Given that we’re currently in an advanced stage of the economic cycle, we’ve been looking at attractive defensible businesses for our global equity portfolios. One such company we’ve recently added is Allergan. As a leading player in the aesthetics space and owner of the Botox brand, its growth remains robust – and not just from its more eye-catching cosmetic segment.
Allergan manufactures and markets pharmaceutical products worldwide. Its largest segments are aesthetics and eye care, but the company is probably best known for its leading brand, Botox. Other products include drugs used in the fields of gastroenterology, cardiovascular, women’s health, urology, infectious diseases, the central nervous system and dermatology.
Contrary to popular belief, Botox is far more than just an anti-wrinkle treatment – in fact, Allergan now derives more revenue from its therapeutic applications than from its cosmetic uses. The drug was first used by eye doctors to stop spasms – it freezes the muscles around the eyes. It was given government approval for this use in 1989.
Since then Botox has obtained multiple approvals, for neck pain (2000), removal of frown lines (2002), severe sweating (2004), muscle stiffness (2010), migraines (2010), overactive bladder (2011), and removal of crow’s feet lines (2013). In total, it now generates over US$3 billion in sales annually for Allergan.
In terms of cosmetic use, anti-wrinkle treatments are gaining in popularity in new markets, although the growth trajectory has slowed in the US, the largest market. Nonetheless, the American Society of Plastic Surgeons recorded 7.2 million anti-wrinkle procedures last year, an 819% increase from 2000.
COMPETITIVE ADVANTAGE
Despite a few years of disappointing performance, Allergan’s growth remains robust. Its competitive advantage remains in the brands it owns. In our view, the lacklustre performance largely relates to missed expectations for various reasons rather than poor operational performance.
There are of course risks in the pharmaceutical sector related to pricing, but we believe the market is overlooking a few factors:
- Made using bacteria, Botox is one of the deadliest toxins known to man. It has been reported that one teaspoon can kill an entire city of people! Strangely enough, this can be viewed as a competitive advantage, since Allergan has to produce so little of the active ingredient that it’s difficult for competitors to replicate.
- Drugs for aesthetic use are generally not covered by medical schemes. They’re paid largely out of pocket and are therefore largely protected from conversations about drug pricing.
- Allergan understands distribution, marketing and incentives. Doctors are trained to use Allergan products, and they get bundle discounts on various aesthetic products. In our view, the incentive to switch to cheaper products remains low for both customers and doctors.
‘OPEN SCIENCE’ APPROACH
The company follows an ‘open science’ approach. This means that instead of investing a large amount of capital into proprietary research, it looks for later-stage drugs that have a good chance of approval, and then buys these companies. Allergan therefore has a lower budget for research and development than traditional pharmaceutical companies.
Of course, poor acquisitions are always a risk, but we believe this risk is diminished in the near term as management engages in a strategic review of the business that highlights running the current operations well.
Three years ago, Allergan was valued at US$363 per share by pharmaceutical behemoth Pfizer (of Viagra fame). The US government quashed an attempted merger, and the share price has since slipped to below US$190. During this time the company unexpectedly lost exclusivity on a few drugs – and the negative sentiment around the pharmaceutical sector as a whole didn’t help.
In our view, this has created an opportunity to own one of the premier companies in the aesthetics space – a business with strong brands, coupled with good growth prospects.
