Specialty Pharma Caught a Cold

June 6, 2019

Source: Bloomberg; *Representative basket compiled of on-the-run (OTR) bonds of MYL, TEVA, ENDP, MNK. Source: Bloomberg; *Representative basket compiled of on-the-run (OTR) bonds of MYL, TEVA, ENDP, MNK.

Since the start of the year, a representative basket of specialty pharmaceutical companies in the high yield universe has underperformed high yield due to pricing pressure combined with legal and regulatory headwinds. The range of spread widening across these credits has varied; certain names now trade with implied distressed valuations.

The pricing pressure from last year continued as consolidation in the distributor market weakened pharmaceutical companies’ bargaining power. With drug pricing under the spotlight in Washington, D.C., the risk that increased pricing transparency will pressure margins for these manufacturers is difficult to estimate, but must be accounted for in models.

On the regulatory and legal front, there have been two key drivers for these manufacturers to the downside. The first is the antitrust lawsuit led by the Connecticut Attorney General, which implicates 20 generic drug manufacturers in alleged price fixing. This litigation has been in process since 2014 and is unlikely to be resolved this year.

The second and more topical driver is the involvement of nine pharmaceutical manufacturers in lawsuits spanning multiple states regarding the opioid crisis. In total, these companies face 2000-plus suits, many of which have been consolidated under multidistrict litigation (MDL) suit in Ohio. We can rely on previous lawsuits of this nature (tobacco-related, though in a different format) and extrapolate from the recent settlements in Oklahoma to assume a cash-liability range of $1 billion to $5 billion, with individual liability based on demonstrable involvement. For some of the names in the specialty pharma high yield universe, it would be more advantageous to file Chapter 11 as civil litigation would be paused post-filing.

It is unlikely, however, that a majority of the companies affected by this litigation will file. A number of these companies have ample liquidity and capacity within their capital structure to be able to absorb litigation-related liabilities. The amount and seniority of additional debt they need to take on will affect the recovery value of the existing debt in their capital structure, and guide pricing of these bonds accordingly. The first federal trial in the MDL suit is scheduled for October 21, and the lack of any delay in trial date could incentivize companies to settle, as was the case in the recent opioid-related settlements in Oklahoma.


Key Takeaway

Litigation and regulatory headwinds have put pressure on bonds in the high yield specialty pharmaceutical sector. Still, I believe companies in this space can prove to be a good trading opportunity once the litigation-related timeline is more clearly defined. Investors are well served to analyze names from a bottom-up perspective while considering liquidity and capital structure.


Tags: High yield | Bonds | pharmaceutical

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