Mylan: Merger Creates Significant Generic Scale

While normalized EPS came in notably above expectations, results were secondary to the announced tax-free divestiture combining Mylan MYL with Pfizer’s off-patent branded and generics business, Upjohn. The new entity will be the largest generic manufacturer with significant scale. As a result of the better-than-expected quarterly operating margins with the ramping of Fulphila (oncology) and Wixela (asthma), we are increasing our full-year non-GAAP EPS to $4.06 from $2.85. Although our second-quarter estimates were short, we do not see significant upside to our $20 fair value estimate, as the current operating margins are likely not sustainable based on the company's stand-alone (existing) pipeline. Mylan shares are up 13% intraday and trade near our fair value. We maintain our no-moat rating and await additional transaction details.

The all-stock, Reverse Morris Trust transaction effectively combines the two generics businesses, providing Mylan shareholders a 43% ownership of the new company. The new entity would displace Teva as the largest generic drug manufacturing company focused on developing complex generics, purposely de-emphasizing the North American generic market, which has been under duress. In our view, the stand-alone businesses were likely the weakest competitors in a highly competitive market and the combination is a logical step that would provide better footing in a market where scale is a critical differentiator. Further, the departure of Mylan key executives will hopefully increase operating transparency. Pro forma 2020 guidance includes roughly $250 million in synergies, with roughly $1 billion in synergies by 2023, which seem conservative considering Teva is on track to reduce $3 billion of operating expenses on a stand-alone basis. Management is targeting a debt/adjusted EBITDA ratio of 2.5 by 2021, from 3.9 for stand-alone Mylan with plans to initiate a dividend of at least 25% of free cash flow after the first quarter after the deal closes.

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