Reason for comment

York Pharma have announced the acquisition of the sales and worldwide commercial rights to two dermatological products from the Belgian Pharmaceutical and Chemical Company Solvay for a total consideration of €28.5m.

The products are Flammazine® and Flammacerium®, both brands are established in Europe for the prevention of infection in burns and topical wounds. The agreement with Solvay entails the transfer of the brands, any IP and sales on a worldwide basis as well as an associated 5 year supply contract of finished product from Solvay.

These silver-based sulfadiazine (anti-bacterial) products are approved in 21 countries although sales of the product are concentrated in France, Germany, Belgium and Spain. York estimates that the global market for topical anti-infectives is valued around US$450million with the current sales of these products around the $17.2 million (£ 8.7 million) mark or a penetration of 3.8%.

To finance this acquisition, York has raised a three-tier financing equivalent to some US$ 55m comprising US$25m in senior secured non-convertible notes, US$23m in subordinated convertible debentures and £3.9m in equity through the placing of 8.9 million York Pharma ordinary shares at a price of 44p per share.

The debt, which carries a two year capital repayment holiday, has a coupon of Euribor (currently at 4.23%) + 11% with a cap at 16% per annum. The convertible debentures, which have an annual coupon of 10%, are payable in either cash or can swapped for newly issued Ordinary Shares (at market price) at York’s option.

Both the debt and convertible tranches entail the issue of warrants (3.24 million and 13.1 million respectively) to be issued at an exercise price of 44p and 52.8p respectively subject to shareholder approval at an upcoming EGM. These warrants, if authorised and issued, will expire in August 2013. The equity raised via an equity placing at 44p also entail the issue of 1.15 million warrants that are exercisable at 50p pursuant to a warrant issued in February 2004 (as amended in March 2004). The latter warrants expire in February 2009.

Objective’s view:

Although the ink is barely dry on this transaction but at this stage we believe the Solvay acquisition fits well into York’s developing strategic path. We view it as supportive of our previously published core valuation of £3.68.

Strategically, this deal makes eminent sense and is a step in the right direction in building a significant player in the specialty topical dermatology market. It is evident the market is unwilling (or does not care) to recognise the value-building exercise that is emerging with the acquisitions that York Pharma is undertaking. This apathy is reflective of current investor sentiment in the sector as well as more broadly in the AIM market.

In our view, this acquisition model works if there is the potential for price increases, as well as significant upside to the sales of these products through better geographic coverage in Europe and the rest of the world. The possibility of entering the US market is the big prize in this area; York are confident that this is the case.

The debt burden taken on to execute this transaction is significant, approximately doubling YRK’s enterprise value with the additional element being charged at a, credit-crunched, Euribor +11%. The cap at Euribor +16% provides some comfort. However, we tend to believe that it is unlikely that management would shoulder this burden unless there was a significant margin for error built into the acquisition model.

Our current forecasts for York assume that Abasol™ finally makes it through the MHRA in the second half and hits the market in 2009 followed by an 18 month roll-out into the rest of Europe. Given that assumption and if the Solvay product revenues at least match their recent run rates, then group sales could comfortably exceed £25m in 2008/9 and push through the £30m threshold the following year.

In addition there is the likelihood, reasonable in our opinion, of an upfront payment from a partnership and the potential approval of Abasol™ in the second half of this year. Overall, the potential in the near to medium term of both debt coverage and repayment becomes more realistic.

This is still only part of the way towards funding the £15.4 million in operating expenses that we have been projecting for 2008. However, the DDL product line currently generates, on our estimates, some £1m to £2m and we expect all cashflow streams to grow significantly over time.

The acquisition has been made at around 2.7x annualised revenues which we believe is not demanding for pharma products. An estimated 70% gross margin minus debt costs of some £1.7m would leave additional gross cash flow of some £4.2m – £4.5 million to fund operations and R&D.

As with the acquisition of DDL, this acquisition enables York to push more product through its now established marketing platform with a product line running at an annualised rate of around €10-11 million or £ 8.7 million (leading to circa 5 months of sales at a rate of around £2.5-3.5 million).

For all our previous comments on this company visit:
http://www.objectivecapital.co.uk/YRK.L.asp

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