American Home Products: Beaten Down But Cheap |
By Steve Smith (9/17/99)
Shares of American Home Products (NYSE: AHP - Quotes, News, Boards), maker of such brand name drugs as Advil and Robitussin, have been under relentless pressure over the past five months, having declined 33% from the April 12th high of $70.25 to its current price of $46.75.
The sell-off began as a result of simple sector rotation. High-flying drug stocks were being dragged back to earth as the prospect of higher interest rates, Medicare reform and valuation concerns led people to take some money off the table. That accounted the first leg of the decline to $50 in July. Then, negative developments in pending litigation rocked the stock even more.
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While a stock is never a ?bargain? just because it is way off its highs, we feel that at its current level American Home Product presents a significant buying opportunity.
American Home Products has been surrounded by a black cloud of legal concerns and product recalls. As quickly as one problem was put to rest -- last month the company paid $53 million to settle lawsuits over its Norplant birth-control device -- another problem appeared.
Fen-Phen is No-Fun
The current cloud involves the diet drug fen-phen, and it is a dark one.
Fen-Phen, a combination of fenfluramine and phentermine, was prescribed almost six million times before American Home pulled it from the market it 1997 after it was linked to heart and lung damage.
On August 6th the first verdict in a fen-phen lawsuit was reached. A Texas jury awarded a 36 year old woman $23.3 million in damages. The decision was tremendous shock to American Home Products not just due to the size of the award but for the fact that it lost the case at all.
Investors took this as a sign that a wave of suits would follow. Shares tumbled $6 or 12% that day.
There are currently some 4,000 more cases pending and that number is expected to triple in the wake of the Texas decision.
Another blow came on August 27th when a judge granted class-action status, allowing symptom free fen-phen users the right to file a claim. This opens the door to potentially millions of claims and may make American Home Products financially responsible for monitoring the medical condition of everyone that ever took the drug.
One last wrinkle was added to this pimpled goose on September 9th when the FBI revealed that it?s investigating whether American Home withheld information during the approval process of the drug. Double oy.
Many analysts think the class action status will actually accelerate a settlement and is the ?beginning of the end of fen-phen litigation? as Alex Zisson, an analyst with Hambrecht & Quest, put it.
That theory is being born out. News on Thursday morning that American Home is zeroing in a on a settlement more quickly than Wall Street had anticipated has encouraged analysts and traders alike.
This confidence has boosted the stock by a few bucks in past two trading days. Zisson, however, acknowledges that ?a global settlement of $3 billion will only resolve about 60% of the litigation.?
One sticking point to reaching a settlement is that lawyers for the drug users wish to retain rights on behalf of those that have yet to show any health problems. American Home Products would to set a firm date by which they must file or join the settlement. While it is impossible to gauge the final toll, a worst-case scenario puts the cost at $10 billion. That would be a nasty blow but one that American Home could survive.
The company?s insurance would cover about $1billion of its liability and it has sufficient cash ($1.2 billion) lines of credit ($500 million) and revenue ($1.3 billion in 1999) to absorb the cost.
Zisson expects American Home will take a one-time charge, though the payment will most likely be spread over a number of years, and that should remove ?any remaining overhang in the stock.
Once the litigation gets settled or at least quantified, concerns will begin to fade and start taking a back seat to American Home?s continuing business and future earnings prospects. And those my friend, look bright indeed.
American Home has one of the fullest drug pipelines in the industry. It just received approval of its organ transplant drug Rapamune that is expected to have annual sales of $500 million.
All told, the company has six drugs that will come to market in the next 18 months that have a combined market potential of $3 billion annually.
American Home is likely to spin-out the Agri business once the five-year holding period for assets acquired from the American Cyanimid acquisition expires later this year.
Analysts estimate that the slumping division could fetch about $3.5 billion and would reduce earnings by just $0.15 per share. American Home is expected to earn $2.01 per share for 2000.
We feel that all the bad news is currently priced into American Home?s shares. Jeffery Chaffkin, an analyst with Paine Webber, who had held one of the gloomier views of the stock, recently upgraded shares to ?attractive.?
Just three weeks ago Chaffkin had warned in a research report ?the cloud of litigation and the inability to determine the time or size of any settlement will lead the stock to underperform the market and its peer group.?
Chaffkin also added that until the ?cloud is removed there is reduced possibility of a merger.? Well he?s singing a different tune now that the stock is perking up.
With the cloud lifting merger speculation has renewed.
American Home has been previously rumored to enter a possible combination with SmithKline Beecham (NYSE: SKB - Quotes, News, Boards) and Glaxo Wellcome (NYSE: GLX - Quotes, News, Boards) among others.
With the shares trading at depressed levels American Home becomes an attractive takeover candidate once an acquirer has some comfort level as to the scope of litigation liability.
American Home is trading at just 22 times next year?s earnings estimates, making it the cheapest in its peer group which trades at an average of 27 times earnings. So at a minimum we feel that American Home Products should trade at $54 per share.
Zisson thinks that given American Home?s pipeline, the potential spin-out of the Ag business and merger potential a multiple of 30 should be awarded to American Home stock.
Here?s one last tidbit to tempt you with. The company has scheduled a conference with analysts for the second week of October (the exact date is still being finalized). This should take place prior to the October 20th earnings report and accompanying conference call. We are speculating the meeting will hold good news.