Bradley Pharmaceuticals: Reality Check, Please

Bradley Pharmaceuticals (BDY) reported Q2 earnings last Thursday after the close, and it was not pretty. It looks like the consensus of the 4 analysts who follow the stock was for almost $40 million in revenues and for EPS of $0.17/share; the company reported $32 million in revenues and LOST $0.10/share. Despite the gargantuan miss, the stock was up 12% on Friday August 10 (the company reported after the close on the 9th) and at yesterday's close (August 13) was still almost 10% higher than its last close before its earnings report. The earnings shortfall was multi-faceted, suggesting problems at several layers in the business - revenues were light owing to channel de-stocking (it is truly amazing that despite implementing inventory management agreements with their major wholesalers beginning in 2005 Bradley continues to experience bloated wholesaler inventories; I guess this is what happens when you cram the channel with excess product from every crummy line extension that you launch), gross margins were sharply lower sequentially, and SG&A expenses were higher than expected owing in part to legal fees spurred by the CEO’s bid to take the company private (more on this below).

Underscoring the completely counter-intuitive nature of this stock performance is the sell side slashing of its overly bullish forecasts. Before this quarter, analysts had expected Bradley to earn $0.72/share in 2007 on $159 million in revenues and $1.09/share in 2008 on $178 million in revenues; as of Thursday's close the stock was trading at 21 times this year’s earnings and 14 times next year’s earnings. Now, analysts are forecasting that Bradley will earn just $0.26/share this year on $144 million in revenues, and $0.77/share in 2008 (barely above what the 2007 estimate was just days ago!) on $164 million in revenues. Bradley now trades at more than 64 times 2007 earnings and 21 times 2008 earnings - this is about where Genentech (DNA) and Gilead (GLD) trade!!! (Bradley is a tad more expensive than Genentech on 2008 earnings, in fact).

I for one think it would be generous to pay 12 times next year’s earnings for a battered collection of products such as what Bradley has in its portfolio, given the weak management and lack of financial flexibility (they announced that they paid off their existing high-interest debt, leaving them with by my estimate, merely $10 million in cash and a paltry $15 million revolving credit line, barely enough liquidity to operate the business). Assuming the consensus is correct at $0.77 for 2008, 12 times gets me a $9/share price target. I’ll confess that I expect the key franchises hit by recent generic entrants to fare worse than the consensus, new product launches to similarly underperform expectations, and margins to be a bit weaker than expected leading to 2008 EPS meaningfully short of the current Street consensus, so I think the company is actually worth less than $9, but the downside from here to $9 is plenty so I'll stick with that price target.

Now, this is of course the height of ridiculousness. Bradley is facing generic competition across almost all of its major product lines. Its old business model of mixing up new formulations of combinations of GRAS ("generally regarded as safe") skin products has been shown to be completely non-proprietary as the generics industry has been able to reverse engineer these unpatented creams and lotions within months of their market introductions. To its credit, the company did eventually realize its business model was broken and thus has attempted to in-license products with patent protection. However, with no real business development experience, limited resources, no research and development capability, and a saleforce that has been selling an impoverished product line for some time, Bradley has been hard pressed to compete against the bigger players in the dermatology space in the quest for assets. Thus, the bargain-basement products it has been able to find are uninspirational, to say the least – let’s take a look:

The first product the licensed as part of the new strategy was Veregen, a treatment for genital warts made from green tea extract approved by the FDA in 2006 (launch is expected later this year). While Veregen is effective, so is Aldara, the current market leader, and Aldara is a white cream that is applied to the genitals 3 times per week, compared with Veregen, a brown-red cream applied to the genitals 3 times per day! Imagine having to deal with that every day during your lunch break, in the office bathroom.

The second product in-licensed in the "patent protected" strategy is Elestrin, a topical estrogen formulation for the treatment of hot flashes approved by the FDA in December 2006. Although Elestrin's gel formulation does have patent protection, there are actually many different topical formulations of estrogens available, so the company actually finds itself in the familiar position of having to sell an undifferentiated product in a crowded market. While estrogen patches have captured a decent share of the estrogen market, the estrogen gel/cream market is much smaller. The leaders in this sub-segment of the topical estrogen space are Estrogel and Estrasorb, which have been on the market for a few years. Bradley launched Elestrin in June, followed in just a few weeks by the launch of another similar product, Divigel from Upsher-Smith. And, at the end of July, KV received approval of Evamist, an elegant topical spray formulation of estradiol that they acquired from Vivus (considering they paid $150 million to acquire this product, you can bet that they are going to pour promotional effort into its launch). Thus, this market segment has rapidly gotten crowded and Bradley, which has never marketed to obstetrician-gynecologists before, admitted that the first few weeks of launch have been disappointing and that they may need a marketing partner for the drug.

So what can explain the stock’s gravity-defying move? Only one answer – the company’s self-serving announcement of "non-binding" bids for the company after the company reported its mess of a quarter. A bit of background on this – back in late May (notably, just 2 weeks after another weak quarterly report and a few weeks ahead of the launch of generics to the 150 mg Adoxa tablet, a major Bradley), CEO Dan Glassman announced that he was bidding to take the company private at $21.50/share. Did Mr. Glassman even have committed financing before announcing his bid? Well, no, it would appear not - according to his letter to the Board, Mr. Glassman had "indications of willingness" from One Equity Partners and Credit Suisse Securities to finance the bid. He also said he would "provide shortly a proposed merger agreement" that nearly 3 months later has not yet been made public, if it has even been submitted to the Board at all. Of course, in assessing the seriousness of this bid and Mr. Glassman’s ability to execute, we must not only cast a skeptical eye at the level of commitment shown by his financiers, but must put the bid into the context of what has happened to the LBO space over the last 3 months. Unless you have been hiding in a cave in Siberia, you know that the credit markets have undergone some major turmoil, in turn throwing cold water on many pending LBO transactions. The ability to finance these buyouts with cheap capital seems to have disappeared for the time being; thus, one must seriously question whether the "indications of willingness" to finance Mr. Glassman’s bid still exist. We would be asking this question about Mr. Glassman's ability to finance his bid if the Bradley business had been continuing to chug along at its old mediocre pace - but, in the meantime, we’ve just learned that the business is actually doing much worse than anyone expected, missing analysts estimates for revenues and earnings by a wide margin and driving future earnings forecasts significantly lower. So, realistically, given the dramatic shifts in the LBO finance picture and the disastrous performance of Bradley’s business, who can seriously imagine that those "indications of willingness" can possibly still exist? Yet on the quarterly conference call, Mr. Glassman would not answer a direct question as to whether or not his bid for the company remained in force.

In any case, just a few hours after the company released its messy and disappointing quarterly results, the Special Committee of the Board of Directors, which is evaluating Mr. Glassman’s bid, announced that it had received "preliminary bids for a possible sale of the company." Amazing, isn’t it, that last time there was bad news (poor first quarter report and just ahead of generics for Adoxa 150 mg) a single bid materialized from Mr. Glassman; now, literally hours after a horrible quarter, multiple unspecified bids have materialized! While the press release provided no details on these bids other than to say they were "non-binding and subject to various conditions," it did say the Special Committee "will continue to pursue a possible sale of the Company." Does this mean that the current bids are inadequate? It would appear so. Those of us familiar with the ImClone bidding fiasco from last year will recall that a company merely announcing it has received bids does not imply that those bids are even in the ballpark of what the Board thinks fair value of the company is!

I think it is unconscionable that a company CEO can basically announce that he is bidding for his own company, seemingly without any realistic possibility that he can finance the transaction and without announcing any details of the proposed trnasaction or its financing months after the "bid" was first announced, and moreover that the company’s Board can then go on to announce phantom bids that for all the market knows are below the current stock price, all in a seeming effort to prop up the stock price in the face of a business that is facing serious deterioration. If you or I tried to pull such stunts with a stock we owned, I believe we’d have the SEC breathing down our necks. Why is this any different? In fact, perhaps I should consider using this forum to announce my bid for Bradley, at $4/share. That would be a nice place to cover. Hell, I'd even own the stock there.

Disclosure: Author has a short position in BDY

BDY 1-yr chart

Comments

[wax]

From my CAPS portfolio.

Wax

Pitch by: wax 9/30/06 1:41 PM
Reply | Report this post

My reasonable value estimate is $40


Pitch ReplyReply: wax 11/01/06 6:23 AM
Reply | Report this post

I closed my position today (10.31.06) because of the recent issues surrounding the company and Costa Brava Partnership.

Costa Brava wanted directors from their limited partnership, the company didn't and mounted a campaign against Costa Brava with the shareholders. The company cited reason after reason why having Costa Brava folks on the board was a bad thing. All of this went on for weeks.

In the end, management cratered and let Costa Brava have it's way, and also reimbursed Costa Brava for some of it's expenses in getting board positions. Allowing this to happen was a mistake on the part of management, at least to my mind, and it tells me that management was more interested in themselves than their shareholders.

Put bluntly, I believe current management to be spineless and since Costa Brava is really a hedge fund, why hang out and watch the hedge fund slowly pick the company clean. So I closed my position.

I had a real world 200 share position in Bradley which I took 03.08.05. The position had a basis of $8.88. I closed my position yesterday, 10.31.06, at $16.77 a share.