Investment Summary:
Organon & Co. (NYSE: OGN) is an attractive special situation that started trading on the 3rd of June 2021. The company was spun-off from Merck (NYSE: MRK) and the stock is currently trading at $30 (~5x times my estimates of 2021 EPS). The unwillingness of Merck shareholders (legacy shareholders) to own the stock due to historical revenue decline in what is perceived to be a business with unattractive assets in favor of Merck’s vaccine, animal health and most importantly oncology franchise, lack of operating and trading history as a stand-alone business are all factors at play for Organon. If management executes on its growth strategy of growing revenue by low to mid-single digit in 2022 and beyond without pursuing expensive acquisitions, the stock should re-rate and sell at ~$72 in 2025 (~45 today at 10% discount rate), yielding a ~22% IRR including dividends through 2025.
Company background:
Organon is a global pharmaceutical company headquartered in New Jersey and is focused on women’s health, biosimilars, and generic drugs. The company has 64 drugs across three portfolios and derive ~79% of its revenue or $5.1 billion from 140 countries outside the United States. Most drugs are manufactured by the firm (6 plants across the world). The company employs ~10000 people of which 40% is focused on commercial activities (sales and marketing).
Company segments and strategy.
Organon’s strategy has three pillars:
- To be the global leader in women’s health: No other big pharmaceutical company has women’s health as their primary therapeutic area of focus. This segment includes 10 products including contraceptive and fertility products such as the patented long-lasting reversible contraceptive (LARC) devices Nexplanon and Implanon NXT whose sales have grown by 11% CAGR from 2010 to 2020. This segment fetched $1.6 billion in sales in 2020 and represented 25% of the company’s sales. The women’s health market is expected to grow at a 3% CAGR from $33 billion in 2020 to $40 billion in 2026. In addition, parallel conditions affecting women disproportionately such as osteoporosis, lupus, urinary tract infections, migraines and celiac disease is expected to grow at 10% CAGR provide the company with an expected $21 billion opportunity by 2026.
2. Focus on growth in the biosimilars segment: Organon has an agreement in place with Samsung Bioepis where the latter is responsible for product development, clinical trials, manufacturing and Organon does the commercialization, market strategy and pricing. This segment generated $300 million in 2020 and is expected to double by 2025 especially after launching Hadlima, a biosimilar to AbbVie’s Humira (a drug to treat rheumatoid arthritis and other conditions) which is the best-selling drug in the world with sales equal to $20 billion in 2020. The biosimilars market is very lucrative with an estimated value of $17.3 billion as of September 2020. Only 86 biosimilar products have been authorized (60 in the EU and 28 in the U.S) so far and over the next decade, it is expected that 54 major biologics with an estimated market value of $220 billion will lose patent protection, which would boost the biosimilar market to over $30 billion. Biosimilars are alleviating healthcare cost pressures globally and many developed countries (especially the EU) have been pushing towards more biosimilar drugs. Organon currently has 5 biosimilars (mainly oncology) and intends to capitalize on the growth in biosimilars by striking deals to commercialize other products and expand the market share of existing products.
3. Legacy drugs to provide float: Organon willrely on the highly predictable, cash flow generative legacy drug segment to generate cash flows to pursue opportunities in the women’s health and biosimilar drugs segment. The legacy drug segment currently has 49 drugs that span across cardiovascular, respiratory, non-opioid pain, bone and dermatology and other segment and amounted to $4.5 billion (60% of the company’s revenue in 2020). Although this segment has declined at 15% CAGR from 2016-2020, it is expected to stabilize according to management since most of the Loss of Exclusivity (LOE) is behind the company in major markets.
Management:
The company’s Chief Executive Officer (CEO) is Kevin Ali who was previously at Merck, leading the global enterprise portfolio strategy and reporting to Chairman and CEO Kenneth Frazier. Kevin spent more than 30 years with Merck in different roles and was the president of MSD International, where he was responsible for the management of all commercial markets outside the US which amount to over half of Merck’s revenues and currently represent ~80% of Organon’s revenues. Kevin holds an MBA from Santa Clara University and a Bachelor of Arts from the University of California, Berkeley.
Matthew Walsh is the company Executive Vice President and Chief Financial Officer (CFO). Mr. Walsh joined Organon after spending 2 years as the CFO of Allergan, a global pharmaceutical company, and 10 years as the CFO of Catalent, a global provider of delivery technologies, development, and manufacturing solutions for drugs, biologics, cell, gene therapies and consumer health products. Matthew is a graduate of Cornell University, College of Engineering and received an M.B.A. from Cornell University, SC Johnson School of Management and is a CFA® Charterholder.
Capital Allocation: Organon raised $9.5 billion in debt through term loans and senior notes in USD and EUR. The average yield on its debt is ~3.8%. The company paid Merck $9 billion in special dividend and kept $500 million as cash on the balance sheet for general corporate purposes. Total debt stands at 3.4x 2020 EBITDA and the company is committed to Ba2/BB rating. The company is targeting a long-term sustainable leverage of below 3.5x and will focus deleveraging for the first 12-24 months of its operation. The company will have a dividend payout ratio in the low twenties (I am assuming 20%) which translates into roughly 4% current dividend yield. I expect research and development expense to be close to ~$300 million (in line with previous years). Capex was 240 million in 2020 or 4% of 2020 revenue and should be equal to that going forward.
Valuation:
To value Organon, I have built a DCF model with three scenarios in mind (base, bull, and bear). My base case scenario assumes revenue growth of 3% from 2022 after a slight decline in 2021 (in line with management guidance of low-to-mid-single digit organic revenue growth rate off of 2021 base). Growth margin kept flat at 65% (in line with historical average) and average operating margin of 38%. The base case scenario yields a price of ~$45 per share based on an exit multiple of 10 times earnings in the year 2025. My bull case scenario assumes revenue growth of 5% off of 2021 base through 2025 with 200 bps sequential expansion in EBITDA margin due to operating leverage as a stand-alone company. The bull case scenario has the stock valued at ~$79 per share assuming an exit multiple of 15 times 2025 earnings. My bear case scenario assumes a revenue decline of 5% CAGR through 2025, operating margin contraction to 35% due to unforeseen challenges and fierce competition from rivals and an exit multiple of just 5 times 2025 earnings. The bear case scenario yields a price of ~$14 per share. All scenarios assume a 10% Weighted Average Cost of Capital (WACC) up from 8% to increase my margin of safety. Some people might argue that Organon is a generic drug manufacturer and should trade at a similar forward P/E ratio to companies like Teva Pharmaceuticals (NYSE: TEVA) with a forward P/E of 4.22 or Vitaris (NASDAQ: VTRS) whose forward P/E is 4.41. However, I believe that those people are making the wrong comparison simply because although Organon derives 60% of its revenue from generic drugs, I expect this mix to shift more towards less than 40% over the next 5 years in favour of women’s health and biosimilars. Also, Organon has better margins than both companies and is not heavily leveraged like them too. Teva and Vitaris have both operating margins below 20% while Organon’s is above 40%. Additionally, Net Debt/EBITDA above 5 while Organon’s stands at 3 currently.
| Scenario | Bear | Base | Bull |
| Revenue Growth 2022-2025 (CAGR) | -5% | 3% | 5% |
| Average Operating Margin 2021-2025 | 35% | 38% | 40% |
| WACC | 10% | 10% | 10% |
| Exit P/E Multiple | 5x | 10x | 15x |
| FCFF Per Share | 13.91 | 44.49 | 78.60 |
Catalyst:
Management Execution: Management’s execution of its growth strategy in 2022 and beyond of increasing revenue by a low to mid-single digit number without pursuing expensive deals that are destructive to shareholders’ wealth will make the stock re-rate.
Risks:
- Patent expiration: Nexplanon represented 10% of sales in 2020 and its patent expires in 2025 in the EU and 2027 in the US where the majority of sales occur. However, given that the company was the first to launch Marvelon in 1981, the first lower dose estrogen oral contraceptive with a selective progestin, the launch of Livial in 1987, the first-non estrogen gonadomimetic hormonal replacement treatment, the launch of Follistim, the first recombinant follicle -stimulating hormone available in the United States for infertility, the launch of NuvaRing in 2001, the first once-a-month contraceptive ring, and the launch of Nexplanon / Implanon NXT in 2011, the first and only single-rod radiopaque contraceptive implant with preloaded applicator combined with $300 million expected investment in R&D mostly focused on women’s health (since biosimilar research is being taken care of by Samsung Biopeis) should mitigate this risk.
- Overpaying for acquisitions: Organon has a few patents in women’s health as a stand-alone company and might pursue acquisitions that are destructive to shareholders’ wealth if their R&D efforts doesn’t produce drugs with meaningful sales to offset expiring ones. This is the biggest risk in my opinion.
- Leverage: The company’s Debt/EBITDA stands at 3.5x currently. While it’s not alarming, I would love to see the company deleverage in the next 12-24 months as outlined in their presentation.
Conclusion:
Organon offers what I believe to be a very attractive risk/reward proposition. My bull case scenario yields a return above ~250% while my bear case scenario yields a return of (~50%). If management executes on its growth strategy starting in 2022, the stock should re-rate, compound at ~22% IRR through 2025. sell closer to my estimate of fair value of ~$72 in 2025 or $45 today.
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