A Drug Company Addicted to Growth

As America’s baby boomers grow older, complaints of chronic pain are on the rise.

A report released last year by the Institute of Medicine, one of the United States National Academies, found that about 100 million Americans reported suffering from some form of chronic pain in the past year at a total societal cost of nearly $635 billion. More people suffer from chronic pain in any given year than those who suffer from diabetes, coronary heart disease and cancer combined.

As chronic pain has become more prevalent in America, so have the opioid pain relievers most commonly used to treat it. Between 1999 and 2008, the sale of such drugs increased by 300 percent while the number of prescriptions written for them shot up from about 75.5 million to 209.5 million.

Unfortunately, opioid pain relievers act on the same neurological pathways as heroin, making them highly addictive and increasing the potential for abuse. It’s estimated that in 2011, nearly 2 million people in the US alone meet the generally accepted criteria for opioid abuse or dependence.

Amid the growing use and misuse of opioid pain relievers, the race is on to create effective, opioid-like pain relievers with lower potential for abuse.

Mallinckrodt PLC (NYSE: MNK), which resulted from Covidien’s (NYSE: COV) pharmaceutical business spinoff this past June, is leading the charge in that arena.

Mallinckrodt operates in several channels: it manufacturers active pharmaceutical ingredients (API), which it markets to other pharmaceutical companies; uses its APIs to develop and manufacture its own branded and generic drugs; and has a global medical imaging businesses that develops, manufactures and sells contrast media and delivery systems, including nuclear imaging agents.

Since the company’s spinout, it has made a modest gain of just 5.7 percent, largely thanks to the fact that the company’s 18! 0-day exclusivity period on generic Concerta has expired and will lose its protections next year. Because of that looming expiration, management has issued earnings per share guidance significantly below this year’s earnings.

The earnings downgrade has created an attractive entry point for investors to take advantage of four new drugs that the company will introduce to the market over the next 18 months or so.

Two new branded products, Xartemix XR and Pennsaid, have been submitted to the FDA for approval and are designed to treat acute and moderate-to-severe pain with abuse-deterrent characteristics that make them excellent alternatives to currently used opioids with high abuse potential. The company’s new formulation of its Concerta pain medication is also currently under review by the FDA and all three drugs are scheduled for launch by the end of next year.

According to data from Mallinckrodt, the acute pain market is valued at nearly $3 billion, with $1.2 billion worth of prescriptions written annually in the company’s target market. If it offers attractive alternatives to opioids, it can snag a large share of that spending for itself in fairly short order, particularly by targeting the specialized pain treatment practices that have sprung up around the country. Specializing in treating patients with chronic pain, those practices will be eager for less additive alternative pain treatments, which will ultimately reduce their potential legal liability.

Thanks to aggressive patenting strategies, Mallinckrodt will enjoy patent protections on its new products through 2032. Although they won’t render the company’s products bulletproof, those protections will at least reduce the potential for new competition to enter the market.

One of the company’s key growth strategies will be to heavily invest in research and development to exploit its patent portfolio in less addictive pain medications.

In addition to those new drugs, Mallinck! rodt also! has a few other competitive advantages that make it attractive. Through its generics and API businesses, the company currently holds a 40 percent share in controlled substances as defined by the Drug Enforcement Administration (DEA), through licenses it holds to manufacture those drugs. In particular, it holds a 32 percent market share of DEA schedule II and III opiate compounds.

Mallinckrodt is also the only non-Asian based manufacturer of acetaminophen, the active ingredient in over-the-counter pain relievers such as Tylenol.

Most significantly, about a quarter of the company’s revenues are generated by its nuclear imaging segment. This segment is one of only two manufacturers of generators that convert molybdenum-99 into technetium-99 in the US and one of only three in Europe. Given the extremely sensitive nature of that technology, the emergence of any new competitors in that field is extremely unlikely, especially in light of heavy regulatory controls in place.

Because of these existing advantages, Mallinckrodt should be able to hold its own in terms of earnings over the next year. At the same time, it will draw growing amounts of investor attention as its new products enjoy likely FDA approval.

Although its shares will likely remain volatile over the next few months, Mallinckrodt’s solid long-term prospects rate it a buy up to 56.