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Author: steveting One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 253  
Subject: The Return of the King Date: 3/9/2006 11:04 AM
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It's been a wonderful year for King Pharmaceuticals (KG). If one needed a good example of a turnaround company I believe King Pharmaceuticals would fit the bill as a number of significant events that were of major concern have been resolved.

1. Merger with Mylan Laboratory has failed. What ever management was thinking in trying to sell the company on the cheap has thankfully blown over in 1Q 2005. I don't know how others felt, but my understanding was that KG as a stand alone independent company was much better off (and more profitable) than a combination of Mylan + King. Luckily for us shareholders, Carl Icahn was beating Mylan's management over the head and additional accounting errors forced King to restate its financial results. This gave Mylan a back door out of the deal by trying to low ball another offer, which King's management had some sense to refuse.

2. Settlement of OIG under payments. This major concern has thankfully come to an end with King having to pay a huge settlement of $124 million - split about evenly in underpayments and fines. It looks like King isn't the only one facing scrutiny for under paying Uncle Sam as a few other pharmaceutical companies are also under the spot light. Good luck to them I'd say as they too will be spending millions in lawyer fees, back charges and fines, not to mention a few years of management distractions. It just goes to show that not having the right business sense in dealing with government will eventually come back and get you. Management should know as they've signed a 5-year integrity agreement that'll force them to do the right thing.

3. Wholesale channel inventories to within manageable levels. Management has signed with its 3 largest wholesalers who account for 75% of its revenues an agreement to keep the channel inventories to about 1 month of prescription demand +/- 2 week variation. Compare this to when previous management were totally clueless on the channel inventory (at times allowing the channel inventory to run up to 3 months of prescription demand) and allowing wholesalers to play the price increase games. This made it hard for management to meet revenue and earnings expectations of the Street – a guaranteed failure scenario. At least this time they seem to be on top of the issue with finished goods declining on a year-over-year as well as quarter-over-quarter basis, that something great to see as a part owner of a business.

4. Back to profitable growth. After two horrible years of declining profitability, KG is now back on track to generate earnings and become the cash generating machine that I once knew it to be. This is the most exciting part of being a shareholder and seeing management execute it like a well oiled machine. The business concept of KG is quite simple:

(a) Develop or acquire a product with patents to protect it from competition.
(b) Manufacture those product(s) with great margins in the +85% range.
(c) Get your sales force in top gear and sell like crazy before the patent runs out.
(d) With the great cash generation, repeat step (a) and with any left over money buy back some shares or return some of the money back to shareholders via a dividend.

Wall Street, investors and the market seem to focus on the past and not the future of KG. This is probably related to missteps by previous management and that has changed with a new management team in place which includes a new CEO, CFO as well as a new sales and marketing senior executive. These guys have decided to focus on key areas, trim the fat within the organization, re-align the sales force and pursue drug development partnerships rather than trying to develop a block buster in house. Of all the products within the pipeline, the greatest near term catalyst is with Remoxy (the abuse-resistant opioid painkiller) and the 3 other opioid products that will follow. Here in lies a multi-billion dollar market that will easily replace lost revenues on Altace, Selaxin, Levoxyl and Sonata and then some more. While Remoxy and its brethren are not guaranteed to get FDA approval, the probability is greatly increased due to the active ingredient being well known and has been used for decades as pain relief.

Then there is PT-141 in Phase II trials, a new type of compound for the treatment of male and female sexual dysfunction. While approval for PT-141 far from certain it also has broad indications, is easier to administer (squirt it up your nose!) and can be combined with currently approved products. Thus it has the haul marks of a block-buster, but don't hold your breath as it'll take a while before coming to market – if at all.

King also has binodenoson (currently in Phase III) the next generation cardiac pharmacologic stress-imaging agent to replace Adenosine. There isn't much information on this product as management is keeping things close to their chest due to a competitor's product which is running in parallel with binodenoson in the approval race.

Even if revenue is flat for the next few years due to challenges in marketing its branded products, I'm expecting intangible impairment charges to slowly decline as well as the SGA expenses. Offset this will be increases in R&D spending to improve the pipeline – that's really a good thing as there's now hope that declining revenues due to patent expiration of its branded products are going to be replaced by new products down the road. I see at least $1.50 per diluted share in earnings for 2006 and 2007. With the current price at $18, that makes the forward P/E at about 12. For the naysayers out there, no price is too low to pay for a company with stagnant or decline revenues. To those I'd say, “Have you looked at the pipeline? What do think?” Remember, the company is generating a lot of free cash and management has said they'll do another deal this year. So a PE of 12 might well be a bargain a few years down the road.

Best and regards,
Steveting
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