Tickers in this Article: MRX, VRX, AGN, JNJ, WCRX, TEVA, SLTM, IPXL, MYL
There are a lot of interesting talking points to take from Medicis Pharmaceutical's (NYSE:MRX) latest earnings report. The company certainly does deserve praise for how it has managed potential generic threats to Solodyn, as well as arguably maximizing what it could from its LipoSonix business. Looking ahead, there is certainly the possibility that Medicis can become a more formidable competitor to Allergan (NYSE:AGN), but shareholders may want to consider the likelihood that Medicis will be folded into a larger pharmaceutical company in the not-so-distant future.

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So-So Results for the Third Quarter
Although there was no glaring problem area for Medicis, this quarter, it was still not all that strong. Revenue rose about 4%, and came in basically at the bottom end of the range. Growth in the core acne business was light (below 1%), while non-acne revenue rose 12% on strong unit sales of Restylane and Dysport.

Profitability was mixed and a little confusing. Gross margin did improve almost a point from last year. Operating income looked weak (down 43%) on a huge increase in research and development (R&D) spending, but that is not the real story. Much of that R&D spending increase was in the form of upfront and milestone payments, while operating results also included legal settlements and write-downs. All in all, adjusted operating income was down 5% - still not an especially strong result. (To know more about R&D spending, read: R&D Spending And Profitability: What's The Link?)

Solodyn Still Drives the Bus
Medicis' management has done a good job of preserving its Solodyn acne business, and as well it should as this is about three-quarters of the company's profits. Like Warner Chilcott (Nasdaq:WCRX) navigated potential generic sales erosion by moving patients to different (patent-protected) dosages and formulations, so, too, has Medicis. So, while generic companies like Teva Pharmaceutical (Nasdaq:TEVA), Impax Laboratories (Nasdaq:IPXL) and Mylan (Nasdaq:MYL) are getting into the Solodyn business, the doses going generic are only about 10% of total scrips right now.

This is a good news/bad news situation. Sure, it's great that Medicis has preserved this key business, but it's still an Achilles heel. Sooner or later, these patents will go away. Just ask Forest Labs (NYSE: FRX) what happens when a company loses patent protection on major sales and earnings contributors.

Alternatives Have Plenty of Competition
Medicis is trying to diversify its business by getting into some of the same aesthetic markets as Allergan. Specifically, Restylane has done well, relative to Allergan's Juvederm, while Dysport is the only approved alternative to Botox. While Johnson & Johnson (NYSE:JNJ) hopes to enter the fray with its own drug (Purtox), that is likely a late 2012 event.

Aesthetics is a competitive business with its share of pluses and minuses. As it is usually out-of-pocket, reimbursement is not an issue, but consumer disposable income is - and this is not a great market for cosmetic procedures. It's also a business that requires a meaningful sales and marketing infrastructure; Medicis wisely decided not to compete in the liposuction business, and sold its LipoSonix assets to Solta Medical (Nasdaq:SLTM) for $35 million in cash and future payments.

The Bottom Line
Does Medicis have a bright future as an independent? It's hard to say, because management is very tight-lipped about its pipeline. Since so much of a specialty pharmaceutical's value is predicated on pipeline sales, that makes the fair value much more uncertain.

As a company with a fairly narrow focus, Medicis should be a mergers and acquisitions target firm. Valeant Pharmaceuticals (NYSE:VRX) is a name commonly tied to Medicis in the rumor mill, but it would not be surprising to see a company like JNJ, Teva or even Forest Labs consider adding this company. Although merger speculation has moved the stock, to some extent, there's still some value left here for shareholders wondering whether it's time to cash out or hold on for more. (To know more about M&A, check out: What Makes An M&A Deal Work?)

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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