Bausch Health is far from the LeBron James in eye care, so don't compare it to Alcon

After Novartis eye care spinoff Alcon made a successful debut on the Swiss Exchange earlier this month, some analysts used it as an argument to make a bullish case for Bausch Health. But one analyst disagrees.

Wells Fargo's David Maris, in a Wednesday note to clients, maintained his "underperform" rating for Bausch Health. His reason? An irreplaceable leader such as LeBron James in basketball or Alcon in eye care makes "significantly more" than others.

"Alcon has a long history of being a market leader and in some markets [Bausch] is a distant, and what we consider, an insignificant #4 player in ophthalmology, has growth supported by price increases, and is launching products that do not threaten the market leaders," he said.

Maris noted that the NBA superstar’s pay in the 2018-19 season is set to be nearly five times that of the fourth-highest paid player on his team. Therefore, he argued that applying Alcon’s EBITDA multiple to Bausch fails to consider the "mass and structural advantages" that a market leader has.

Such comparison seems problematic to Maris, as Bausch’s surgical business is much smaller than Alcon’s. To the Wells Fargo analyst’s estimation, Bausch’s largest ophthalmology product might be a vitamin.

But perhaps more importantly for Maris’ bearish estimate is the Canadian drugmaker’s meager commitment to R&D, especially in its Bausch & Lomb franchise, whose portfolio is more suitable for comparison purposes with Alcon's.

On very loose terms for illustrative purposes only, Maris calculated a Bausch & Lomb standalone—without the segment’s non-ophthalmology business—EBITDA of $1.14 billion in the year 2018, versus $906 million for 2012, which the company had disclosed in a go-public attempt.

At first glance, the number doesn’t look bad. But Maris noticed that the company was spending a lot less in R&D last year. The entire new Bausch & Lomb International business—with about $1 billion in 2018 non-eye-care sales—spent only $96 million in R&D in 2018, or 2% of its sales, versus $227 million in 2012.

Spending less obviously boosts EBITDA. If it had been paying for R&D like it was in 2012, the Bausch & Lomb's EBITDA would be merely $982 million, Maris said.

In comparison, Alcon, in its filing with the U.S. Securities and Exchange Commission, said it invested $587 million in R&D in 2018, representing 8.2% of its total revenues that year.

"To us this is critical to a valuation, and in our opinion, it is tough to be a leader if you spend so little in R&D," Maris said.

All told, Bausch Health’s R&D expenses for 2018 were $413 million, with a large part going to the drug business—which hasn’t exactly paid off. For example, its plaque psoriasis lotion Duobrii, which Bausch has dubbed among the "Significant Seven" drugs it’s counting on for growth, got an FDA Complete Response Letter last year. And the FDA has postponed its decision date on Bausch’s resubmission, the company disclosed in February.

Recently, the FDA approved competitor Cosmo Pharmaceuticals’ Aemcolo in travelers’ diarrhea, but that indication constitutes only 2% of prescriptions for Bausch’s top seller Xifaxan.

Still, "we think investors should ignore any straw man arguments that the lack of impact from Aemcolo on Xifaxan is good news for BHC as we are unaware of any significant investor worry about this threat," Maris said. And he cautioned that a potential positive phase 2 in irritable bowel syndrome with diarrhea could help Aemcolo eat away Xifaxan shares more significantly.

To sum it up? Maris said Bausch should trade at "a significant discount to peers […] based on low growth, underinvestment in R&D, and dependence on price increases and product concentration risk with Xifaxan."

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