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Growing appreciation for the long-term potential of the aesthetic market has lifted the fortunes of the three major players in this space, Allergan ( AGN), Mentor ( MNT) and Medicis Pharmaceutical ( MRX).

The shares of all three have performed well with about 10% gains year to date. More recently, the performance of Allergan and Mentor has begun to improve with the FDA's long-awaited approval of silicone-gel breast implants in late November.

I expect these companies to show improved top- and bottom-line momentum in '07 as a result of this key product approval. I believe the diverse and improving growth platforms of Allergen and Mentor offer greater investment appeal and lower risk profiles compared with those of Medicis.

The table below shows that the forward valuations of the three stocks in this group have all moved well above the specialty pharma group average at about 40 times this year's and 30 times next year's earnings. The group's near-term growth outlook is stronger than the industry average, but the risks have risen at these valuation heights, particularly if trends start to slow. However, the prospect for accelerating growth at Mentor and Allergan should continue to support their hefty share valuations.

Conversely, I expect the valuation and earnings performance of Medicis to come under pressure in the face of upcoming marketing challenges for its key Restylane franchise and a shortage of additional growth drivers.

Primed for Growth

Medicis shares plummeted in June on news of the earlier-than-anticipated approval of Allergan's Juvederm. This product competes with Medicis' important Restalyne product line in the dermal-filer segment. Medicis shares have since recovered and are now about 40% above mid-summer levels, despite the coming full-scale launch of Allergan's Juvederm in January.

Medicis has prepared for this competition with increased marketing and DTC advertising behind their Restalyne line, but share losses could be significant against Allergan's marketing power and bundling capabilities.

Allergan intends to leverage its strong relationships with dermatologists and plastic surgeons, as well as the dominant market position of its Botox franchise by bundling Juvederm with it. Medicis has the chance to match this full-scale facial assault with its own Reloxin/Restalyne combination, but Reloxin is not expected to reach the market until late 2008.

More recently, Medicis shares have benefited from the strong launch of their acne treatment, Solodyn and a blowout third-quarter earnings report. I expect more modest gains from Solodyn going forward, as prescription trends have started to flatten out. In addition, the company may need to further increase its marketing spending with the anticipated launch of another new acne treatment, Ziana, in early '07.

Meanwhile, I expect momentum to pick up for both Allergan and Mentor as patients begin to transition to higher-priced silicone implants from saline versions. Allergan and Mentor are the dominant players in this $500 million to $600 million global market segment. Most analysts expect 30% to 40% first-year conversion rates of the saline-implant market, but early gains may be greater, as a result of pent-up market demand. The anticipated switch to more profitable implants supports a strong revenue outlook and further margin upside for these two players in '07.

In addition, both of these companies have exposure to another high-growth aesthetic segment in the treatment of obesity. Allergan markets supplies for the Lap-Band procedure, while Mentor supports liposuction-related product lines. Allergan also has new product catalysts in the eye-treatment segment, which provides another important growth platform for the firm.

Overall, I view Medicis' growth platforms in dermal filers and acne treatments to be narrow and underpowered in the increasingly competitive aesthetic-market environment. Medicis has several aging product franchises that are facing decelerating growth. The company expects to offset this pressure through new product launches in the acne-treatment segment. I don't believe the company will be able to continue to manage a smooth transition, as competitive inroads are likely to disrupt this balancing act.

Big differences are starting to emerge for the group -- in terms of business diversity, competitive positioning and risk profile -- that should lead to divergent valuations going forward. As a result, I expect continued gains from Allergan and Mentor with the early benefits of breast implant conversions coming though in '07.

I expect a much more difficult road for Medicis in the early part of next year, as a result of Allergan's ability to market its Juvederm dermal filer with their market-leading neurotoxin Botox. This pressure should dampen expectations for Medicis' future growth, as it still has very sizable exposure and double-digit growth forecasts afforded to its Restalyne franchise.
At the time of publication, Michael Latwis held no positions in the stocks mentioned, although positions may change at any time.

Michael Latwis has directed health care content at Professional Products. He also has worked at Barclays Wealth management division and was previously associated with Lazard Freres and Fiduciary Trust. Latwis covered companies in the pharmaceutical and specialty pharmaceutical sectors as well as biotech, medical technology, healthcare services, retail and media stocks. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Latwis appreciates your feedback; click here to send him an email.