Elanco's $1.3 billion deal may give the animal health company more flexibility as product launches ramp up

Published Tue, Feb 6 20242:44 PM ESTUpdated Tue, Feb 6 20243:01 PM EST

Christina Cheddar Berk @in/christina-cheddar-berk-b864404/

Elanco Animal Health's decision to sell its aqua division will narrow its focus on pet health and livestock sustainability, as management prepares to launch several new products this year. On Monday, Elanco said it would sell the division, which supplies the aquaculture industry with medicines, vaccines and nutritional supplements, to Merck for $1.3 billion. After the deal closes, likely by the middle of the year, proceeds will be funneled toward debt reduction and the net impact will be a 20% reduction in Elanco's debt. "We're in the midst of launching our most exciting pipeline," Elanco CEO Jeff Simmons said in an interview with CNBC. Over the next two years, Simmons expects the company to launch six products that will each have more than $100 million in peak sales. ELAN 1Y mountain Elanco stock over the past year. Simmons said the decision to exit aquaculture followed a review Elanco conducted to find pockets of business with the greatest growth potential. One area it identified is pet health, a $15 billion market that has benefited from increasing pet ownership, especially among people who see their pets as family and value their animals' health care. The other area is an emerging market it hopes to develop around reducing methane emissions from cattle. A key piece of that strategy is the expected approval of Bovaer, which is expected in the first half of this year. Two other products are also nearing approval: Credelio Quattro, a combination parasiticide, and Zenrelia, a JAK inhibitor that will allow Elanco to add a dermatology product to its offerings. These drugs join a lineup that includes a monoclonal antibody to treat deadly canine parvovirus, a first for this disease. Zenrelia treats atopic dermatitis , which affects between 10% and 15% of the dog population, according to Cornell University's Richard P. Riney Canine Health Center. Simmons said the condition is a common reason for vet visits. 'Flexibility' to invest behind launches The product launches will also give Elanco a chance to prove itself. Last year, shares rose nearly 22%, but those gains followed two years of declines. According to FactSet, slightly more than half the analysts who cover the stock rate it a buy, and collectively have an average price target of about $16. With Monday's 7.9% gain, the stock closed only 2.2% below that mark. JPMorgan analyst Chris Schott reiterated his neutral rating shortly after the announcement Monday, but said the deal will provide Elanco with "more flexibility to invest behind upcoming launches." "More broadly, we see the focus of the ELAN story increasingly on the upcoming product approvals … and new launch execution (where we expect more gradual product ramps and are watching [operating expense] trends)," Schott wrote in a research note. In the short term, costs will likely be on the rise. For example, Simmons said the company has boosted its sales force 20% as it prepares to roll out new products. The asset sale will also put some pressure on earnings. The aqua business was responsible for $175 million in sales last year and about $92 million in adjusted earnings before interest, taxes, depreciation and amortization. In a research note, Jefferies analyst Glen Santangelo said the aqua unit fetched an "attractive multiple." Using proceeds to pay off a portion of Elanco's debt will cut interest costs by about $65 million a year, or about 11 cents a share in earnings. Simmons declined to provide further details about the company's financial forecast. Elanco reports its fourth-quarter results Feb. 26. Lower debt could make the company, which was spun off from Eli Lilly in 2018, more attractive to some investors. In late January, Argus analyst Jasper Hellweg said his firm would consider upgrading Elanco if it were to improve its balance sheet or show sustained improvement in its operating results. Hellweg currently rates the stock a hold. Ahead of Monday's announcement, the stock was trading at a discount to its three-year historical average price-to-earnings ratio of 14x, according to Jefferies' Santangelo. "We believe there is potential for multiple expansion from here, driven by continued strength from new innovative companion animal products … coupled with accelerating debt paydown post the transaction," he said. Jefferies has a $17 price target, which implies nearly 7% upside even after Monday's pop. Success in these new markets isn't a lock. The pet health business is very competitive and, once approved, Zenrelia will compete directly with rival Zoetis' Apoquel. Meanwhile, the role Bovaer could play in lowering greenhouse gases will take time to play out. Elanco has been working with farmers to track livestock methane emissions. The idea is that dairy farmers will purchase Bovaer, a feed additive, to lower emissions and then sell carbon credits to help companies, including large food manufacturers, meet their environmental goals. "This is probably one of the most anticipated products that I've seen in Farm Animal in 30 years as this could reduce methane by 30% in dairy and 50% in beef," Simmons said. "We see this as a product with $100 to $200 million potential in the U.S." "These are major markets, differentiated assets, higher margins as a whole, greater growth rates and it just allows us to concentrate our focus here. Then we see the next wave in these same spaces," he said. — CNBC's Michael Bloom contributed to this report.