- Allergan’s recent failure with Rapastinel adds to the company’s woes. However, there is a portion of the investor community that remain believers in Allergan’s underlying value

- These investors see value in the Medical Aesthetics business, which will face competition soon from Evolus’s Jeuveau and Revance’s RT002. Bulls still believe the segment will grow in the mid single digits.

- Unlocking this value, either through drastic company actions (as activists are pushing for) or through consistent execution over the next several quarters, should drive the stock higher.

Despite failures and headwinds, there are many believers in the underlying value of Allergan

Allergan faces numerous headwinds. The most visible headwind was Rapastinel, which recently failed to meet both primary and secondary endpoints in three pivotal studies for major depressive disorder.

Rapastinel’s failure was a setback for Allergan. Rapastinel was one of the company's "6 stars" - therapies that management had identified with the potential to generate as much as $13 billion in peak sales. Rapastinel also had the attention of the sell-side, as several banks had written deep-dive notes in the prior months ahead of the announcement. With the failure, target prices have shifted down by about $3 as analysts have removed risk-adjusted sales of anywhere from $500 million to $1 billion from their models.

The Rapastinel setback adds to several other woes that the company faces. In August, Allergan received a CRL on Esmya, another one of its “6 stars,” adding to its list of pipeline failures. Additionally, the company faces a number of competitive headwinds for several key franchises, including Botox Aesthetics, Botox Migraine, and Restasis. The stock has traded down over 50% from its prior high in mid-2015.

Despite these headwinds, there is a vocal segment of the investors that believe in the underlying value of Allergan. The believers note that the Rapastinel failure, although disappointing, was not a complete surprise. Many investors had picked up on the shift in management tone after the last quarter conference call, and as a result were cautious heading into the announcement. Sellside analysts largely held onto their buy ratings on the stock and noted the company’s underlying value despite the setback.

These views are echoed by a portion of its investors as well. After the announcement, the stock actually ended positive for the day. The reason the stock ended up was because investors think the odds are now higher for more drastic actions by the board or by management. Appaloosa has had a very visible back and forth with the company over the splitting of the Chairman and CEO roles as a first step towards larger change, such as a potential breakup to unlock hidden value.

But why are sellside analysts and activist shareholders so bullish on Allergan? What’s the hidden value that they’ve identified that the rest of the street hasn’t?

Medical Aesthetics is Durable Even in the Face of Competition

The Medical Aesthetics segment is the key to the story. This segment includes Botox, Juvederm, and CoolSculpting. Together, these franchises made up roughly 28% of 2018 sales and grew 13% from the prior year.

As I highlighted in my previous Allergan article, Botox is the largest component of the Medical Aesthetics segment and faces upcoming competition. The two drugs to watch here are Evolus’s Jeuveau and Revance’s RT002. Evolus’s Jeuveau received approval for glabellar lines (frown wrinkles between your eyebrows) in February and plans to launch in the spring of this year, going head to head with Botox and other competitors. Revance’s RT002 will launch in 2020.

The obvious argument for slower growth is that this competition is going to hurt Botox sales significantly, just as you see for most other drugs. There are a few differentiating factors between these drugs and Botox that could help them take share from Botox. First, Jeuveau has shown non-inferiority to Botox and will be discounted at 20-25%. Second, Evolus has also announced plans to invest and build the Jeuveau brand. Early surveys from sellside analysts have shown that Jeuveau has the attention of physicians, and that many will take a closer look at it given the economics involved. Meanwhile, RT002’s data has shown that the drug’s duration could be 5-6 months compared to Botox’s 3-4 months, an important differentiating factor.

The counter-argument to the new entrants is that competition against Botox has existed for some time. While the introduction of these new competitors might affect sales growth, it will not materially lower the growth to the low single digits or turn negative. Bulls argue that we have seen the impact of competition on Botox already; Dysport and Xeomin both gained share in the first several years as they discounted heavily, but share gains plateaued as Allergan’s loyalty programs, injector training, and broader Aesthetics offerings all were more appealing to physicians and consumers.

Another argument for Botox’s resilience to competitors is its strong brand. The brand value is harder to quantify but cannot be ignored when the patients are cash-paying. Botox is embedded in the culture as the treatment to reduce wrinkles and make slight modifications to one’s appearance. It is unclear if patients would trust other brands enough to be injected into their face on a regular basis.

Looking beyond the competition, Allergan also has several initiatives to expand the market for Botox and its broader Medical Aesthetics business as well. Allergan plans to expand the number of indications for Botox and Juvederm over the next several years, with key Botox expansions into Masseter and Platysma in 2023 and 2024. The company will also expand the number of Botox formulations and CoolSculpting customizations.

Management also plans to increase investment to raise awareness and target potential customers. Allergan will add 20% more salespeople to reach more practices. Additionally, the company is doubling investment in direct-to-consumer advertising through social media and other platforms.

In short, the bull thesis is that market growth, and minimal share gains from competition, will still leave growth north of mid-single digits for the Medical Aesthetics business. I personally find the bull thesis to be the more convincing, especially when I think about the horrors of Botox advertising unleashed on millennials in social media. With that said, the physician surveys, and Jeuveau uptake post-launch, should be closely monitored, as it will undoubtedly take some share from Botox.

Quantifying and Unlocking the Value

After valuing the Aesthetics business, it becomes more apparent why some shareholders and analysts are so bullish on Allergan. Bulls split up the business into two parts and use a sum of the parts valuation methodology. The first business is one focused entirely on its durable, high-growth segments (including Aesthetics, eye care, and CNS/urology). If you apply an earnings or EBITDA multiple in the mid-teens (appropriate for a durable, fast-growing business), this alone would value this business at around $200. The remaining businesses, which include Gastrointestinal and Women’s Health, would require more investment and would be valued at a lower price of $20 - $40. The two together would value the business north of $220.

So why isn’t the stock trading at these levels? The bulls argue that the value is “locked” behind the company’s visible pipeline failures and missteps, which most investors are mistakenly focusing on. Investors may also be overestimating upcoming competition from Revance and Evolus.

How we “unlock” the value going forward is where the bullish investors split. Some bulls argue that the value will be unlocked with consistent execution; after several quarters of Botox outperformance after the Jeuveau launch, investors will realize that the Allergan base business is much more valuable and durable, and the stock will gradually move up over time.

Other bulls argue that the value must be shown more explicitly and quickly. These are the activists who are pushing for more drastic action such as a potential breakup or divestment of numerous businesses. The shareholder meeting in May will be a key date as activists will be pushing for a splitting of the Chairman and CEO role, which could be the first step towards larger actions.

Either way, if you are a believer in the underlying value of the Aesthetics business, Allergan will likely realize this value over time. The stock currently trades at just 9x 2019 EV/EBITDA and 8x 2019 earnings and presents a compelling opportunity if one can get past the timing and catalyst questions.