Mayne Pharma – Imperial Hubris

Mayne Pharma – Imperial Hubris

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Hubris is probably the wrong word with Mayne Pharma. An empire must have been established for some time to rack up enough greatness and glory, crystallised, unquestioned… to then have the arrogance worth bragging about.

Imperial Ambition is probably more accurate… but it does have a positive connotation. Imperial Overreach would be alright, but then it implies the company has an established empire it could safely and prosperously kept if it didn’t overreach and “liberate” more “savages”. You know, like the Rome of Augustus having its borders drawn, its sphere of influence set so that it does not need to execute perpetual wars for that perpetual peace Orwell talks about.

I’m waffling here because it really doesn’t take much to show that Mayne is a bad business that’s probably going to lose all its investors their money when the credit crunch hit.

I say probably because, one, you got to cover your hinnies; two, there’s no limit to how far or how long people are willing to put in good money after bad. Particularly when it’s new shareholders, one after another.

 

DISCLAIMERS: I have no financial interest in Mayne Pharma. I am not shorting or longing its share price. Not intending on doing any of that. I will probably discuss Hikma Pharmaceuticals for comparison purposes… I have a related interest in Hikma as a member of my family own some of its shares.

 

BEWARE SHARE PRICE MOVEMENT

A quick look at Mayne’s (MYX) price chart shows that its shares, hence its business, has taken a beating since July last year: from $2 down to $1 (for no apparent reason; for some unjustified reasons like the US Department of Justice talking to generic drug makers about some alleged price fixing etc.).

When a company is going to seriously expand its business through acquiring potentially outstanding products a seller (Teva and Allergran) is forced to offload to satisfy regulator’s competition concerns, it seems quite an over-reaction that its share price should be halving like it has.

But here’s why an investor should follow Graham’s and Buffett’s advise to ignore the share price as a basis of judgment. Study, analyse then value the entire company first. Then look up how many share it has outstanding to then determine its price and value.

 

MYX share price

 

At the end of FY2016, MYX has 810 million shares outstanding. Its share price at the same period was around $1.80. Giving a market capitalisation of $1.456B.

As reported in its Appendix 3B on 27th June 2017, MYX has 1,512,592,738 [1.5B] shares outstanding. At $1 a share price that’s a market cap of $1.5B.

So while the share price has gone down by half, the increase in number of shares by about 2 times mean that the company’s market price has remain the same. So no apparent bargain to be had in that drop unless we think MYX was a bargain at $2 a year ago.

It is also worth reminding that an investor should always look for the latest market releases to know how many shares the company currently has outstanding. Do not rely on the previous annual report’s figure, do not rely on data vendor’s figures. They can be quite outdated and the company can seriously dilute its ownerships between reports. See, you come here for both bad humour and wisdom – other people’s mistake is also wisdom, right?

Shares Update: Just as I’m writing this, MYX released its latest Appendix 3B on 14th July stating they’ve sold 19,531,513 ordinary shares to 42 members of US and Australian management team. Under this Employee Share Loan Scheme, each share is sold at $1.1307 (some 13% above recent share prices), put them in a lock box until 31 July 2022. The thinking, and here I am guessing, is to incentivised management to do great work so that the share price will be a lot higher when management cash in and pocket the difference between a higher price to this lower price. That or the Board just decided to give 19.5 million shares away at today’s low prices with management having the option to cash this free shares in if and when they can get it for free-plus.

Incentives must be made but to link it to share price performance leads to haphazard empire building. Anyway, what was a company with 1.513B shares a couple of weeks ago now has 1.532B shares (excl. the 15.9M options currently on the books).

 

HOW EMPIRES ARE BUILT, AND MAINTAINED.

There are two types of business empires. The one that destroy most of the world but benefit its shareholders; Then there’s one that destroy both the world and shareholders’ wealth.

In Equity: Signs of a Great Business I made the point that a quality business is one that increases its shareholders’ wealth (equity) from existing business operations. Such operations are profitable after paying workers’ a fair wage, pay the banks and other lenders their due, pay the tax office their cut, account for the upkeep from depreciating assets. Such earnings can then be paid out as dividend if that is appropriate, or be retained as “retained earnings” in the company.

That is, a quality business starts off with equity contributed by its shareholders. Use that capital wisely, earn a net profit they can either kept all back to further reinvest, or kept some back and pay some out as immediate return to shareholders. From time to time, new opportunities are too great to wait so a business could reasonably go back to their shareholders for more equity to further expand through acquisition or capital investment.

However, when a company keep on raising new equity, keep on borrowing money with that equity raising for acquisition and expansion… these are empire builders of the incompetent kind.

Putting this in pictures:

This is how empires were built…

 

eqt wmteqt WPC

 

In the above charts, the slimy green bar shows Retained Earnings – net profit the company keeps back, i.e. profit after interests, depreciation, taxes and dividends paid out to shareholders. The aqua are equity shareholders has put into the company.

The idea of business is that entrepreneurs put in some or no cash, work hard, put their genius and energy to produce goods and services of value to both the consumers and themselves, the shareholders. So we’d want to see constant, and little, amount of cash injection from the owners but big and rising amount of greens. If the green don’t rise, it ought to be because dividends (purple) are paid out.

When both dividend and retained earnings rises – as is the impressive case with WalMart – with negligible rise in contribute equity, you know you got yourself a high quality business. Ones that at a reasonable price – or even slightly unreasonable level – will do very well for its owners.

 

How not to build an empire… or any business…

eqt abseqt Dick

 

Both ABC Learning Centres and Dick Smith Electronics collapsed.

And here’s Mayne’s history:

eqtMYX2

 

See how the aqua bar for contributed equity just turned death black? 😀

That’s at $263m, not yet counting the $888m Mayne announced it plans to (and did) raised as part of the $1,033m costs to acquire “…generic product portfolio from Teva and Allergan” on the 27th of June 2016.

The good news is that the money raised has good Feng Shui numerology. That and the bankers are willing to risk $145m on top of the new equity to help pay for transaction costs, working capital for new inventory and technology transfer. It’s also cheap on the moving expenses as 99% of the purchase price (or $868m of the cost) are intangible assets, with $63m extra for new inventory and another $89m being capex, transaction fees and a few guys from Teva turning up to show Mayne how to read the IP documents.

 

A NEW, NEW BUSINESS MODEL?

You’re probably thinking… that’s a bit unfair man. Mayne is a drug company manufacturer in its investing phase for growth…

Here’s BNSF… intensive capital investment requirement… new equity investment soon enough lead to higher retained earnings, and dividends.

 

eqt bnsf

 

Though it is true that excessive Contributed Equity is not always bad. You gotta spend money to make money. More money never cause any company to collapse (it usually lead to it if you keep it up). Often, it is, obviously, what kept the company afloat.

But having studied a few rotten corps thus far, investors in companies selling these kind of “growth” and expansion often have their new money used as new asset to ease lenders’ concern in borrowing more money. That and to help meet operational shortcomings.

Could Mayne be raising and investing all these cash so that it will dominate and corner a certain generic market?

No.

Remember that Mayne is a generic drug company. It’s not supposed to invent new drugs or go where no pharmacists has gone before. So its operations – selling true and tried drugs to established markets, for cheap – ought to be very simple, and very profitable. Yet it hasn’t been that profitable.

Below are the same figures for another generic drug company – Hikma Pharmaceuticals (HIK: LSE).

 

eqt HIK

 

Hikma acquires new drugs, expand into new markets on a relatively frequent basis… yet it managed to pay dividends, increased retained earnings but kept a tight lease on raising new equity and thereby not diluting shareholders’ ownership.

Probably because its management are more capable in their acquisitions. For instance, in 2015, Hikma proposed to acquire from Boehringer Ingelheim its Roxane Laboratories operations – “…a well-established US specialty generics company with a highly differentiated product portfolio and R&D capabilities.”

For what eventually worked out to be $US2.12B ($647M in cash, 40m Hikma shares or 16.7% of the company), Hikma purchased a portfolio of 88 “specialised” generic drugs with sales for FY2017 expected to be between $US700m to $US750m; 75% having three or fewer competitors; 89 pipeline products with a $41B addressable market, together with the labs and R&D team etc. etc. immediately making Hikma the 6th largest US generic company by revenue.

This compare to Mayne’s $1B purchase for a portfolio with sales “…of at least $US237m”; 6 product pipelines with addressable market greater than $US700m; issuing the equivalent of 82% of the company’s existing shares… [further details see companies’ respective presentation on acquisition].

Sure sounds like Mayne is continuing that long Aussie tradition of getting tricked and losing money whenever they expand overseas. Well at least Teva’s portfolio has a gross margin of some 50% compare to Roxanne’s 35% EBITDA margin.

 

CONCLUSION

Based on that one contributed equity chart alone I can pretty much conclude that Mayne is one of those companies to avoid. It’s not worth going into anymore its operations or financial details any more than that.

Note that we as investors are not here to past judgment or carefully appraised companies for the fun of it. Our job is to see what companies we invest in… and we do that by first eliminating from analysis companies we cannot understand, companies we judge (wrongly or otherwise) to be of poor quality and low financial return. There are, of course, investment decisions based on moral obligations and such… it is best to achieve both.

But being polite, and probably sensible if I don’t want to be sued, let’s carry on and further examine Mayne’s financial performance and position here.

 

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