Hospira Proving Drug Takeover Target With FDA Scrutiny: Real M&A

Hospira Inc., embroiled in regulatory scrutiny for flaws in its manufacturing practices, has become so cheap that buyers may now pounce to claim a third of the world’s market for specialty generic injectable drugs.

The maker of anesthesia and cancer treatments had fallen 49 percent this year before today, the steepest drop of any health-care company in the Standard & Poor’s 500 Index, as Hospira works to fix quality control problems at its plants after receiving warnings from the U.S. Food and Drug Administration. The Lake Forest, Illinois-based company traded this week at a record low of 1.46 times net assets, making it the cheapest generic pharmaceuticals maker in the U.S. greater than $500 million, according to data compiled by Bloomberg.

Hospira’s depressed valuation and 30 percent share of the $12 billion market for specialty injectable generics may attract takeover interest from competitors Fresenius SE or Teva Pharmaceutical Industries Ltd. amid a decade-high drug shortage, said Capstone Investments. While Sanford C. Bernstein & Co. says the risk of the FDA halting manufacturing may deter potential buyers, Hospira may be worth as much as $60 a share in a takeover, according to Collins Stewart LLC, a 95 percent premium to its 20-day trading average.

“The stock looks inexpensive here,” Maria Mendelsberg, a fund manager at Denver-based Cambiar Investors LLC, which oversees about $8 billion and owns more than 2 million Hospira shares, said in a telephone interview. “For some of the bigger drug companies this would be a good way to diversify. There are so many injectable drug shortages.”

Working with FDA

Joachim Weith, a spokesman for Bad Homburg, Germany-based Fresenius, didn’t immediately respond to an e-mail sent outside normal business hours. Denise Bradley, a spokeswoman for Petach Tikva, Isreal-based Teva, said the company doesn’t comment on market speculation.

Dan Rosenberg, a spokesman for Hospira, said the company doesn’t comment on stock price movements or market speculation.

“We are committed to addressing the FDA’s concerns and are working diligently to make sure we fully comply with the agency’s expectations,” he said in an e-mail. “We have worked closely with the FDA during this process and our interaction has been open and constructive.”

Hospira’s 49 percent drop this year had wiped out $4.6 billion in value for shareholders through yesterday. The S&P 500 Health Care Index of 51 companies had added 7.3 percent.

‘Attractive Candidate’

The stock reached a two-and-a-half-year low of $28.17 on Nov. 29, the cheapest relative to book value, or the value of its assets minus liabilities, since it was spun off from Abbott Laboratories and started trading separately in May 2004, according to data compiled by Bloomberg.

At 1.46 times book value as of yesterday, Hospira is the cheapest generic pharmaceutical company in America with a market value greater than $500 million, data compiled by Bloomberg show. The group trades at a median of 2.35 times net assets.

“With a stock that’s under a lot of pressure, it is an attractive candidate because it trades at a value that’s below what it is worth to an acquirer,” Shibani Malhotra, an analyst at RBC Capital Markets in New York, said in a telephone interview. Hospira may become an acquisition target if the valuation is “further depressed,” she wrote in a note to clients this week.

FDA Warning

In April 2010 the FDA sent Hospira a warning letter citing deficiencies in manufacturing practices at its Clayton, North Carolina facility and failure to validate manufacturing processes at its plant in Rocky Mount, North Carolina, according to Hospira’s U.S. Securities and Exchange Commission filings. The warning also covered inadequacies in quality control and investigations, Hospira said.

The same month, Hospira recalled two drugs -- propofol, the anesthetic that contributed to Michael Jackson’s death, and liposyn, an intravenous nutritional product -- for a second time in six months because of manufacturing defects. The drugs had been contaminated by particulates during manufacturing, Hospira told the FDA.

In follow-up inspections in June and August of this year at the Rocky Mount location, which accounts for about 25 percent of revenue according to Capstone Investments, the FDA also listed observations regarding quality systems, operating procedures and areas for remediation and improvement, the company said. Hospira said it is implementing a “comprehensive remediation plan.”

Hospira would still be an attractive acquisition candidate for Fresenius or Teva to boost their share of the specialty injectable generic drug market, an industry that’s growing about 5 percent a year, according to John Putnam, a Delray Beach, Florida-based analyst for Capstone Investments.

‘Great Opportunity’

“There is a great opportunity here for generic manufacturers to step in and produce these drugs,” Putnam said in a telephone interview. “Those are companies that could make some inroads or a foray into this.”

Hospira declined 2.3 percent to $27.64 today in New York. Fresenius fell 1.2 percent to 71.03 euros in Frankfurt. Teva’s U.S. shares slipped 0.1 percent to $39.70.

Fresenius, with a market value of 11.7 billion euros ($15.8 billion) as of yesterday, owns Fresenius Kabi, which sells infusion therapies and clinical nutrition products and provides generic intravenous drugs in the U.S.

Recent drug shortages may also drive takeover interest in Hospira, said Cambiar’s Mendelsberg. There have been 232 drugs in short supply this year, and most are generic injectables used for cancer treatment and anesthesia, the American Society of Health-System Pharmacists said last month.

Drug Shortages

More than 50 of the specialized injectable drugs in short supply last year were manufactured by three companies: Teva, Hospira and closely held American Regent Laboratories, October data from the FDA show.

Last month Teva, the world’s biggest maker of generic drugs, reported its first drop in quarterly earnings in four years because of fewer new U.S. generic-drug introductions. Teva’s U.S.-traded shares were down 24 percent this year before today, giving it a market value of $37.4 billion of yesterday.

While the injectable generic drug industry is attractive, the risk of Hospira’s issues with the FDA escalating would be too great for a potential buyer, according to analysts Ronny Gal with Bernstein in New York and Rick Wise of Leerink Swann LLC.

Hospira shares fell 9.1 percent on Nov. 29 after RBC’s Malhotra wrote in a note to clients that the manufacturing issues may be “far greater than investors realize” and take at least two to three years to resolve.

Consent Decree

Conversations with FDA experts indicate “a consent decree is more likely than not,” she wrote. A consent decree would give the FDA authority to shut down plants and force Hospira to hire a third-party consultant, which could reduce production and earnings, Malhotra wrote.

“I have no doubt that the stock is inexpensive relative to its long-term prospects,” New York-based Wise of Leerink Swann said in a telephone interview. Still, “companies dealing with complex regulatory issues are not likely to be acquired,” he said.

It wouldn’t be the first time that a company mired in FDA scrutiny of its manufacturing violations was purchased, said RBC’s Malhotra. Sanofi, France’s largest drugmaker, acquired Genzyme Corp. this year after the maker of genetic-disease medicines was fined $175 million by the U.S. government under a consent decree after one of its plants was contaminated.

“The best example is Genzyme where, once things got really bad for them, they were a takeout candidate,” Malhotra said. If Hospira were to be bought, “it would be much longer term. A potential acquirer would want to know what they’re dealing with and the depth of the issues, if there are any, and what it would take to fix them before making any plans,” she said.

Buffett Criteria

Hospira was one of more than 30 companies in developed and emerging markets identified by Bloomberg in October that met the acquisition criteria Warren Buffett listed in his annual letter to shareholders and were also cheaper than Berkshire Hathaway Inc. based on its discount to net assets.

Hospira may be worth as much as $60 a share in a takeover or breakup, based on a sum-of-the-parts analysis from Louise Chen, a New York-based analyst at Collins Stewart. That would equate to a price tag of almost $9.9 billion, compared with its market value yesterday of $4.7 billion. Chen expects the shares to reach $35 in the next 12 months on a standalone basis, according to a Nov. 29 research note.

“Maybe if the stock continues to get cheaper another party might become interested in it because it’s a unique franchise,” Cambiar’s Mendelsberg said. “Even before all this happened I thought it could be an attractive takeout. I’m hoping they can get this resolved, but when you’re dealing with the FDA you just don’t know what’s going to happen.”

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