Struggling Perrigo Plans To Spin Off Or Sell Prescription Pharmaceuticals Business

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Perrigo Company(PRGO) is another company with a spinoff heritage returning to our pages. Back in 2013, Perrigo acquired the Elan Corporation for $8.6 billion. Elan had completed its spinoff of Prothena(PRTA) in late 2012.  Perrigo subsequently sold the Tysabri royalty stream acquired with Elan to Royalty Pharma for up to $2.85 billion. Today, Perrigo’s market capitalization stands at under $5.5 billion.

Most recently, Perrigo was dealt a blow when it revealed that the Irish government had informed it that Elan had underpaid taxes in 2013 by $1.8 billion, saying that the company had misclassified income from its sale Tysabri to Biogen(BIIB).  The company vehemently denies this and defends its accounting treatment as correct.  The tax bill, which does not include penalties or interest, would be disastrous for the company.

This tax bill comes as the company is already in turmoil. In August the company announced that it intended to separate its struggling prescription pharmaceuticals business.  This would allow the company to focus on its consumer business:

The Rx business serves patients and health systems with ‘extended topicals’ medications, to treat ailments at more affordable prices. The differentiated and diversified portfolio includes topical generic medicines in multiple dosage forms, including creams, foams, mousses, gels, liquids and inhalable products.

The company hopes to complete the separation in the second half of 2019. While a spinoff, a sale or a merger are all listed as potential transactions, it is hard to imagine this division fetching a reasonable price in a sale. Third quarter numbers tell a grim story for the RX business.

Three Month Comparison
Three Months Ended
(in millions)
September 29,
2018
September 30,
2017
Net sales
$
179.3
$
250.6
Gross profit
$
73.4
$
116.7
Gross profit %
41.0
%
46.6
%
Operating income
$
36.0
$
82.1
Operating income %
20.1
%
32.8
%
Three Months Ended September 29, 2018 vs. Three Months Ended September 30, 2017
Net sales decreased $71.3 million, or 29%, over the prior year period as a result of:
•
A decrease of $70.8 million in sales of existing products due primarily to increased competition driven pricing pressure, and customer service challenges resulting in decreased sales volume of certain products; and
•
The absence of sales of discontinued products of $3.8 million; partially offset by
•
New product sales of $3.3 million.
Operating income decreased $46.1 million, or 56%, over the prior year period as a result of:
•
A decrease in gross profit of $43.3 million and a decrease of gross profit as a percentage of net sales of 560 basis points due primarily to pricing pressure and product mix.
•
An increase of $2.8 million in operating expenses due primarily to an increase in R&D of $7.0 million, which represented 580 basis points increase in R&D as a percentage of net sales.

The business is rapidly declining and, in this environment, a spin off may be the only reasonable path to separate it. The company has no indication of improvement.

We continue to experience a significant year-over-year reduction in pricing in our RX segment due to competitive pressures. This softness in pricing is attributable to various factors, including increased focus from customers to capture supply chain productivity savings, competition in specific products, and consolidation of certain customers. We expect this softness to continue to impact the segment for the foreseeable future and we are forecasting a 11%-14% pricing decline in this segment for the year ending December 31, 2018.

In October, after the company had completed Q3 but not yet reported it, the Board acted and  Murray Kessler became the company’s third CEO in three years. Mr. Kessler’s background is in consumer products, and the company continues to pursue a separation.

On August 9, 2018, we announced a plan to separate our RX business. We have begun the preparations for the separation of our RX business, which may include a possible sale, spin-off, merger or other form of separation. We believe the separation, which we currently are targeting to be completed during the second half of 2019, will enable us to focus on expanding our leading consumer businesses. In connection with the proposed separation, we anticipate incurring significant preparation costs, excluding restructuring expenses and transaction costs, in the range of $45.0 million to $80.0 million depending on the final structure of a transaction, with a spin-off resulting in costs at the higher end of this range.

Assuming the company can survive the existential threat of its large Irish tax bill, a spinoff seems like the most likely outcome of the separation process. But with the business deteriorating daily, it is unclear how much value it might provide to shareholders.

Disclosure: The author has no position in any stock mentioned