Viatris Inc. (VTRS) Earnings Call Transcript & Summary

Good afternoon. Welcome to the Viatris presentation at Raymond James' 43rd Annual Institutional Investor Conference. Viatris is an emerging global pharmaceutical leadership name, formed via the combination of Pfizer's legacy Upjohn business and Mylan's global generics and specialty branded products business. From the company here today, CEO, Michael Goettler; CFO; Sanjeev Narula. Michael?

Yes. Thank you, Elliot, and thanks for inviting us. Just wanted for those that are not that familiar with the name, summarize a little bit. We had -- about a week ago, we had an investor event, and I just want to summarize what we announced. We announced, number one, a deal with Biocon Biologics on combining our biosimilar business in return for up to $3.335 billion, $2 billion upfront and then some participation in 12.9% stake in the future company. That's a deal that is, number one, creating a vertically integrated biosimilar champion. We think it's very important. There's a strong investor logic there, but also unlocking significant value. The implied multiple of the deal is 16.5, and we're trading at significantly less than that, even more so after the event on Monday. So hopefully, we can clarify some of the points that we made. We also announced that we plan to monetize additional assets that we think generates another $4 billion to $6 billion in pretax proceeds. So all in all, that's the $9 billion in pretax proceeds. After tax and after debt pay down, that leaves us $4 billion to $5 billion in investable proceeds and -- that we can use to return value to shareholders or share buybacks or if we have cases in business development, R&D, to beat that other things, but share buybacks, that definitely is the primary one. Number two, we announced strong '21 results as well as guidance for '22. That guidance came in lower than expected. So there was disappointment, a difficult message to convey, and we can talk about that. And number three, we clarified for the longest time, we've been saying we want to move up the value chain as this business evolves, move the value chain. We specified how we intend to do that and which therapeutic areas we want to invest in, and that was the other part of the announcement. So these are the 3 things. I think there are a lot of things that need to be clarified. And Elliot, appreciate the opportunity to be here and have the chance to clarify some of these.

No, absolutely. Well, I think it's fair to say that there's a significant disconnect between the message the company was trying to convey and market's interpretation of that message. And I guess it kind of falls along a couple of different fronts. I mean, first, obviously, is capital allocation and where that -- what are you going to prioritize in terms of discretionary cash flow and use of proceeds from asset divestitures. Markets, of course, are -- we're anticipating a much stronger message with respect to share buybacks, which was not the interpretation that people came away with, at least from our conversations with investors who are much more concerned about the deployment of proceeds into what they see as higher-risk development stage assets. So maybe we can talk a little bit about in terms of capital allocation and prioritization, where share buybacks fall relative to investments in proprietary assets.

And that's really the first thing to clarify. I mean, look, the case to beat without any doubt is share buybacks. We talked a lot about R&D and BD and where we want to focus. I think the message really got lost. But the case to beat, no doubt is share buybacks. You can't argue with the math. You take the $4 billion to $5 billion, if you invest all of that, hypothetically, into share buybacks, right, I mean the EPS accretion would be very, very substantive. So that's what the Board is going to hold us accountable for. That's what we want to do is every BD investment that we make, every R&D increase that we're going to make has to compete with that for the dollars.

And Elliot, I think that's -- building on that, I think that's what is critically important for people to understand. Once we pay down our $6.5 billion of debt, which the base business covers the $8 billion generation on the Phase 1, and we have this extra cash and focus on share buyback. We want to pivot the company from EBITDA to EPS. And the intention would be to look at EPS, adjusted EPS accretion as we go forward from not only this cash, but going forward as well.

Okay. And so how should we be thinking about capital allocation strategies vis-a-vis the dividend versus share buyback?

So let's just step back. So when we set up the company, Viatris, we clearly laid out that this is going to be a TSR-focused company. So we wanted to have a strong balance sheet. We gave a commitment. We want to have an investment-grade rating company that required 2 things: paying down $6.5 billion of debt; and then initiating dividend, which we did last year. And then we recently announced in January, growing the dividends. Those 2 were the tenets that we laid out in terms of returning capital to the shareholders, and we are on track. We are on track, as Michael pointed out. In '21, we paid down $2 billion of debt. We initiated the dividend. We paid $400 million of dividend. So the phase 1, even without any of these divestment of biosimilars, we are on track with our commitments we said. Now with these divestments, starting with the biosimilar deals, that accelerates our commitments. We're talking about $2 billion of additional cash pretax in fourth quarter that was not kind of in the base business. That then allows us to accelerate paying down some debt and also have flexibility for buying back shares or doing anything in the fourth quarter. So dividend will still be an important part of that, but now we are adding share buyback on top of that as an important way to return capital to shareholders.

And really the moves we did to -- or we announced to unlock value, the Biocon deal and the additional investment, really accelerates that. We always said dividend, we initiate dividend, we raise the dividend already once, right? That's part of the strategy. We said we would consider share buybacks after hitting the investment grade 3.0 leverage, right? Originally, we said 2.5. Now these deals and unlocking our value allows us to accelerate that, accelerate our achievement of Phase 1 commitments as well as start returning value to shareholders.

And the other thing, Elliot, I think what we probably could do a better job in communicating is the strong cash flow generation of the business. We said in Phase 1, we're talking about generating over $8 billion of cash. We are on track with that. We generated $2.5 billion, $2.6 billion. We're on track of increasing the free cash flow generation this year. And then that allows us to meet our commitments. So very strong cash flow that is coming from the base business before we talk about this additional cash flow.

Okay. So just going back to the dividend and the dividend policy. Would it be reasonable to expect the dividend to continue to grow in line with free cash flow? Or given what obviously seems to be a significantly higher ROI from share buyback that, that seems to be far more compelling than...

So I don't want to get ahead of the Board of Directors. So we increased 9% dividend, which is $0.12 per quarter. And clearly, we've said that the intention is to grow the dividend in absolute value. What that percentage is and how the -- I'll let the Board decide next year. But right now, for this year, we're committed to $0.12 each quarter.

Okay. So I think other areas of concern that emerged post the investor event and conference call so with respect to asset divestitures and expected proceeds, which seem to carry a much higher multiple than the company as a whole is being valued at in the marketplace. So there's concerns that those numbers may be too high relative to what you're ultimately going to realize.

No, we have confidence there. I mean, so again, the process we went through as we -- as we promised in 2021, we do a thorough strategic review. We view the entire business, we looked under every rock. Part of that came out to biosimilar strategy. We saw the potential to unlock value as well as set the company up for success. Part of that also we defined where we see the company in the future. It's going to be a company that's balanced, consisting of generics, complex generics, off-patent brands and then a small but growing kind of more novel portfolio of 505(b)(2)s and NCEs, right? That's how we saw the future. And then we look at all the assets that don't fit into that future and where we have opportunity to unlock value, right? That's what we will go after. I know there's a little bit of disbelief because we haven't announced what they are. But you also have to understand we can't because there's integrity of the process. And just like we did with biosimilar, at the right time, we will reveal what those are. We worked with external advisers. We work with bankers to make sure we have reasonable multiples that we put on these, and that's what we're going to execute against.

These are good businesses. They are, as Michael pointed out, they are not core to where we want to be. Plus the value of these businesses is better in hands of somebody else. That's the determination, and that's why we feel confident about what we came out with the proceeds.

Okay. And then with respect to the innovation strategy, I mean, you keep referencing 505(b)(2)s and NCEs. But I'm assuming that biologics are also part of the set of possibilities?

That's a good catch. I mean, I wouldn't exclude biologics as a modality. I think what we try to focus on is what are the areas, the therapeutic areas that we see opportunities that fit our specific set of capabilities, our development capabilities, our manufacturing capabilities, our regulatory capabilities and the kind of competitive set and the availability of assets that are out there. But again, everything we do in that space needs to compete with share buybacks.

Okay. Can we step back or pivot to a decision to divest the biosimilars business? While it's difficult to argue that you were able to capture an extraordinary multiple for it, particularly relative work, the company as a whole trades. I mean, that business, in particular, had sort of been positioned as a key long-term growth driver. Legacy Mylan and then combination Viatris was envisioned to be a leader in this marketplace. I understand that it's a relatively low margin because of the profit split with Biocon, but it's also faster growth. So one could make the argument that somewhere down the road with faster growth, that business may contribute a much higher portion of operating income growth. And you may get a benefit across the entire business with respect to valuation upgrades. So I'm just sort of curious how that -- the process and ultimately sort of what led to the decision to...

Yes. Look, as I said, it's the outcome of the strategic review that we did. And the -- I think the key insight there and that starts with that is the business and industrial logic, right? And we see the biosimilar business is maturing. It's not in its infantile state anymore. The competition is increasing. And to be successful in this business in the long run, just like you had many, many years ago maybe in the generic business, right, vertical integration, we think, is the key to do it, right? So they have the lowest cost structure possible, you have the flexibility, the speed of reacting, et cetera. Now to get that vertical integration, you really have only 2 ways to go. Either we build it ourselves, that will be a very, very long process, very capital intensive, takes -- to build the factories and develop the cell lines and all of that or go the route that we did and create that biosimilar champion together with Biocon and still continue to participate in. We have a 12.9% stake in the company. They're hopefully going to have a very successful IPO. We're still connected with them. We have a Board seat. So we're still participating in the business just in a more optimized way.

And one other thing, Elliot, just to add to that. By having a vertically integrated company, you are actually reducing your execution risk because you have the end-to-end responsibilities in one company, and you can manage that. And therefore, we believe this is the right way to kind of move forward and grow this business.

Okay. And with respect to realization of proceeds, that transaction is expected to close...

End of this year. End of this year, which would then trigger the first $2 billion in payment, right? And then we get the roughly $1 billion, 12.9% stake. And then we have the opportunity to participate in the IPO when it comes later.

Okay. And that also opens the door to a share repurchase?

Right.

Yes. It does, yes.

So again, what we are going to do this $2 billion post tax, roughly about 1.6. We're going to pay down some debt, short-term debt, and then we'll have cash, which we'll then evaluate share buyback in the fourth quarter.

Okay. So based on conversations with investors and analysts that you've had since the announcement and event last Monday, what's your read on sort of the general receptivity to the decision to divest the biosimilars business?

I think the Biocon part of it has been very well received, right? It's clearly value unlocking. I think the logic is clear. We're creating this virtually integrated champion, unlock the value for Viatris and bring in these financial flexibility, starting to bring the financial flexibility that allows us to accelerate what we set to do on Phase 1 as well as then accelerate share buybacks compared to what the base plan was. So I think that has been well received. The confusion has been around, I think, as you pointed out, the capital allocation priorities, right? What comes first, what comes second? I think we hopefully have the chance to clarify that. And I think there's also been some confusion around the new therapeutic areas that we're going to move in, why we picked those. And somehow there's impression that we're going to become a binary risk biotech company now, which is furthest from the truth, right? We're still going to be a very diversified business. We keep that strength in us. But we have to keep moving. We have to keep moving up the value chain. We picked areas that we think particularly fit our capabilities, and we see opportunities to develop [ the usual ].

Sure. And we should explore that in a little bit more detail in terms of why you ultimately settled on those areas. You continue to reference an innovative strategy, an R&D-based strategy. I guess my assumption would be far more D than R. I'm not sure that message has been properly conveyed.

You couldn't say it better, Elliot. You couldn't say it better. I mean, there's no doubt we are -- and we try to say that in the presentation. We are a development powerhouse. We're not going to go into early case research. All we talked about is late-stage assets potentially and development, absolutely. And it's not that new to us. I mean, you look at Yupelri, for example, as a product. That's a $250 million product now, right? It's partnered, right? So we're sharing the profitability on that one. But it shows that we have the capability to develop these assets, move into them, promote them and launch them very successfully.

True. And you do have those examples, and I think a lot of that's probably been hidden just kind of underneath the size and complexity of the company. So it'd probably be good case studies to show markets at a future point. I mean, look, the other issue that investors have with the strategy, frankly, is just sort of the communication of significant acceleration in R&D and mainly just D spend, going from 3.5% of sales to 9% and then potentially reaching numbers of $1.4 billion. I mean, that's a -- it's a lot of additional incremental R&D spend. And people...

Yes. I think we should clarify that as well. I mean, the 9% was meant to be directional. And obviously, as with everything else, subject to competing with what we do with share buybacks, right? That's -- so it was a directional estimate of saying, look, this is -- if we do what we want to do and we bring some of these assets and we may want to -- may have to do it in the future, but not necessarily at the expense of EBITDA and certainly not at the expense of EPS accretion.

I think that thing got missed out that the investment that we're talking about in R&D, we have to be sensitive about what does that do to the P&L and the earning potential of the company. And that's why it's an illustrative and a direct number, but we've got to be mindful of how we invest and where we invest.

Sure. And then I guess the other -- obviously, not time to do this in the course of a 1-hour conference call, there's a lot of information. But we didn't really talk about deal structure either, right? So I think people look at that and assume that's kind of sort of a new long-term natural base of spending versus the possibility of having a lot more bio box-type structures in there with respect to simply success-based milestones.

There's the opportunity to get creative with this, right? I mean, look, for example, at the one deal that we announced, which is for Blepharitis, molecule Pimecrolimus, which we're very familiar with, right? That was a deal structure where we essentially pay $40 million upfront, right? We have 0 development risk, right? And we have an agreed-upon formula at which we can acquire the license at the end when the Phase III study is successful, right? So that's a creative deal structure, takes out this binary development and scientific risk, but allows us to move forward an area in a very strategic way.

Sure. And I'm -- I would like to explore a little bit more in terms of why you selected the areas that you did, particularly, I guess, dermatology and ophthalmology. I mean, traditionally, more specialty pharm-type markets in the U.S., but a lot of the innovation there has come from big pharma. And if you think about some of the higher-value therapeutic areas, atopic derm, psoriasis, wet AMD and DME, those are all very competitive areas. And you're going against the best in the world in those disease states.

100%. And -- but let me tell this. There's a lot more to ophthalmology and dermatology in those areas. There's wet MD, dry MD, that's where the VEGF inhibitors compete, right? I don't think that will be the area we want to move into, right? Or the I&I assets, whether it's Humira or a JAK inhibitor in psoriasis, that's not the area where we want to compete. We explicitly don't want to compete with big pharma. There's a lot more. Take -- there is dry eye, there is Blepharitis. There are other dermatology indication. There is other innovation. If you look at it, there's about 80, 90 to 100 Phase II, Phase III assets in each of these areas, right? 70%, 80% of those are developed by small mid-cap companies. Though it's not necessarily something we have to go up against big pharma. It's a very specialist-driven area. You can deal with very small sales forces. You can cover the U.S., for example, maybe 70 reps. You need to cover it. You have small clinical trials. You have clearly defined endpoints. You don't need outcome studies. You often deal with -- that's why I kept emphasizing 505(b)(2) as you often deal with existing molecules that kind of repurposed, reformulated. We have a lot of reformulation expertise that we can bring to bear, right? And again, working with an existing molecule decreases a lot of the risk. And you have moderate probabilities of technical and regulatory success. That's why we picked these areas because they have these specific characteristics. Are we going to go after all 3? Probably not. Maybe one of them, maybe 2 of them depends on the opportunities as we find them.

We heard the message from a lot of your shareholders that they would like the company to remain a little bit more agnostic in terms of evaluating opportunities. I think your global platform gives you a lot of flexibility in terms of asset selection and rather than sort of defining yourself out of the gate in those 3 periods.

100%. And again, this is -- it's a direction for the more novel products where we'd like to move if you launch global assets that you need to have that focus. But it doesn't mean we walk away from regional deals. We have a lot of regional strength in -- different strengths in different regions that we can find a way to complement. We can do distribution deals. I mean, there's a variety of things that we can address through the global health care gateway. But again, I think the key message that we have to get out today is capital allocation priorities, and that any of these deals need to compete for dollars with share buybacks. That's the key message.

So as you look to build assets and a pipeline in that area, do you have the deal team in place that you need to have in order to become the leader in those areas?

We've got a very strong and experienced business development team that we're very proud of. We have the expertise in commercial development to generate some of these. And we're going to look at continuing to strengthen that as we go along, yes.

Okay. I want to go back. I've got to ask a question on the Biocon transaction. So you're holding mandatorily convertible preferred shares. What's the holding period?

There's none.

There's no holding period. We have free to transact after the IPO. We'll obviously evaluate the marketplace at that time and make a decision.

Okay. And then I assume that with the proceeds that are generated from asset divestitures that you'll be equally open to asset acquisition as opposed to pipeline development, perhaps not company, not platforms, but asset acquisition...

Yes, I think we're agnostic about it, yes.

But again, I think the case to beat there is share buyback. We keep talking about that. I think with the valuation that we have, the mandate that we have, I think that's going to be our primary focus area. Clearly, everything else that comes into play, whether it's the business development, R&D assets, we'll have to compete against that.

It's a very high ROI. At these levels, it's going to be challenging to find...

The math is undeniable.

Innovative investments that exceed that. Okay. Maybe we can switch gears and just kind of talk about base business trends, what you're seeing in terms of potential supply chain issues, inflationary pressures and how that impacted the guidance for 2022.

Yes. So I think -- look, obviously, it's very -- it's not an easy decision to come out with guidance, especially after we emphasized the floor so hard on $6.2 billion, then come out with lower guidance. And I think what I want to say is the base business has not changed. The kind of what you see in the base erosion of the business, offset by the very strong pipeline that we have of $600 million more with the biosimilars, maybe $500 million a year in new product development, the synergies we can generate. None of that has changed. What really has triggered is the incremental additional inflation that we saw really that we became aware of towards the end of the year as well as inflation that we saw towards -- let's say inflation rise, exchange rates and inflation, those 2 of the things that triggered this. But look, the thesis has overall not changed, right? The cash flow generation is very, very strong. The base business without any of the divestitures, we're still paying down the debt. We're still generating over $8 billion in cash. We're still being able to deliver and grow the dividend. And then the deals come on top of that, able to accelerate that. And then as Sanjeev pointed out, we intend, after the debt paydown, to convert this to an earnings per share company and a significant growth that's possible, significant accretion possible with earnings per share with the strategy that we laid out.

Okay. And I don't know if you talked about the cash flow impact of the biosimilar divestment along with the potential asset divestiture.

Yes. So sure. I could talk about that. So the cash flow guidance we gave this year, $2.7 billion, that's an increase from '21 and that includes biosimilar business. We'll probably close at the Q4. So there's going to be some impact of that. So I think the way to think about cash flow is in 2 steps. First is on Phase 1, if we hadn't done these deals, we are on track to deliver $8 billion of cash for 3 years, which is what we said before. And that meets our commitment to $6.5 billion of debt, gets us -- maintains and strengthens our investment-grade rating and continues to pay dividend and grow dividends. So that kind of meets that. Now with biosimilar deals and the other deals, we are accelerating the cash -- the sales proceeds. So we're getting after paying down -- after the tax and after paying down the incremental for the debt, $4 billion to $5 billion of incremental cash that we have by the end of '23 or beginning of '24. Now that's what we have. So it's obviously going to be some EBITDA impact as you're divesting this business, which we tried to lay out on that Chart 15 on our investor deck if you look at it. It's like talking about a $15 billion company with $5.3 billion EBITDA on a pro forma basis, right? So that's kind of the new company base that we're talking about. But I think the important thing, Elliot, to look at it is at that time, once we finish our Phase 1 commitment, we want to pivot to EPS because we want to look at these proceeds and focus on growing EPS and focusing on the earnings because it's going to be a different profile of a business because after the divestment of that. So that's kind of how we want to look at that. And the last thing I want to say, again, with the biosimilar, we -- at the end of this year, we're in a far better position from a cash flow perspective and flexibility perspective than we were there before.

Can you -- so outside of additional incremental investment in innovation, can you just talk -- maybe highlight some of the key assets in the portfolio that you think are potential significant contributors that investors probably don't fully appreciate?

Yes. Look, we have a very, very strong pipeline. I think the track record speaks for itself if you look at the number of first that we have and what we develop. And I think on the investor event, we laid out for the first time very transparently what the key assets are and even launch timing. We never communicated launch time before. So you can model it. But let's go through the portfolio. I'll take biosimilars aside for a moment because, obviously, there's still, assembly is still in this launch phase. There's a lot to talk about there. But talk about the core generic portfolio. You've got products like Revlimid coming in '22, Gilenya, Xarelto, right? There's big products that are coming into the pipeline. On the complex side, you have things like Symbicort, for example, coming in 2023, right? So there's -- we just got Restasis approved, first company to get Restasis across the line. So there is a strong also complex area. And then we have some life cycle products like Copaxone once monthly, levothyroxine oral suspension. So it's a strong pipeline. We don't have the binary risk. We don't have one product that makes or break the year, right? It's broad spread, but here's the interesting statistic I want you to take away on the pipeline. 95% of what we expect in new product revenue to come in '22 and '23 has either already launched, approved or at least submitted. So we have high confidence in delivery of that pipeline.

And take note, even after biosimilar, that pipeline on an average will deliver about $500 million of top line on an ongoing basis year after year. And that will then offset the base business erosion and puts that in a good spot.

As you -- so you've identified a range of assets or businesses to be divested. How will those -- just from a high level, how will those divestments impact what you see as sort a longer-term base business erosion trends?

Yes. So if you look at just on the assets that we've identified and look at on a pro forma basis, right, we get to -- if you look at the chart, we get to a company which is about $15 billion on the top line and about a $5.3 billion EBITDA. That's just taking into account the divestment. The base business erosion that we talked about on that and the new product revenue, that's the focus that we have in terms of going up the value chain, so you have a higher gross margin, more durable products that can then offset the base business erosion. And we have a stability on the revenue as we go forward and then continue to focus on the cash flow that we have, which will then drive us -- all our capital allocation priority.

Okay. And I know we're shifting to an adjusted EPS focus, but I'm going to turn -- I'm going to go back to cash flow. And if you could just highlight, once again, sort of the onetime transitory costs that are still kind of flowing through the cash flow statement and how that may trend over the next...

Right, right. So obviously, as we brought 2 companies together, we announced the restructuring in fourth quarter of 2020. And then we have the integration and the TSA exit, all that requires onetime cost, which we obviously estimated that. We had onetime cost in last year. That's trending to come down if you look at the guidance we gave this year. Before the legal settlements and all that, that's about $900 million. It's part of our disclosure, that we had expected to come down significantly next year as we finish these onetime restructuring and the impact. Going forward, beyond 2024, we're going to have a normal onetime cost, which are mostly on the profit share payments or some of the legal settlements. But all the bulk of major restructuring costs and some of those will go away. Now the other thing that onetime cost that's going to happen because of some of the divestments, the net cash proceeds that we're talking about $4 billion to $5 billion is after assuming those onetime costs. So you can see that. And that actually will then drive the cash flow to go up on a base business. And then obviously, we have additional flexibility from these divestments.

Cash flow certainly is one of the highlights of this business, right? And we significantly exceeded what we guided and what expectations was for '21. For '22, we guided at $2.7 billion, but that includes $260 million in the EpiPen settlement. So kind of the underlying real cash flow is about $3 billion. So it shows you the strength that we have. We're clearly on track of generating over $8 billion in Phase 1 just with the base business that we have. The divestitures, the cash generated from that comes on top of that and gives us really very significant financial flexibility.

Okay. All right. Thank you. Appreciate your participation.

Thank you, Elliot.

Thank you.