The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.NEW YORK ( TheStreet) -- Generic pharmaceuticals as an industry has very favorable demand dynamics. Several secular trends are converging that will benefit this market. For one, governments and health care insurers around the world and especially in the U.S. are aggressively seeking out ways to reduce skyrocketing health care costs.
Par has a two-pronged strategy. First, it targets smaller and less competitive drugs to develop. By doing this, the company can beat its competitors in filing abbreviated new drug applications (ANDAs) with the FDA, which provides 180 days of marketing exclusivity after the branded drug goes off patent. This is huge in the generics business -- windfalls from high-margin sales in these 180 days can often generate several "normal years" worth of profits. The second prong of Par's generic strategy is entering into supply and distribution agreements with the maker of the branded drug to become the "authorized generic distributor." This gives Par a slight competitive advantage and also allows them to charge a bit more. On the downside, it usually requires Par to pay royalties to the branded maker. Par is not quite the slam dunk it would seem to be. The company is not targeting any of the aforementioned blockbuster drugs -- there is just too much competition for them. That is one of the big problems with this industry. Scale is hugely important to generating economical gross margins and maintaining the legal talent needed to succeed in patent challenges. At just $1 billion in sales, Par pales in comparison to Teva ( TEVA) ($16 billion), Sandoz ( NVS) ($9 billion) or Mylan ( MYL) ($5.4 billion), not to mention several similar-sized competitors. Once exclusivity periods end, competition usually floods into the marketplace, driving down sales and margins. A good example of this is Par's largest product: a generic version of AstraZeneca's ( AZN) Toprol XL (metroprolol). Par won the authorized generic agreement with AZN in 2006. Early on, competition was limited, and then there was no competition in the first two quarters of 2009, driving a 100% sales increase over 2008. However, Watson ( WPI) came into the market in late 2009, and since then an Indian generics firm has also entered. Pricing and volumes suffered. In the just-reported first quarter of 2011, metroprolol sales fell 65% over the prior year! Competition can also lead to cheating. In the first quarter, Par recorded a $190 million charge to settle claims of the company over-inflating the wholesale prices they report to insurers. The alleged scheme is that Par (and competitors) charge less to pharmacies and report higher selling prices to insurers. Since the insurer is reimbursing the pharmacy at a higher rate than they pay for the drugs, it's a nice reason for the pharmacy to choose Par's product over a competitor's.
This is a difficult company to value. It is hard to predict the effect of new competition on existing sales, and if Par will be able to win exclusivity. The firm reports 12 first-to-file ANDAs, two potential first-to-market opportunities, and plans five to seven new ANDA filings a year over the next few years. Revenues and profitability are very boom-and-bust. Par also has a branded drug unit called Strativa, but so far, this unit has been unprofitable, and probably will remain so for several years. There are a range of possibilities for Par, but a median case puts a fair value of about $40 on the stock. Since this is a very uncertain calculation, MagicDiligence has a neutral opinion. There are better Magic Formula stocks to consider. Steve owns no position in any stocks discussed in this article.