Concerns About Allergan's Health Are Overblown

We think three primary factors have weighed on

While these are valid concerns, we think the current stock price overly penalizes Allergan and ignores the company’s wide economic moat and long-term positives.

We forecast a slowdown in Botox’s therapeutic and cosmetic sales from the launch of calcitonin gene-related peptides in migraine and new competition from products like Revance’s RVNC RT002 in the aesthetics market. However, like Botox’s resilience against previous neuromodulator competition, we think Botox and the remainder of Allergan’s attractive aesthetics business will remain a long-term growth driver for the company.

We also continue to think the market ignores the company’s innovative pipeline even though several products are high risk/high reward. It’s hard to gauge when sentiment may change, especially with uncertainty about the exact timing of a generic Restasis launch, but we view the stock’s valuation as too pessimistic. We think Allergan represents an attractive opportunity for patient, long-term investors.

Generic Headwinds Seem Disproportionately Valued Allergan has a few drugs subject to generic entrants in the near term--including Minastrin ($325 million in sales) in early 2017, Namenda XR ($400 million in sales) potentially by early 2018, and Estrace ($350 million in sales) in 2018--but Restasis seems to be the top concern. Although Allergan recently lost its patent litigation for Restasis, the Food and Drug Administration has yet to approve a generic version. We view Restasis' manufacturing complexity as above average, which offers some partial protection for this product. We anticipate $1.5 billion sales for Restasis in 2017; the drug contributes about 13% of earnings, or about $2.15 in earnings per share and $700 million in operating cash flow, according to management. We currently forecast generic entry in mid-2018, but it's possible that Allergan's patent appeal will delay a generic launch until 2019. We anticipate management will take some cost-cutting measures upon launch of a generic, which should diminish the earnings hit from competition. We doubt the recent launch of Restasis MDPF, a multidose preservative-free version, will offer much market share protection.

Restasis’ patents faced two recent legal challenges. First, a judge invalidated Restasis’ patents in October 2017 following a patent trial in the Eastern District of Texas. Allergan plans to appeal the decision. Second, the inter partes review at the U.S. Patent and Trademark Office that Mylan MYL initially brought in June 2016 has become moot following the patent trial decision, regardless of management’s attempts to avoid the inter partes review following Allergan’s recently announced patent deal with the Saint Regis Mohawk Tribe to protect the patents under sovereign immunity. While the unusual patent agreement with the tribe has put Allergan under the media and political spotlight, we don’t anticipate any significant fallout from the unconventional tactic.

Restasis--formulated as an ophthalmic emulsion--is a more complex drug product than typical oral pills or even more common eye drops. While the FDA still has issued only draft guidance for a generic Restasis approval, we anticipate a generic approval sooner rather than later. We see slim chances that Allergan’s repeal of the court ruling can block a generic launch. A newer formulation of Restasis approved in 2016--Restasis MDPF--now represents about 15% of total franchise prescriptions. While Restasis MDPF will theoretically salvage some franchise sales, we think generic competition will make formulary coverage and pricing difficult to sustain for the more recent formulation.

A generic Restasis launch represents a near-term earnings hit for Allergan. Restasis represents about $2.15 in earnings per share. We think a midyear generic Restasis launch and some cost offsets place overall adjusted EPS near $16, consistent with management’s expectations. Based on management commentary, $15 EPS seems like an earnings floor if a generic launch occurs at the beginning of 2018 with no major cost offsets. And despite the hit to Allergan’s revenue and earnings growth trajectories over the next year, we still forecast a quick return to growth by 2019.

Growth Drivers Face Increased Competition, but Allergan Retains Enviable Position Over the next few years, Botox should see competition from companies like Revance in the cosmetic market as well as the launch of CGRPs for chronic migraine, which could pressure this product's therapeutic sales. Linzess should soon face additional competition from Synergy SGYP as this company hopes to expand Trulance's label into irritable bowel syndrome with constipation. Additionally, newer products like Viberzi and Kybella have underperformed our expectations. We account for these factors in our model, and despite the increased competition, we think Allergan retains an attractive position in many of its core therapeutic areas.

We believe Botox has many years of growth potential, but upcoming cosmetic and therapeutic market competition will probably slow the recent pace of double-digit growth. Botox continues to hold nearly 70% global market share by our estimate, following limited market share gains primarily from Dysport (first approved in April 2009) and Xeomin (cosmetic approved July 2011 and first therapeutic indication approved July 2010). Nestle NSRGY currently markets Dysport for cosmetic uses under its Galderma subsidiary after purchasing it from Valeant VRX while Ipsen IPSEY retains therapeutic sales. Merz Pharma markets Xeomin.

Botox should face a new round of neurotoxin competition in 2018, but we think the franchise will remain a growth driver thanks to brand familiarity among injectors and customers as well as Allergan’s broad aesthetics portfolio and rewards program. On the therapeutic side, competitors have not been able to match Botox’s clinical trial data. These factors--including lack of interchangeability among these biologic molecules, injector training requirements and familiarity, and customer brand recognition and rewards program--have enabled Botox to maintain impressive growth and market share despite the entry of Dysport and Xeomin.

Upcoming neuromodulator competition, such as Hugel’s Botulax and Daewoong’s Nabota, doesn’t look particularly differentiated and will face an even harder battle versus more-established brands of Botox, Dysport, and Xeomin. Revance’s RT002 seems better positioned because of its differentiation of being the first neurotoxin with a longer duration effect. Regardless, we still anticipate limited market share gains for Revance because the duration effect doesn’t appear dramatically different from that of compounds like Botox. We imagine this might not be enough to switch many users who have a long history of adequate wrinkle control with Botox. Additionally, Revance will be challenged by having a limited aesthetics portfolio as well as marketing and training constraints, including in international markets. We’d grow more concerned about Botox’s future if a major aesthetics competitor like Johnson & Johnson JNJ bought Revance.

Meanwhile, Botox seems better positioned from neuromodulator competition in its therapeutic indications. New entrants like Revance need to enroll expensive clinical trials to gain therapeutic indications, which will probably delay therapeutic market share gains over the long term. Botox’s multiple therapeutic indications remain relatively untouched by current neuromodulators. Additionally, training specialists like neurologists and urologists on injection techniques is hard for smaller peers without other marketed products in these therapeutic areas. Last, RT002 is still far away from initial launch. Revance needs to complete a long-term safety trial, which should have results in the second half of 2018. The company then hopes to file for the cosmetic indication in 2019 with approval in 2020. We do not cover Revance, but consensus revenue for fiscal 2022 is approximately $300 million, which implies about 3% market share, by our estimate, which will likely come in part from all currently marketed neuromodulators. Our estimate and consensus forecast for Botox sales are $3.7 billion and $3.9 billion by 2021, respectively.

The upcoming CGRP class of biologics represents the biggest threat to Botox’s therapeutic sales, in our view. Chronic migraine sales approach about $700 million, according to management, or about 40% of Botox’s therapeutic and 20% of total franchise revenue. Based on decent efficacy data and a good safety profile, CGRPs should begin to enter the market by late 2018. Amgen AMGN should be first to market followed by Eli Lilly LLY and Teva TEVA. We anticipate therapeutic sales of Botox to shrink as it gradually loses market share to these compounds. However, we expect Botox can retain a portion of sales thanks to its demonstrated efficacy, some nonresponders to CGRPs, and low cost.

Given the competition from Revance and CGRPs, we forecast Botox sales growth will decelerate but remain positive over the next five years. We anticipate a slowdown in Botox’s recent double-digit growth thanks to new cosmetic neuromodulator competition. Meanwhile, we think positive cosmetic and international revenue growth will offset a decline in U.S. therapeutic sales from the CGRP biologics. We forecast Botox sales growth will remain positive overall. While management doesn’t break out therapeutic Botox sales by indication, management has noted that all indications continue to post growth. Since the overactive bladder indications continue to grow in the double digits while the remaining movement disorder indications grow near midsingle digits, we think therapeutic Botox sales can uphold reasonable growth outside of migraine competition.

A handful of Allergan’s other more promising products also face some challenges. Allergan’s guanylate cyclase C agonist Linzess already faces competition from Synergy’s Trulance after the latter drug received approval for chronic idiopathic constipation in the second quarter of 2017. Synergy filed a supplemental application for irritable bowel syndrome with constipation in June 2017. Trulance has not made major gains versus Linzess despite clinical trial results suggesting lower incidence of diarrhea versus Linzess. Additionally, Ardelyx ARDX hopes to find a marketing partner and get approval for NH3E inhibitor tenapanor by the end of 2019 in IBS with diarrhea (the company is also pursuing hyperphosphatemia in patients with end-stage renal disease for this product). We do forecast a gradual slowdown in Linzess’ growth rate over the coming years. The consensus sales forecast for Synergy by 2021 is $440 million. Consensus for Linzess tops $1 billion in the same year. Linzess was originally approved in August 2012 and currently has sales of approximately $700 million.

Allergan’s other irritable bowel syndrome drug, Viberzi, faced an unexpected setback when it began to show complications in patients with no gallbladder developing severe pancreatitis. Viberzi’s prescription growth has slowed considerably on the apparent safety concerns, but management plans a near-term re-education and awareness campaign to rekindle growth. We did previously trim our peak sales estimate for Viberzi, but we give decent odds that sales can improve because the drug still seems well tolerated in patients with a gallbladder. Limited competition also improves Viberzi’s outlook, in our view. GlaxoSmithKline’s GSK genericized Lotronex has harsh potential side effects of ischemic colitis and severe constipation. RedHill’s RDHL Bekinda might soon enter phase 3 trials but showed mixed phase 2 results with some similar adverse events. Valeant’s Xifaxan cannot be chronically administered and has not seemed to pick us as much market share as Viberzi (it is also approved for traveler’s diarrhea and hepatic encephalopathy).

Pipeline Faces Skepticism, but We See Opportunity Aside from generic Restasis and upcoming competition on products like Botox, Allergan's current market price seems to reflect almost no value for the pipeline. Allergan has faced a number of recent setbacks, including the refuse-to-file letter from the FDA for the negative symptoms supplemental application for Vraylar. Allergan also reported mixed second-year data from its phase 2 study for cenicriviroc in nonalcoholic steatohepatitis. The company has had some small pipeline successes, however, including the recent approvals of Rhofade for rosacea (benefit of no relapse in redness compared with Mirvaso), TrueTear for dry eye, and the XEN gel stent for glaucoma. Our take on some of Allergan's key pipeline products follows.

Abicipar pegol for wet age-related macular degeneration and diabetic macular edema is an anti-VEGF DARPin administered by injection. Abicipar has completed its phase 3 enrollment for both trials in wet AMD and DME with top-line results expected in the second half of 2018. Phase 2 results in the Reach study looked about as efficacious as Lucentis for mean visual acuity improvement and change in central retinal thickness, but the Abicipar formulation suffered from an inflammation rate near 10%. Management is relatively confident that manufacturing and purification improvements can lower the inflammation rate, not unlike Lucentis’ initial approval. Even though Abicipar’s potential ability to be injected every 12 weeks has a possible benefit over Roche’s RHHBY Lucentis (4 weeks) and Regeneron’s REGN Eylea (8 weeks), the product will come to market after Novartis’ NVS brolucizumab (RTH258), which enabled more than half of patients to have injections every three months in phase 3 trials versus Eylea following the initial loading phase.

Bayer BAYRY and Regeneron plan to file Eylea for 12-week dosing based on real-world studies, but we’re skeptical this can lead to an updated label. We place a 50% probability on nearly $500 million in peak sales potential for Abicipar due to its late entry to the market in 2020 and lack of knowledge of its efficacy over current products and inflammation improvements. We assume a 2019 launch for Novartis’ drug with $1 billion peak sales potential and a 70% probability of approval. Allergan also has an anti-VEGF/anti-PDGF combination DARPin in early-stage development.

Cenicriviroc, or CVC, for NASH is an oral, once-daily dual CCR2 and CCR5 inhibitor. In first-year data from the phase 2 study, CVC failed to meet its primary endpoint of a 2-point reduction in NAFLD activity score, but it demonstrated at least one stage improvement in fibrosis without worsening of NASH--a secondary endpoint--in 20% of patients versus 10% for placebo. Second-year data announced in September 2017 showed no significant difference from placebo on fibrosis improvement for patients on the drug the full two years, but patients who began the trial with higher baseline fibrosis scores did witness better outcomes over the two-year period. We have a 50% probability of approval for this drug with peak sales of $500 million following the mixed phase 2 data, but we think potential efficacy in a hard-to-treat population combined with a large market opportunity supports further development. A phase 3 trial was initiated in April 2017. Allergan and Novartis have agreed to pursue a phase 2 combination trial for CVC with Novartis’ FXR agonist LJN452. Main NASH competition in the pipeline includes Intercept’s ICPT Ocaliva, Genfit’s GNFTF elafibranor, and Gilead’s GILD selonsertib. Ocaliva could be first to market, but it has faced issues of elevated LDL cholesterol levels and concerns including liver injury and death from its current approved indication in primary biliary cholangitis. Selonsertib has also shown mixed results, including fibrosis improvement over one stage with simtuzumab but no improvement in prevention of cirrhosis. Phase 3 results should paint a clearer picture for these products because phase 2 data has been complicated and difficult to compare.

Ubrogepant for acute migraine and atogepant for episodic migraine are orally administered CGRPs. Migraine represents a multi-billion-dollar market opportunity with nearly 6 million patients seeking care with few beneficial options, which include anticonvulsants, beta blockers, and Botox. While previous studies with these oral versions had liver toxicity issues, the current formulations have undergone structural changes to reduce metabolic intermediates and improve potency at lower dosages. Allergan has enrolled phase 3 trials for ubrogepant and phase 2b trial for atogepant with data for both expected in the first half of 2018. In phase 2 results for ubrogepant, 26% of patients were pain-free at two hours after taking the highest dosage form versus 9% for placebo, but results for headache response were not significant. There’s also concern ubrogepant has a slower onset than triptans, but a high number of patients unresponsive to currently available medications likely continues to create an opening for this product. Although only studied in an acute condition (and not chronic), ubrogepant did not show signs of elevated liver enzymes. Management has noted in current phase 3 studies with chronic administration of atogepant that only 1% of patients had elevated liver enzymes above the 3 times upper limit, but the distinction between how many were between the drug or placebo will not be known until the trial ends. That potentially bodes well for the product’s safety profile, but safety and efficacy will remain critical data points. We forecast a 30% probability of approval for Allergan’s oral CGRPs in development with launch dates well after the potential 2018 launch of the first CGRPs, but we believe the market opportunity remains compelling for orals to take market share from injectable versions. While Eli Lilly and Biohaven BHVN are attempting other oral medications for acute migraine, Allergan has the only oral product for chronic migraine, to our knowledge.

Esmya for uterine fibroids is a once-daily oral selective progesterone receptor modulator. The FDA accepted Esmya’s application for review in October 2017. Two phase 3 trials showed nearly 50% of patients with absence of bleeding versus 1.8% to 0% for placebo and no major adverse events. While Esmya was originally approved in Europe and Canada for pre-hysterectomy surgery patients only (due to initial endometrial thickening concerns), the product has been approved for long-term management of uterine fibroids through intermittent use based on further studies of four three-month intermittent treatment cycles. These studies showed up to 70% of patients having no bleeding with a similar rate of reduction in fibroid volume. Meanwhile, the U.S. trials included only two three-month treatment cycles; it’s unclear whether the FDA will approve for more than two cycles or only for women preparing for surgery. Allergan has requested approval for chronic intermittent use, which would significantly expand the market opportunity for this product, and submitted the European trial data as part of the U.S. application. Management also recently said the FDA has not indicated the need for an advisory committee meeting. However, Allergan’s partner, Gedeon Richter, will face a review of the product from the European Medicines Agency after reports of liver damage in a handful of patients. While no clinical results showed any liver concerns and the incident rate seems small, it might become a concern for Esmya’s U.S. approval and label. An estimated 10 million-plus women are diagnosed with uterine fibroids in the U.S., and there are approximately 500,000 hysterectomies in the U.S. each year, about half attributed to fibroids. Lupron is the current primary medication for fibroids but has significant menopausal-like side effects. AbbVie’s ABBV gonadotropin-releasing hormone (GnRH) agonist elagolix began phase 3 development in early 2016 (it is also in development for endometriosis) but has shown similar menopausal-like side effects including reduction in bone mineral density. Elagolix combined with Activella showed a 50% reduction in bleeding versus placebo with no bone mineral effect, and we expect a filing for uterine fibroids in 2019 (2017 for endometriosis). Takeda TKPHF and partner Myovant’s MYOV relugolix is another GnRH agonist in phase 3 trials that seems to have a longer duration effect than elagolix with similar hormone treatment to address bone mineral loss. Bayer’s vilaprisan, a progesterone receptor modulator like Allergan’s drug, entered a three-year phase 3 trial in the middle of 2017, potentially putting an approval near 2021 or later. We currently assign a 90% probability of approval for Esmya in mid-2018 with sales near $200 million by 2021. We assume peak sales potential below the lower end of management’s range of $500 million-$1 billion, but if recent liver damage concerns abate, we’d consider boosting our peak sales forecast to the lower end of management’s outlook. Allergan has noted that there’s no previous indication of liver concerns with this class of drug. Esmya is also the same active ingredient as the emergency contraceptive Ella, but it is not chronically administered in this indication.

Relamorelin is a ghrelin peptide agonist currently fast-tracked by the FDA and in phase 2 trials for diabetic gastroparesis, which affects an estimated 2.3 million moderate to severe patients in the U.S. Reglan, the current standard of care, reached over $1 billion in sales before facing generic competition despite having harsh side effects--including several nervous system adverse events and a boxed warning for developing tardive dyskinesia and limitations on use over 12 weeks. Phase 2 trials for relamorelin have shown an approximate 60% decline in both vomiting frequency and severity versus placebo. Relamorelin is currently a twice-daily subcutaneous injection, but Allergan is developing alternative formulations. We think this drug has a peak sales potential near $500 million, and we currently assign a 30% probability of approval. Phase 3 clinical trials should begin soon with top-line data expected in 2020.

Rapastinel is an NMDA partial agonist that has potential as a rapid-onset therapy for suicidal behavior and major depressive disorder before antidepressants can begin to take effect, which typically takes weeks. Estimates suggest up to one third of MDD patients do not respond to currently available therapies, opening a potentially large market opportunity for these treatment-resistant patients. Rapastinel has no abuse concerns and has shown potentially only minor somnolence and dizziness side effects as opposed to the NMDA antagonist ketamine, which can cause dissociation and psychosis as well as a euphoric effect leading to abuse. Phase 2 results showed the drug is effective in a majority of patients with a rapid onset that lasts a week or two before another infusion is required. Rapastinel has been fast-tracked by the FDA and is in three phase 3 clinical trials evaluating for short-term acute efficacy in patients with MDD. These patients can also transition into a long-term maintenance study with weekly or biweekly administration. Initial trial results are expected in 2019 with a potential filing later that year. Johnson & Johnson has a nasal spray NMDA antagonist esketamine in phase 3 trials for acute and long-term administration with initial trial results by early 2018. In phase 2 results, the highest dose of intranasal esketamine showed a response rate in about 58% of patients. As a nasal spray, we think J&J’s product has a potential advantage, but the drug will probably be regulated as a Schedule III controlled substance (like ketamine) with some noticeable side effects, potentially leaving an opening for Allergan’s rapastinel. We place a 70% probability of approval on rapastinel with nearly $500 million in potential peak sales. Although we view this as an intriguing opportunity for the company, we’re somewhat skeptical of management’s estimate of over $1 billion in peak sales potential. We view the weekly injection requirement as a high hurdle for widespread adoption, particularly as a maintenance therapy, even though rapastinel’s infusion takes only one to two minutes. However, Allergan is developing an oral product that could enter phase 2 clinical trials in 2018, which if successful could boost our optimism regarding Allergan’s market opportunity.

Other Investor Concerns Seem Mostly Immaterial We don't put much weight on other investor concerns we've heard, which include the generic collusion investigations, the opioid investigations, Allergan's working-capital arbitration with Teva (for $1.5 billion to be decided in early 2018), consistency of cash flow, financial leverage, and the Native American tribe agreement to sidestep IPR patent challenges on Restasis. Allergan's cash flow has been volatile over parts of 2016 and 2015 as a result of product approval milestone payments combined with restructuring costs of the Actavis generic segment sales and related tax on gain payments. Allergan has faced expected Restasis- and Teva stock-related noncash impairments, and operating cash flow over the past few quarters--$1.6 billion in the second quarter and $1.5 billion in the third quarter--has mostly matched our expectations. We view the generics and opioid investigations as minor concerns for Allergan since it has sold its generic operations and it never had material opioid sales (its subsidiaries stopped promoting Kadian in 2012 and Norco in 2003). Allergan ended September 2017 with a net debt/EBITDA ratio of 3.2 times. Management plans to pay off $3.8 billion in contractual maturities in the first quarter of 2018, and even with a potential generic launch on Restasis in 2018, we forecast net debt/EBITDA falling near the mid-2s for the year. Management remains committed to the company's investment-grade credit rating.

Despite Recent Challenges, Allergan's Wide Moat Is Intact While some products like Namenda XR (3% of sales) and Restasis (9% of sales) will face generic competition much sooner than expected, and the pipeline has posted some mixed results, we still think Allergan possesses a wide economic moat for several reasons.

Allergan has a diversified product portfolio, with most patent expirations into the next decade. Aside from recent hits to Namenda XR and Restasis, we don’t expect any other surprise patent losses for major products. Bystolic, which currently represents 4% of sales, should be the next major product to face generic competition in 2021. Growth products such as Linzess, Viberzi, and Vraylar have composition-of-matter patents into the mid- to late 2020s.

About 35% of Allergan’s business is immune to reimbursement concerns. Botox cosmetic use and most of Allergan’s aesthetics business (except Alloderm) represent elective cash-pay procedures. While this makes a portion of Allergan’s revenue more economically sensitive, these products represent consumer brands not affected by wholesaler, pharmacy benefit manager, or purchasing organization pressure. Additionally, therapeutic Botox sales remain primarily driven by volume, and this tends to be an inexpensive treatment not facing significant payer pushback.

We think opportunities exist across Allergan’s pipeline. While not all products have shown clear clinical trial results, we believe management is taking mostly appropriate steps to remain an innovative and relevant company. While expectations are low for many of Allergan’s larger potential products, resolute phase 3 data could turn some of these into much larger winners than we anticipate.

Allergan’s aesthetics portfolio is unmatched in terms of product breadth and market share. This market has three characteristics that we think give it high barriers to entry. First, it’s a consumer-oriented market, with Botox as one of the leading brands in healthcare. Because aesthetic products place high importance on efficacy and safety of results, patients are hesitant to switch brands, especially for products with modest price discounts (Dysport and Xeomin are priced roughly 30% below Botox). Allergan’s patient rewards program also helps keep customer loyalty high as patients can redeem rewards across the company’s wide product portfolio. Cosmetic neurotoxins and facial fillers constitute nearly 44% of the $9 billion global aesthetics market, by our estimates.

Second, regulatory barriers to entry are high. Neuromodulators, facial fillers, and breast implants (the last two being regulated as devices) require expensive and thorough clinical trials that tend to keep new entrants out. For example, therapeutic neuromodulator indications require separate trials for each patient population. For this reason, most competing companies have lacked the financial resources to enter these markets.

Third, unlike most drug products with simple administration requirements (such as oral or intravenous dosing), nearly all aesthetic products--including Botox, facial fillers, breast implants, Kybella, and so on--require extensive user training. Botox in particular has a precise local effect that requires significant practice to master the art of getting desired results on a patient’s face. Moreover, competing neuromodulators, which are not interchangeable products, have different dose response rates, duration of effect, diffusion characteristics, and adverse events. In Botox’s therapeutic indications as well, Allergan has spent considerable resources training ophthalmologists, urologists, and neurologists on appropriate injection procedures for patient treatments. As a result of these factors, we forecast Allergan will retain high market share in its aesthetics business and leadership in every major category in which it competes.