Mallinckrodt PlC

Description

Mallinckrodt ("MNK") is a specialty and generic drug manufacturer that was written up here many times, but not since emerging from the second bankruptcy in November 2023. The stock - which remains unlisted but available through distressed desks - continues to be attractive at ~99, with 30-50% upside on a business with very low leverage.

Background:

  • As the largest opioid maker in the US, MNK had to file for bankruptcy twice over the last 5 years (in 2020 and 2023) to deal with opioid liabilities. State AGs claimed that MNK understated how addictive opioids were and knowingly filled orders to pill mills. The first bankruptcy allowed them to consolidate opioid-related lawsuits claiming trillions of dollars in damages and to get a release from future lawsuits. All these lawsuits were settled for $1.7bn in 2022, but that was too much for MNK to pay given competitive issues in the rest of the business and high leverage. The second bankruptcy in 2023 allowed Mallinckrodt to write off $1bn of these payments. They also reduced their then unwieldy debt load by $1.9bn.
  • All disclosed opioid-related lawsuits are now in the past. While new claims are technically always a risk for any company that deals with opioids, MNK now boasts a top-tier compliance program. In 2022, MNK signed a Corporate Integrity Agreement (CIA) with the OIG, which runs through 2027. They are also operating under an Opioid Operating Injunction that requires an external monitor. As a result, opoid-related risks are now very low.
  • Following the emergence in 2023, MNK sold the Therakos franchise to CVC, reducing debt by ~60%. As a result, pro forma net debt is ~0.9x (on a business trading at ~4.8x assuming $500m in PF EBITDA).

Business refresher:

MNK operates through 2 segments:

  • Specialty Brands (~50% of pro forma sales) now includes 4 main products, Acthar Gel, INOmax, Terlivaz and Amitiza.

Acthar Gel (~24% of sales) is a complex mixture of peptides that MNK makes from pigs' pituatiary glands through a complex manufacturing process. It is used for multiple indications, most importantly infantile spasms and multiple sclerosis. Although Acthar doesn't have patent protection, it is very challenging to make and relies on trade secrets. First approved by the FDA in 1952, Acthar was approved before the FDA required clinical trials to show efficacy (as opposed to just safety). In the absence of robust clinical trials, MNK relies on docs' personal experience treating patients. Further, given it's high cost of ~$40,000 a vial, Acthar is generally used as the last line of treatment (with the first line being steroids). Given pushback against drug price inflation, a payment dispute with the CMS and competition from a purified cortropin gel product from ANI Pharma in 2022, Acthar sales declined ~18% on average in 2021-2023. However, Acthar remains extremely effective for life-threatening infantile spasms and in 2024 new management was able to stabilize the business at ~$460m/year. They currently expect Acthar to grow 10% in 2024. A new self-injector device was introduced in Q3'24, and should contribute to growth in 2025 as well.

INOmax (16% of sales) is a nitric oxide gas used for neonatal babies with respiratory failure ("blue babies"). It is sold as a total care package, including the gas, proprietary drug-delivery systems, technical and clinical assistance, emergency delivery, and 24/7 customer service. Although INOmax lost sales following the introduction of several generic and competitive products (Praxair Noxboxi, Beyond Air LungFit, Vero) from 2020 onwards, MNK should be able to stabilize the business in the near future. The new EVOLVE delivery system is a step change, while customers continue to value MNK's superior delivery and customer service.

The two remaining products are Terlivaz and Amitiza. Terlivaz (terlipressin) is the only FDA-approved product for adults with hepatorenal syndrome (HRS) with rapid reduction in kidney function, an orphan indication. The product was approved in 2022 and currently has ~$30m in sales, but has been outperforming expectations and should keep growing. Amitiza (lubiprostone) is a branded constipation product. Following generic competition in 2021, it's been declining and I don't expect it has much value going forward.

  • Specialty Generics (~50% of pro forma sales)

MNK continues to make specialty generics and active pharmaceutical ingredients ("APIs"), targeting controlled substances such as opioids and ADHD drugs. Following competitive exits and supply chain issues, this business has been growing nicely (~17%/year in 2023-2024), with EBITDA margins hitting ~30%, which is practically unheard of for regular, commoditized generics. MNK receives ~40% of DEA quota provided to the US market for controlled substances. They are also the sole Tylenol manufacturer in Europe/US. MNK tried to divest this business in the past, but now that no one else wants to do this for PR reasons, it's a real cash cow.

MNK is headquartered in Ireland for tax reasons. They have 11 manufacturing sites, including 8 in the US, and 3 in Ireland and Japan. 94% of production cost is incurred in the US, followed by Ireland (4%) and Japan (2%). 90% of sales are in the US.

Investment Thesis

  1. Sale of additional assets or entire business

The new Board, appointed in February 2024, and the management team are extremely incentivized to sell the Company or its assets. The CEOs options vest mostly upon attainment of divestiture targets or a change of control. The compensation of directors and other members of the management team is also mostly tied to net proceeds from divestitures. They engaged Lazard to assist, and so far sold Therakos in an accretive transaction. (I acknowledge that selling assets like INOmax or Acthar or opoid generics may not be easy. But there is a second option).

  1. Dividend recap

Following the 2nd emergence, performance has improved, especially in the generics business. All opioid lawsuits have been resolved. Leverage is < 1.0x. Existing debt, including a 14.75% bond trading at 105, becomes callable in late 2025. The business should generate a minimum of $200m/year in FCF going forward, allowing the shareholders to do a dividend recap if there is no other way to monetize the assets.

  1. MNK is very cheap

Assuming $500m in pro forma EBITDA (which should grow next year), MNK trades at <5.0x. FCF yield to the equity is ~20%. Public comps such as OGN, TEVA, VTRS, Bausch and Hikma would imply a 6-6.5x multiple is appropriate, especially given that MNK does not have any upcoming patent cliffs. Sure, MNK is unlisted and controlled by former debtholders, and some discount may be warranted - yet there are likely near-term catalysts that will help realize value.

At 6-6.5x of $520-540m Fwd EBTIDA, the stock is worth $130/150 a share, or 30-50% upside from current levels. A DCF may imply even higher multiples than 6-6.5x, though drugs like Acthar are hard to model longer term.

Why does this opportunity exist?

  • Having filed for bankruptcy twice in recent years, MNK is a "tainted" name. Going through 2 Chapter11s in 5 years was very challenging from the morale and operating perspective
  • Since MNK only has 2 small debt issues and the equity is unlisted (though it is traded by several distressed desks), it is not on the radar for most credit or equity investors. Despite this, MNK has almost $2bn in market cap and does trade
  • No analysts publish on the name though a few distressed debt desk analysts follow it

Risks

  • Unlisted equity controlled by former debtholders like GoldenTree
  • New investigations or claims related to opioids (albeit unlikely), breaches of the CIA or Operating Injunction
  • Concentrated product portfolio with high exposure to Acthar and INOmax, which has been declining
  • Failure to find buyers for any of the products or businesses
  • ADHD drug supply shortages may reverse
  • Lack of new product pipeline
  • Manufacturing issues

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