Congratulations are in order for owners of Kythera Biopharmaceuticals (KYTH). Its stock is up a nice 22% on Wednesday thanks to a generous buyout offer from Allergan (AGN).
As for AGN investors, it’s not as clear if congratulations are in order. While the double-chin treatment Kythera Biopharmaceuticals has been developing is sure to find some sort of market, the $2.1 billion price tag for KYTH may be a steep price to pay for a company that hasn’t produced 1 cent of revenue yet.
Can Allergan truly hope to extract $2.1 billion worth of value from the double-chin drug Kythera finally brought to the U.S. market just a few weeks ago?
What’s Kythera?
Kythera Biopharmaceuticals is the maker of a new product called Kybella, which for lack of a better description dissolves fat that can collect below the chin, which otherwise causes a less-than-ideal appearance.
Kybella was approved by the FDA in April, and could soon be approved in a couple of other countries as well.
It’s admittedly not a game-changing, show-stopping therapy compared to a treatment for cancer. It’s not a mismatch for Allergan though. Indeed, AGN is probably better suited to maximize the potential of Kybella more so than any other name out there.
Allergan (formerly Actavis) is the maker of Botox, which is primarily used by plastic surgeons and aesthetic doctors to keep faces looking young and healthy. The mechanism of action is a bit of an eye-opener for the unfamiliar. It’s slightly toxic, and blocks the connection between facial nerves and facial muscles.
Since these muscles can’t contract, they and the skin on top of them relaxes and theoretically softens, resulting in smoother (read “less wrinkly”) skin.
More important to current and would-be owners of AGN stock, Botox is already a well-established name within the cosmetic surgery arena. Therefore, Allergan is too. With inroads already laid, it wouldn’t be even a small leap to add Kybella to its product menu.
People willing to suffer Botox injections would almost certainly be interested in dealing with a double chin.
Crunching the Numbers
While Kybella is a natural fit for Allergan, owners of Allergan stock still have a right and reason to ask what kind of revenue the drug could drive for the company. After all, $2.1 billion is a big chunk for any organization that’s yet to report any sales of its lead product.
The estimates vary somewhat. Kythera noted in a recent SEC filing sales of Kybella could eventually reach or even exceed $500 million per year. Bernstein Research isn’t quite as optimistic, putting peak sales closer to $400 million. Investment research outfit Leerink Partners is looking for even less than that, forecasting $300 million as a peak sales level.
Assuming the company itself was thinking a little too optimistically (as is often the case) and averaging all three outlooks in question, annual sales of $400 million is a figure that makes sense. Allergan just paid 5.25 times that number for Kythera. For perspective, the average S&P 500 stock is currently valued at 1.8 times its trailing sales.
At 5.25 times future — a long-term predicted future, no less — sales, there’s no room for disappointment at the price Allergan is paying. Never even mind the fact that peak sales won’t likely be achieved until around 2020.
Bottom Line for AGN
Giving credit where it’s due, Allergan tends to make good use of its acquisitions, and does well with new product launches. Case in point? Dermal filler Juvederm Voluma has been well received since launching last year.
There’s an inherent risk in Allergan’s acquisition mindset, however. Although it’s yet to prove a problem yet, sooner or later one of these pricey deals is going to come back to haunt AGN shareholders.
While Allergan may have paid 5.25 times the most likely best top line Kythera will be able to produce with Kybella, it’s not the most expensive deal Allergan has done. In early 2014, when it was still Actavis, Allergan paid seven times the sales being done by Forest Labs at the time it was acquired. For that matter, many would argue that Actavis overpaid for Allergan when it acquired the now-namesake company earlier this year.
The big “so what” is, leveraging, borrowing, and diluting are dangerous games to play. Not every deal end up being as great as first presumed. One can’t help but wonder if Allergan’s luck will run out with the acquisition of Kythera.
For the sake of AGN owners, let’s hope it doesn’t.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
