Tickers in this Article: MYL, TEVA, NVS, PFE, IPXL, WPI, IPCI
Quite a lot of attention has gone to Teva (Nasdaq:TEVA) recently, as investors have tried to digest the impact of potentially greater competition in multiple sclerosis and the company's acquisition of Cephalon (Nasdaq:CEPH). While Teva has its own merits, investors may want to spend a little time on Mylan (NYSE:MYL), Teva's considerably smaller competitor. Though there is a risk that investors are underrating the patent challenges coming after 2013, growth and valuation may be more interesting here.

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A Solid Start to the Year
Most analysts seemed quite pleased with Mylan's results and that is something of a mixed bag itself - happy analysts are better than angry analysts, but Mylan is already a well-liked and widely-owned stock. Nevertheless, the company did report 12% overall revenue growth, with the company's small specialty pharmaceutical business adding a small above-trend kicker (up 14%). (For related reading, see Teva And Cephalon Solve Each Other's Problems.)

While U.S. revenue was up a very strong 22%, overseas performance was much more mixed. Growth of 10% (constant currency) was alright, but European revenue dropped 4% in constant currency. Mylan is presently suffering through some European government pricing cuts, and they are certainly not alone in this regard, but building overseas growth has often been something of a challenge here.

There was better news on the profit side of the ledger. Gross margin improved 80 basis points as reported, and also rose about a full point on an adjusted basis. Likewise, operating income rose by whatever numbers an investor wishes to use; up about 7% by GAAP, up 19% by the company's adjustments or up 23% by some alternative adjustments.

Good Outlook for the Next Two Years
Mylan is in good shape to enjoy the end of what has been a pretty remarkable wave of patent expirations in the pharmaceutical space. A generic form of Novartis' (NYSE:NVS) Femara should be one of almost 90 new launches in the U.S. this year, and upcoming generics for Lexapro (from Forest Labs (NYSE:FRX)), Lipitor (from Pfizer (NYSE:PFE)), Actos (from Takeda) and Diovan (also from Novartis) should offer a meaningful bump to revenue.

The question, though, is what then? Major drug patent expirations fall off after 2013, and that could make it more difficult for Mylan - at the very least, there is likely to be more competition to be first-to-file for the smaller pool of major branded drugs. By the same token, Mylan's size could be some help; relative to giants like Teva and Novartis (the Sandoz generic unit), Mylan needs less incremental revenue to post good growth rates. (For more, see Tepid Teva Somewhat Tempting.)

Challenges and Opportunities
Like Teva, and to a lesser extent Impax Labs (Nasdaq:IPXL), Mylan is likely going to look to build its branded drug business. The company's EpiPen business has been exceptionally successful and it would make a lot of sense to find (or develop) similar highly-focused specialty drugs.

Of course, nothing ever comes easy in the generics space. Mylan recently lost litigation against the FDA concerning Ranbaxy's upcoming launch of Lipitor. It was quite frankly a Hail Mary case, but the details of the matter (including Ranbaxy's allegedly grievous compliance issues) and the lack of clarity from the FDA are still a reason for some concern for anybody in the business. (For more, see There Is Nothing Generic About The Profits.)

The Bottom Line
It seems fair to wonder if there will be more M&A activity in this sector. Mylan, Watson (NYSE:WPI) and Impax would all look like credible targets for a company looking to establish a presence in generics or boost their scale. That could interest any number of drug companies including Johnson & Johnson (NYSE:JNJ) and Sanofi-Aventis (NYSE:SNY).

Barring acquisition, it may make sense to look at generics that have some sort of edge to them. Hospira (NYSE:HSP) isn't really a generics company, but it nevertheless has an interesting opportunity in high-barrier generics like biosimilars and oncology. At the other end of the scale, a company like IntelliPharmaCeutics (Nasdaq:IPCI) has some appeal as a risky growth idea.

For Mylan, though, it is all about growth and a reasonable price. Mylan has been an underperformer when it comes to returns on capital and free cash flow margin, but if management can pick up the pace, investors should consider picking up the shares. (For more, see 6 Drug Companies With Expiring Patents In 2011.)

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