unless the Rx is designated ‘dispense as written’)
  2. Therapeutic substitutes are available (a different dose, formulation, or molecule is available and is an accepted treatment for the same condition the company’s product is typically written to treat); or
  3. No substitutes are available for the company’s product

VRX’s and ENDP’s US Rx product lines are similarly substitutable – each has just over a fifth of US Rx net sales in products with A-rated alternatives, and roughly half of US Rx net sales in products with available therapeutic substitutes (Exhibits 1a, 1b). HZNP has very little of US Rx net sales (2.6%) in products with A-rated alternatives, but fully 75% of sales in products with available therapeutic substitutes (Exhibit 1c). And, HZNP’s two largest products which account for 40% of US Rx net sales are designated as therapeutically substitutable; however, because both products are single-pill combinations of drugs that are A-rated generics, these products are nearly as easy to exclude from formulary as A-rated generics. Thus on net, VRX, ENDP, and HZNP each derive roughly three-quarters of US Rx net sales from products that payors have the option of excluding from formulary

In contrast, only 5% of MNK’s US Rx net sales have A-rated alternatives, and 18% have therapeutic substitutes (Exhibit 1d). Our notes on why products were placed in various categories of substitutability are provided in the appendices for all four companies

Prices relative to alternatives: highest at VRX and HZNP, lowest (but still significant) at ENDP

Having categorized products by degree of substitutability, we then compared each product’s net price with the net price of its feasible substitutes[2]. For VRX products that have generic alternatives, we estimate that the VRX products carry an average 33-fold higher price than the generic alternative. For VRX products that have branded alternatives, the VRX products are priced at par with the potential brand substitutes (Exhibit 2a). HZNP is even more aggressively positioned – HZNP products carry net prices that are on average 44-fold higher than generic alternatives (Exhibit 2b)

MNK products with generic alternatives carry relatively high (38-fold) premia to the potential generic substitutes, however bear in mind that unlike VRX and HZNP, in relatively few cases are the generic alternatives truly A-rated. Where branded alternatives exist to MNK products, the MNK products are priced at par to those brands (Exhibit 2c)

ENDP products with generic alternatives carry a much lower, but still significant 9.6x premium to the generic substitute. Only two ENDP products have branded substitutes, and the ENDP products carry a price premium (4.3x and 2.0x) to both of these branded alternatives (Exhibit 2d)

Worst-case scenario exposure – impact of forcing prices on substitutable products down to the price of substitutes

Payor pressure is likely to force the prices of substitutable products down closer to the price of substitutes. If we assume for the sake of argument that substitutable products’ prices fall all the way to the price of substitutes, then we can estimate the maximum amount of US Rx and worldwide sales at risk by company. Results are shown in Exhibit 3

In making these calculations we assume product volumes are unaffected, and that product prices fall completely to the level of substitutes. Where a product has both generic and branded substitutes, we conservatively assume the price falls to the level of the branded alternative[3]

HZNP clearly has the most to lose – in theory the firm’s US Rx net sales could be reduced by 69% if all products’ prices were forced to the level of available substitutes. Nearly all of HZNP’s risk comes from therapeutic subs instead of A-rated generics; however bear in mind that two of HZNP’s largest products (Duexis, Vimovo) are single-pill combinations of A-rated generic drugs, and are thus nearly as easy to substitute as A-rated generics. VRX and ENDP have the same amount – 35% of US Rx net sales – at risk; however in VRX’s case more than half (18%) of this at-risk amount is explained by products with A-rated generic substitutes, as compared to 12% for ENDP. MNK has 16% of US Rx net sales at risk, only 3% of which is explained by A-rated generics. To roll these US susceptibilities up to a global figure, we simply multiply by US brand Rx sales as a percent of global sales. HZNP is by far the most susceptible, with 68% of global sales at risk if US payors lower the price of substitutable US products to the level of alternatives. VRX is 2nd at 17%, followed by ENDP and MNK at 12% and 10%, respectively

Relationship between pricing risks and debt coverage

Using 2016 consensus EBITDA and debt service figures, we calculated simple EBITDA / debt service ratios before and after adjusting consensus EBITDA for pricing risks. To adjust 2016 consensus EBITDA, we subtracted an amount equal to 2015 sales at risk times 2015 gross profits percentages. We used 2015 sales and gross profits primarily because we can see product level sales for 2015, but lack 2016 consensus sales estimates at the product level. Consensus calls for revenue growth in 2016 for all companies, thus our use of 2015 sales for calculation of gross profit at risk if anything understates the potential effect of pricing pressure to debt coverage ratios. Results are in Exhibit 4a

HZNP is most severely affected in the sense that re-pricing its products to the price level of substitutes eliminates EBITDA, theoretically leaving debt unpaid. However HZNP’s 2016 debt service ($68M) is very low, meaning HZNP would likely have other means of covering its obligation

VRX’s 2016 EBITDA consensus figure of $5,580M would be reduced by $1,406M if its products’ prices were forced to the level of substitutes, lowering the firm’s EBITDA / debt service ratio from 2.2x to 1.6x

ENDP’s 2016 EBITDA consensus of $2,050M would be reduced by $279M, lowering the EBITDA / debt service ratio from 2.7x to 2.3x

MNK’s 2016 EBITDA consensus of $1,625M would be reduced by $228M, lowering the EBITDA / debt service ratio from 4.4x to 3.7x

Debt covenants tend to be stated in terms of EBITDA / interest, with 3.0x being a common critical threshold. Of the four companies analyzed, only VRX’s EBITDA / interest ratio falls below 3.0x if we assume all substitutable products are repriced to the level of relevant substitutes (Exhibit 4b, middle column). It is significant that VRX’s EBITDA / interest ratio can be driven to the 3.0x threshold with little more than half of the potential pricing pressure (Exhibit 4b, rightmost column); and, that this level of pricing pressure can be achieved by reducing only the US prices of the company’s products that have A-rated substitutes

If pricing premia (and pricing growth) are lost – what else is left?

The following price / volume / mix analyses are all pro forma in the sense that acquisition and divestiture effects on growth are controlled for by including the acquired companies’ products in price / volume / mix calculations for the four quarters preceding acquisition for annual growth rate calculations, and for one quarter preceding for quarterly growth rate calculations

Exhibit 5 compares the four companies’ real, pro forma growth in net sales (blue), net price (green), volume (black), and product mix (grey) for the trailing 3-year period. Only in VRX’s case is a very large positive net pricing gain (+23%) offsetting a very large negative volume trend (-14%). HZNP’s net pricing gains are much larger than VRX’s; however HZNP’s net pricing gains have contributed much less to growth than their far larger growth in volumes. Net pricing gains at both ENDP and MNK are negligible

Exhibits 6a thru 6d set the price / volume / mix contributions in motion over time. With the exception of two brief periods VRX has had negative volumes, and with the exception of a single period net pricing gains have exceeded volume – thus VRX’s US growth has been all about net pricing gains (Exhibit 6a). Despite early volume strength and modest pricing; since late 2013 ENDP has looked more like VRX, with strong net pricing gains offsetting negative volume (Exhibit 6b)[4]. HZNP net pricing recently has been negative, but underlying volume growth is robust (Exhibit 6c). And finally MNK has seen eroding net price and negative but improving volumes, all offset by mix gains (Exhibit 6d)

Exhibits 7a thru 7d illustrate which products drove the companies’ US Rx net sales change in any given quarter – and whether it was the products’ price or volume contributions that had the greatest influence on change. The top rows of Exhibit 7a show which products had the largest positive influence on VRX’s US Rx net sales change in any given quarter (and on 3 and 8-yr cumulative bases); and whether it was this product’s price (product name shaded blue and appended with a ‘-P’), or volume (product name shaded green and appended with a ‘-Q’) making the contribution. For example in 4Q15, quantity growth in Jublia was the single biggest factor driving change in VRX’s US Rx net sales, and Jublia quantity explains 119% (second set of rows) of the US Rx net sales change for the period. In the third set of rows we identify the largest negative contributors to change in US Rx net sales, and show that Jublia’s price (declines) were the single largest factor, with an impact equal to 96% of the overall change in US Rx net sales. Looking across VRX in the aggregate over time, it’s quite clear that net pricing gains (top rows) have been relied upon to offset quantity declines (third set of rows

ENDP’s recent pattern (Exhibit 7b) is similar to VRX’s, with net pricing gains offsetting weak volumes. Conversely HZNP has since late 2014 been driven primarily by volume gains which are offsetting falling average net prices (Exhibit 7c). MNK’s growth is largely explained by very significant Acthar volume gains being offset by modest erosion in Acthar net pricing (Exhibit 7d)


  1. “While Gulliver Slept: The Rapid Pace and Fragile Pre-Conditions of VRX’s US Pricing Power”, SSR Health LLC, October 14, 2015. Also: “VRX: Analysis of US price / volume”, SSR Health LLC, October 22, 2015
  2. The relative price exhibits in this section offer a point (default) estimate of relative pricing, as well as a low and high relative pricing estimate. Because assumptions are necessary in calculating relative price, and because these can in some cases have a large effect on the relative price estimate, we’ve calculated the highest and lowest feasible relative price estimates
  3. Assuming the product in question carries a premium relative to the branded alternative. If not, we assume no deflation
  4. Notably, ENDP’s CEO, Raj De Silva, was hired in March 2013; prior to that he was President, and COO of Specialty Pharmaceuticals, at VRX

©2016, SSR, LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein. The views and other information provided are subject to change without notice. This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. In the past 12 months, through a wholly-owned subsidiary SSR Health LLC has provided paid advisory services to Pfizer Inc (PFE) and to Merck (MKGAY) on both securities-related and non-securities-related topics

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