Viatris (NASDAQ: VTRS) announced its fourth quarter results and guidance for 2022 earlier this week. To call the results a bad surprise would be an understatement. Shares are down 30% and hit all-time lows.
While many comments have focused on the company’s abrupt shift in strategy regarding biosimilars, the truth is that’s only part of the reason the stock sold off. The report and advice contained many red flags that undermine trust in the management team and significantly erode Viatris’ central thesis.
Here are three fundamental questions that management must answer to restore a minimum level of investor confidence.
1) What happened to 2021 being a slow year?
A year ago, in its financial advice ahead of its Investor Day, Viatris repeatedly said that 2021 would be a “low year”. Specifically, they declared “2021 a low year for revenue, adjusted EBITDA and free cash flow.
Fast forward a year and we see that 2021 hasn’t been a “slow year”. In fact, revenue will decrease by almost $300 million and EBITDA will also decrease by $300 million. Check out page 59 of the Q4 2021 Investor Event. It’s the chart that’s perhaps most responsible for the stock’s 30% drop.
As you can see, this is a waterfall chart that takes you from 2021 Adjusted EBITDA to the median 2022 Adjusted EBITDA forecast.
Ignoring the $119 million decline in EBITDA due to currency effects, we see that 2022 faces a $787 million decline in gross margin. This is due to “basic gross margin erosion” and the impact of inflation. This decline is well above the $370 million positive gross margin impact on new products.
It is clear that management did not anticipate the decline in its prices and gross margins that it will face in 2022. The concern is that this will be a repeating pattern for years to come.
When most people think of Viatris as a “generic drugmaker,” they think of low-cost generic drugs that are manufactured like a commodity and sold at low cost. There’s no patent expiration to worry about, so you’d be forgiven for thinking it should be a lower margin but more stable business than a typical pharmaceutical company.
But over the years, Mylan (the predecessor of Viatris) and now Viatris has pursued a strategy of spending billions (actually tens of billions) to acquire “branded” generics that sell at very high gross margins. . The problem is that these high gross margins may be temporary, and over time you may find that your profits shrink while you still owe the billions you borrowed to close the deal.
In EpiPen’s case, Mylan acquired the product in 2007 and has jacked up the price over the years, from $50 to $300. But such high prices have drawn the attention of regulators and competitors.
In the case of brand name drugs that Mylan purchased from Pfizer (NYSE: PFE) to create Viatris we also see huge margins for generic molecules. With GoodRx (NASDAQ:GDRX)Generic Lipitor (atorvastatin) is $1/pill at CVS (NYSE: CVS). But the brand name Lipitor sold by Viatris costs $17/pill (that’s $515 for 30 pills).
Now, I’m not saying that Viatris sells all of its Lipitor at prices as high as the generic, but clearly the premium is substantial. Viatris obtains almost patent margins for off-patent molecules and this seems to me to be unsustainable in the long term.
The slow elimination of this undeserved margin is what is called “basic business erosion” and I am afraid it is not just a one-time or temporary thing. I fear this will be an ongoing process as these excess margins are subject to increasing competition.
Mylan’s business strategy (paying top dollar for generic “brands”) was flawed (as evidenced by the stock price). The margins don’t last and you are left to pay off the inherited debt.
Viatris is not Mylan, but they are run by many of the same executives. I’m afraid this team is focused on the short term, but do they know how the business will grow in 3-5 years or beyond? Do they tend to make deals that look good for 1 or 2 years but destroy value in the longer term?
History is replete with examples of large corporations selling declining, debt-laden companies to greedy investors who don’t look past the PE ratio. Verizon did it with Superpages and again with Frontier. Noble did it with Paragon. Viacom with Blockbuster. Maybe that’s what Pfizer did with Viatris.
Is that what’s going on here? I don’t know, but I’d love to hear this leadership team explain how they got it so wrong in 2022 and why they misunderstood the trajectory of their business. Then I’d like to hear them explain why they think they’re right this time around.
2) What is this additional $875 million in one-time costs?
Let’s go back again to last year’s Investor Day and the advice provided by Viatris management. They said the “one-time” costs would be $1.5 billion. These were meant to be “one-off” to achieve $1 billion in annual synergies.
One-time costs actually increased, to $1.775 billion, but that also includes $330 million in litigation settlements. Thus, the actual cost of the restructuring approached $1.445 billion.
The problem is that they have now guided to an additional $875 million in “one-time” restructuring costs for 2022. That might be understandable is that they were doing additional cost cutting and restructuring, but they don’t – the synergy count hasn’t gone up. In fact, it has gone down. The synergy figure in the 2022 EBITDA market is $250 million; in the initial scoping documents it was supposed to be $500 million.
It must be explained why an additional $875 million must be spent to achieve the same or a lower level of cost reduction. $875 million is a lot of money, even for Viatris.
3) Wait, weren’t biosimilars the future?
Now comes the issue that many others have been focusing on after the fourth quarter report and that is the abrupt about-face regarding the biosimilars sector. You will recall that last year their R&D strategy was to focus on complex generics and biosimilars (page 110). They said they were targeting 30 products (7 launched, 10 in pipeline, and 13 more targeted) with combined global sales of $161 billion (!). That’s a lot of revenue to stay away from (even for Viatris).
It seems like an ideal marriage and a compelling long-term vision. A company the size and global footprint of Viatris could handle not only the manufacturing, but also the legal process of approving these generics and marketing them around the world in a way that a small, niche company would. wouldn’t be able to do. They could use their massive short-term cash flow to help build this new business.
But instead, the company said it would sell its portfolio of biosimilars to Biocon for $3.335 billion and sell “other selected assets” for about $5.5 billion. After paying taxes, they expect to make $7 billion from these transactions and they will lose $700 million in EBITDA.
I have questions. Does this mean that Viatris is giving up the entire biosimilar opportunity for $3.4 billion, or is it simply selling its distribution rights to the molecules it has developed under the Biocon partnership?
If it’s the former, then I’m confused because I thought the opportunity for biosimilars was much greater than Viatris. I fear this is another example of short-term focus at the expense of long-term vision on the part of Viatris management. If it’s the latter, then they need to articulate their biosimilars strategy going forward.
So what is it worth?
It’s not really a question for management. But I think someone posting about this company on Seeking Alpha should have a point of view.
In my opinion, I think the stock is ok to buy here. One thing I’ve done is write (sell) investment options in the stock and use some of the proceeds to buy back the money calls.
This company and this management have a lot to prove and are not starting off on the right foot. However, even a used cigar butt has a price. When I calculate the numbers, I assume that the asset sales are going as planned. EBITDA continues to decline by about $300 million per year and I assume there are no major restructuring or litigation expenses anymore. I’m coming with this business, at this price, returning 12% per year for the next 5 years. Incidentally, when I calculate the numbers without the sale of assets, it’s pretty much the same.
However, Viatris could be a home run if we can have some confidence in this company’s future earnings trajectory. But that would mean having faith in that management team, which I don’t think anyone has right now.
A generic drugmaker (or any low-margin company) must distinguish itself through its efficient and low-cost operations. The management team at Viatris doesn’t seem content to just do things organically. They made deals in series and it often seems that the deals they made were accretive in the short term but destructive in the long term.