Online Extra: Forest Labs: A Little Giant Rises

The drugmaker has two potential blockbusters, and analysts say its smaller size makes it hungrier for success, which it seems to find regularly

By Amy Tsao

The BusinessWeek 50

Forest Laboratories (FRX ) is the poster child for so-called specialty drug companies -- those that sell smaller-market drugs, generics, and improved formulations of older products. Over the last decade, no other drugmaker has been as consistently profitable as the New York City-based company, and Forest's strong performance has earned it favorable comparisons to pharmaceutical titans. "It's by far the best-run company among its peer group, and it's the best in the business, even next to Pfizer (PFE )," says David Lickrish, an analyst at Punk, Ziegel & Co. (Lickrish doesn't own the stock, and his firm has no banking ties to Forest.)

The accolades are well-deserved considering that drug industry growth has slowed dramatically in the last several years. In the fiscal year ended March 31, 2003, Forest reported an 84% rise in profits, to $622 million, on sales of $2.2 billion -- up 38% from 2002 levels. Analysts expect another solid, though somewhat less spectacular, performance in fiscal 2004, which ends this month.

Consensus estimates have net income rising 17%, to $725 million, on revenues of $2.6 billion -- a 16% increase. With such consistent profits and growth, "just about everyone would like to be Forest when they grow up," says Anne Underhill, health-care analyst at Baring Asset Management. (She owns the stock personally and the firm has owned it for the past six years.)


  Forest, last year's No. 1 BusinessWeek 50 company, is back in that exclusive club again as No. 5 in 2004. And its shares have been on a tear over the past year. They're trading at $72, up from a 52-week low of $48 in September. Investors have bid it up on high hopes for fiscal 2005. Earnings are expected to rise 24%, to $900 million, on revenues of $3 billion-plus in 2005. Expected to help fuel the boost are robust sales on two key drugs: Namenda, Forest's recently approved drug to slow the progression of Alzheimer's disease, and Lexapro, its latest antidepression drug, which hit the market in fall, 2002.

Forest shares certainly aren't cheap, but many investors are willing to pay up for the anticipated solid growth ahead. Underhill figures the stock can rise an additional 17%, to $85, in the next 12 months. Brandon Carl, health-care analyst at BB&T Asset Management, says his firm doesn't own Forest now, though "it's definitely something we've been trying to get our arms around better." He notes that the 2005 price-earnings ratio of 29 is not far from the stock's 10-year historical average p-e of 34. Valuation "could expand if we get tremendous [sales] on Namenda," Carl says.

There's reason to believe Forest can deliver. Namenda taps a huge market: 4.5 million Alzheimer's patients who have few viable options. Pfizer's Aricept is a billion-dollar drug approved for mild to moderate Alzheimer's, while Namenda is the first drug to treat more advanced cases. From January through the end of February, Forest says it gained 11.6% of total prescriptions for Alzheimer's and 23.9% of new scripts written for the debilitating disease.


  Analysts expect Namenda's annual sales to top $800 million in fiscal 2007. That, however, may turn out to be conservative. Studies have shown a combination of Aricept and Namenda to be effective in combating the disease's symptoms. Though Namenda isn't approved as such, Forest also has data that show it's effective on its own in mild to moderate cases. Add possible additional approvals for other uses like dementia, and analysts say the drug's potential could be well above the billion-dollar mark. "We see Namenda sales closer to $1 billion in 2008 or 2009," says analyst Ken Wahl of Mehta Partners. (Neither Wahl nor his firm owns the stock.)

In addition, Forest's drive to make Namenda a success could be more fierce than Pfizer's for Aricept, Wahl says. Even though the companies have comparable salesforces -- roughly 500 each -- Forest is likely to be more aggressive because "a drug of this size for Forest is huge," Wahl says. Since Pfizer splits sales of Aricept with a Japanese marketing partner, it makes only $500 million a year on the drug -- which barely registers at a company with $45 billion in sales.

In the depression-treatment area, Forest is in transition mode. Lexapro is one of the newest entrants in the category of antidepressants that started with Prozac more than a decade ago. Lexapro acts more quickly than Forest's own Celexa, has fewer side effects, and is approved for a wider variety of mental-health problems, the company says, making it a better option for more patients than already popular Celexa. Longer term, the drug should be a big seller. Celexa sales totaled $1.5 billion in fiscal 2003, but Lexapro could reach peak annual sales of $2.9 billion by 2007, says Wahl.


  Forest is trying to persuade doctors to prescribe Lexapro instead of its older, soon-to-be-off-patent Celexa. Drug companies' success in making this kind of shift has varied, but so far it's "working very well for them," says Underhill of Forest's efforts. Celexa isn't expected to lose patent protection until 2006, giving Forest some time for transition. Underhill sees Lexapro sales growing sharply, from $1 billion in fiscal 2004, to $1.68 billion in fiscal 2005.

Certainly, Forest's pipeline could be fuller. The company recently bought rights to a drug in Phase III testing for fibromyalgia -- a musculoskeletal pain and fatigue disorder that affects upward of 3 million Americans -- from a smaller drug company, Cypress Biosciences (CYPB ). And Forest also has a drug in late-stage testing to treat alcohol dependence. Earlier-stage projects are in the works, and Forest says it's searching for drugs to buy from other companies. But it could be doing more, analysts say.

Of course, no drug company is bullet-proof. Competition -- especially in the depression-treatment market -- will be intense. Generic manufacturers are already trying to prove that Lexapro will lose patent protection as early as 2006. "We believe we have a strong and valid patent estate for Lexapro but do not comment on ongoing litigation," says Forest spokesman Chuck Triano. Potential changes in guidelines on how antidepressants are taken and by whom could also put a dent in expectations for Forest's drugs. The Food & Drug Administration recently put Celexa and nine other depression drugs on a list of those requiring stronger language about patient monitoring for suicide.

Still, with two potential blockbuster drugs poised for takeoff, Forest is positioned better than most of its peers. It could have at least 20% compounded annual earnings growth for the next four years, Wahl says. "That's probably on the low side" if Lexapro and Namenda outdo analysts' expectations. That's excellent news for investors seeking above-average growth in the drug industry, and it would give Forest good shot at getting into the BW50 again in 2005.

Tsao covers financial markets for BusinessWeek Online in New York

Beth Belton

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