Mallinckrodt Overview Notes

Business Overview

Mallinckrodt is a global specialty pharmaceutical company that was spun off from Covidien in
mid-2013. Their products can be found in almost every hospital, diagnostic center, or pharmacy
in the US and they have a footprint in about 50 countries. About 2/3rds of MNKs sales are
generated within the US.
MNK operates in two main business segments (specialty pharmaceuticals and global imaging)
which each comprise 50% of Mallinckrodts $2.2bn in revenues.
o The specialty pharmaceuticals segment is further broken down into branded drugs (8%
of total revenues) and generic drugs (42% of total revenues). Combined with the
generic drug category is MNKs active pharmaceutical ingredients (API) division which
sells pharma inputs to other pharmaceutical firms.
o The global medical imaging segment is broken into CMDS (contrast media delivery
systems) and nuclear imaging. The former generates 27% of total revenues and the
latter generates 24%.
Covidien announced it would be spinning off MNK so that they could each pursue separate
strategic initiatives in addition to separate capital structures and compensation packages that
better align management incentives with shareholders. However, Covidiens main source of
revenue is its medical device segment which was experiencing growth while MNK was
experiencing generally flat revenue growth and was a lag on Covidien.
MNKs strategy going forward will be to focus on expanding its specialty pharmaceuticals
segment, mainly its branded portfolio due to its higher margins. The global imaging segment is
generating stable cash flows but the market is mostly saturated due to MNKs existing global
footprint in the developed world. It is difficult for MNK to penetrate emerging economies with
this technology since it is very capital intensive. MNK could only really hope to grow revenues in
this segment by capturing larger market share but revenues have gradually declined over past
two years.
In the drugs segment, MNK specializes in pain killers and anti-spasticity medications. In the
global imaging, it sells syringes with materials that can help contrast imaging and also nuclear
medical devices which help diagnose illnesses like renal dysfunction or cancer.
MNK has recently been expanding its pipeline through acquisitions, licensing, co-promotions,
and apparently less frequently through internal development.

Product Portfolio

June 2009 Exalgo, a pain management drug, was acquired for $10m and included under R&D
expense. Structured more like a license since future payments will be made upon achievements
of milestones. This will mainly go off patent in July 2014 and earnings should be adjusted
accordingly.
August 2012 Acquired rights to Roxicodone for $13.2m from Xanodyne. Unusual acquisition
since this is a branded version of oxycodone which is already off patent.
October 2012 Acquisition of CNS Therapeutics for $95m which added Gablofen to their
portfolio. This drug treats spasms originating in spine and brain.

Other drugs were licensed Acuform, PENNSAID, and MNK-395. The last is a product candidate
for treatment of osteoarthritis in the knees.
At the end of 2012, MNK received approval to manufacture generic versions of Concerta (ADHD
medication) in several formulations. It will have exclusivity to produce the sole generic version
for 180 days which will expire on some dosages during 2013.
MNK has one outstanding NDA, another drug which is about to have an NDA submission, and
another potential drug which is in phase III clinical development.
In the tables below, we see that the global medical imaging segment has stagnated and even
begun to decline slightly. Specialty pharmaceuticals have increased decently, which is largely
driven by their branded drug portfolio. It should be noted that the generic version of Concerta
doesnt show up in the top table because it was only first sold by MNK in 2013.

Speciality Pharmaceuticals Segent ($m)

Acetaminophen (API)
Oxycodone (API)
Hydrocodone (API)
Other controlled substances
Other
Generics and API
Exalgo
Other controlled substances
Brands
Specialty Pharmaceuticals
Global Medical Imaging ($m)
Optiray
Optimark
Other
CMDS
Ultra-Technekow DTE
Octreoscan
Other
Nuclear Imaging
Global Medical Imaging

2012
$217.7
$144.1
$130.5
$111.7
$244.8
$848.8
$91.9
$64.5
$156.4
$1,005.2
2012
$352.2
$48.0
$141.8
$542.0
$202.5
$78.7
$173.6
$454.8
$996.8

2011
$222.2
$154.1
$116.9
$107.9
$223.6
$824.7
$41.2
$43.5
$84.7
$909.4
2011
$374.9
$50.3
$170.3
$595.5
$200.3
$76.9
$187.3
$464.5
$1,060.0

Percentage
Change
-2.0%
-6.5%
11.6%
3.5%
9.5%
2.9%
123.1%
48.3%
84.7%
10.5%
Percentage Change
-6.1%
-4.6%
-16.7%
-9.0%
1.1%
2.3%
-7.3%
-2.1%
-6.0%

Competitive Advantages

Mallinckrodt boasts several comparative advantages, some of which I feel are more relevant
than others.
First, MNK describes their skill and experience in acquiring highly regulated raw materials. I do
believe this will help them to the extent it will keep COGS lower, but their API segment is
basically seeing flat revenue growth. Moreover, they are supplying raw materials for their

competitors which isnt necessarily a great strategic move. It does receive about 40% of the
allocation of controlled substances for their drug classes from the FDA, but this is the nature of
operating in the specialty pharmaceuticals space.
Secondly, MNK boasts of its deep regulatory relationships and knowledge. This is likely true, but
a necessity for any company that operates in the pharmaceutical industry as either a branded or
generic drug supplier.
Lastly, I believe MNKs strongest advantage is its leadership position in the nuclear diagnostics
industry. MNK is one of only two manufacturers of technetium-99m generators in the US which
requires deep technical expertise and the engineering of radioactive materials. However,
operating in such a narrow niche can have its disadvantages as well. In 4Q 2012, MNKs Dutch
High Flux Reactor experienced a shutdown which disrupted the supply of MO-99, a precursor to
technetium-99m. The VIC write-up estimates this caused a 30m drop in operating income
demonstrating that a glitch in the manufacturing process of such specialized materials can be
very disruptive and costly to MNKs business model.

Take Aways and Valuation

From the perspective of Covidien, I believe it made a lot of sense for them to spin off MNK as a
separate entity. Forced selling should have occurred as Covidien was a member of the S&P500
and MNK is not. However, the spin off occurred at $44 in July, and the minimum market
valuation was about $41.50.
A little bit less than 1/3 of its enterprise value is debt ($900M of $3.2bn). VIC analyst spoke over
the ability for MNK to lever up to optimize equity valuation for shareholders.

MNK has potential drivers for growth in the pipeline to offset the gradual decline in global
medical imaging. An application for one new branded drug is on file along with 5 new generics.
2 new branded drugs are in development.
o However, it is very unpredictable to determine if these drugs will be approved, when
they would be approved, and how much revenue they could possibly bring in. The new
branded drugs are reformulations (me-too drugs) of existing medications that have
been approved and Im not sure if this would make them less marketable. Perhaps they
would be more likely to gain approval if we know they have already passed safety and
efficacy testing.
The VIC valuation says that the company is 50% undervalued since it is trading at 8x EV/EBITDA
where comparable specialty pharmaceuticals are trading at 12X EBITDA. However, it should be
noted that of the business is dedicated towards diagnostic imaging which is shrinking and only
4% of the entire business is currently dedicated towards branded pharmaceuticals. Beyond
that, many of their drugs are licensed or acquired externally, rather than generated internally.
Due to the idiosyncratic nature of each pharmaceutical company, I dont particularly like using
the comps method for MNK.
Initially - at a P/E ratio of about 45 and no clear line of sight into safe and secure growth
initiatives, I instinctively feel MNK might be currently overvalued.