SkyePharma, Drugged Up And Burdened With Debt

SkyePharma (SKP.L) compared to better known UK pharmaceuticals is small, tiny in fact. Think of it as a GlaxoSmithKline (GSK) mini-me with profit potential yet unfulfilled. So bite-sized is SkyePharma, compared to GSK and AstraZeneca (AZN), that either of the drug goliaths could buy it with a month’s loose change from the sales of just one their better performing drugs.

So SkyePharma’s management, having formed the firm relatively recently in 1996, presumably spend half their time developing new drugs to build on the current portfolio of twelve products, and the other half of their hectic diaries gently flirting with the industries big fish. That presumption, pure speculation on my part, implies SkyePharma would rather be a small part of a globally significant operation rather than a solitary and small player in control of its own destiny.

Everything has its price so time will tell. In the meantime speculators can focus on SkyePharma’s latest results which offer mixed guidance with the enigma of ‘exceptional items’ being the difference between healthy profits or painful losses. Pre-exceptional items, for the six months ending 30th June, SKP made a profit of £4.9m. Post exceptional items a loss (£6.1m) occurred.

Exceptional income of £5.0 million arose as a result of reaching agreements in July 2009, with Novartis and with a subcontractor, on the immediate termination of the contracts relating to the Foradil and Certihaler products. These termination agreements follow the decision not to proceed with US commercialisation of Foradil Certihaler, previously announced in December 2008. Following the termination, SkyePharma retains exclusive rights to seek alternative uses for the SkyeHaler multi-dose dry powder inhaler, used in the Foradil Certihaler.

Foradil Certihaler was approved in the United States in December 2006. The effect of the termination agreements has been a net cash inflow in the second half of 2009 of £5.0 million.
A further exceptional item, a charge of £4.5 million consists of a non-cash £3.0 million impairment charge related to goodwill, and £1.5 million of employee termination and other costs associated with the restructuring of the manufacturing facility in Lyon, France and the research & development facility in Muttenz, Switzerland.

For the investor such exceptional items are a dilemma. If firms systematically and regularly nominate business transactions such as asset disposals, reorganisations and deals as ‘exceptional’, then it must be tempting to look at the post-exceptional figure. If however such items are truly rare then possibly the pre-exceptional data can be viewed as more relevant.

Financial statement ‘beauty’ is therefore in the eye of the beholder and a better measure is probably cash flow and assets versus debt, rather than more easily manipulated profit data. If a firm, year-in-year-out, improves its cash-flow position, increases assets and reduces debt, that must be more meaningful that the ebbs and flows of headline profits.

Unfortunately by using cash as a measure SkyePharma is in a barely adequate position and one that is closer to weakness rather than strength. Cash usage in the first half of 2009 was in line with management’s “expectations”. The Group’s cash balance at 30 June 2009 was £22.1 million and since that date a further £5.0 million in cash has been retained by the Group from the settlement with Novartis. Total liquidity, cash & short-term cash equivalents and un-drawn facilities totalled £23.8m compared to £37.5m a year earlier. Total debt less cash was £112.3m at the end of the half-year.

That’s a lot of debt for a firm the size of SkyePharma. On reflection, SkyePharma shareholders shouldn’t hold their breath for a call from the GSK acquisition team.

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