veritas securities in it itation of coverage 2

8/13/2019 Veritas Securities in It Itation of Coverage 2

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Halcygen Pharmaceuticals Ltd

Mayne Pharma acquisition a company maker

HGN.ASX BUY

Wednesday 15 September 2010

With the Mayne Pharma acquisition, HGN is now a leading specialist

pharmaceutical group in the growth area of Super Generics, as:

Mayne Pharma with its predecessor (FH Faulding) brings a 160 year

background of pharmaceutical development and manufacturing.

The acquisition adds a portfolio of oral dosage pharmaceuticals, with

strong market positions and outstanding growth opportunities.

It has a product development pipeline with a focus on Super

Generics, including leading products in pivotal registration trials,

especially SUBA

-Itraconazole in a US$600m product market.

It gives HGN critical size and financial capability, a certified plant,

distribution network and brands, backed by capable management

and a strong Balance Sheet.

It includes a growing revenue base, leveraging into improving

margins, acquired at a very attractive EBITDA multiple.

FY2010 Result adds confidence

For FY2010, the underlying profit result was in line with forecasts,

despite a currency impact, with the net profit of $7.3m on revenue of

$36.7m, mainly due to an initial contribution from Mayne Pharma.

The Mayne Pharma result was mainly driven by revenue from licensed

sales of Doryx in the US (60% of revenue), where sales increased by

15.6% in FY2010, and growth in the established product portfolio.

The Balance Sheet remains strong following the $13.7m equity raising

in FY2010 and strong cash flow, with no net debt and cash of $19.7m.

Scope for Growth

Forecast profit growth of 68.1% and 15.0%in F2011 and FY2012, with:

Full inclusion of Mayne Pharma and organic growth in its current

portfolio, especially Doryx.

Changes in the distribution of its products, improving margins.

Growth opportunities, including the introduction of Doryx into the EU

and Asia, and new formulations.

Its development pipeline, especially SUBA-Itraconazole, with a

target market of over US$600m, and manufacturing opportunities.

Reasons to BUY

We commence coverage with a BUY recommendation and a 12 month

target of over $0.85 ps, based on:

A strong market position, with growth opportunities, both organic

and structural, backed by a strong Balance Sheet.

Development potential from an advanced pipeline.

An attractive Valuation with the prospect of a substantial re-rating.

Price 0.52$

Target price 0.85$

Valuation method Relative Valuation

GICS sector Healthcare

12 Mth Price Range $0.30 - 0.75

Avg monthly t/o 9m

Market Capitalisation $77m

Shares on issue 148m

Enterprise value $66m

Previous rating Initial Coverage

Year Ended June 30 09A 10A 11E 12E

Operating Revenue $m 0.6 36.7 58.2 63.3

EBITDA $m -4.6 12.2 19.5 22.0

EBITDA margin % 33.2 33.5 34.8

EBIT* $m -4.6 10.9 17.0 19.1

EBIT margin % 29.6 29.2 30.2

NPAT* $m -3.8 7.3 12.3 14.1

EPS ps -4.9 5.8 8.2 9.5

EPS growth % 8.3 -216.4 43.4 14.9

DPS ps 0.0 3.0 2.5 3.0

Franking % 0.0 0.0 0.0 0.0

PER x -10.5 9.0 6.3 5.5Dividend yield % 0.0 5.8 4.8 5.8

NTA/share $ ps 10.1 17.4 20.8 25.9

EV/EBITDA x -6.9 5.4 3.5 2.8

Gearing (D:E) % 0.0 0.0 0.0 0.0

P/OCF x -11.0 6.4 9.7 4.7

ROA % -46.2 27.4 24.9 28.2

ROE % -39.3 30.6 29.2 29.4

Interest cover (EBIT) x na 25.6 56.7 na

*Excluded Amortisation o f Intangibles & Not ional interest

Source: IRESS

Activities

HGN is a leading specialist pharmaceut ical company

focused on improved delivery systems for super generics

w w w .halcygen.com

Brent Mitchell 03 86054830

[email protected]

HG N v XSI (S&P /A SX Small Industrial Index)


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Investment Case:

HGN is now an innovative specialty pharmaceutical company that develops, manufactures and

marketsSuper Generics, offering an attractive investment opportunity, with:

Leading Sector Position - With the acquisition of Mayne Pharma, HGN has a portfolio of

market leading oral dosage pharmaceuticals which contain both Maynes and the previously

acquired FH Faulding proprietary drug delivery systems.

Growth Opportunities - Opportunities within its existing operations from:

- Its product development pipeline with products in advanced/pivotal registration phase,

especially SUBA-Itraconazole.

- Registrations in new areas and new formulations within its existing product range. In

particular HGN is looking to register Doryx in the European Union and Asia.

- Direct distribution of its product range in Australia and Asia.

- Increased productivity and efficiency at its underutilized Salisbury facility, including

manufacturing opportunities for SUBA-Itraconazole and within its pipeline.

Distribution- Strong distribution network through long standing relationships with

international pharmaceutical groups in Australia, USA, Europe and Asia.

Management- A highly committed and capable management team, boosted by recent

appointments, with the skills and technologies to continue to develop its existing portfolio

and its development pipeline, building on the established record of success.

Profit leverageWith a relatively fixed cost base, profit and margin leverage from escalating

revenue and cash flow, especially as proprietary drugs have margins up to 70%. The

acquisition of Mayne Pharma was at an extremely attractive multiple of 3.2x current EBITDA

multiple at the maximum 6 year payout level, which assumes revenue of A$65m pa (86%

above annualised FY2010 Doryx revenue) for HGN, or a total of A$390m over the 6 years.

Balance Sheet- A strong Balance Sheet with the capability to further reduce debt and to

fund growth and product development.

Valuation- An attractive valuation reflecting limited awareness of the HGNs background and

opportunities. We would expect an improved rating with the release of the further results

and progress on its development program, especially SUBA-Itraconazole.

The main risks for HGN are:

Doryx US sales- If the court fails to uphold its HGNs patents, generic competition for the

150mg dose in June 2011 on expiry of the 30 monthstay of approval, with five generic

competitors already filing for entry. While HGN is opposing the patent challenges, its

offsetting this risk through life cycle management, especially the development of new

formulations and dosages and registration in Europe and other territories.

However, success in defending the patents would give a major boost to HGN. Warner

Chilcott is aggressively pursuing the legal action and has a good record in defending patents

or settling actions. Accordingly, competition is unlikely until the legal action is decided.

Doryx Entry into European Union and AsiaAny delay in registration by the MHRA, or

requirement for trials, which would delay a launch by 6 to 9 months.

SUBA-Itraconazole- Delays in registration of SUBA-Itraconazole, either in Europe

(additional trials) or the US (requirement for Phase III trials). While unlikely, these cannot

be totally ruled out.

Currency- Further strength in the A$ through the translation effect on offshore earnings.The currency impact is partly offset by US$ borrowing, the sourcing of active pharmaceutical

ingredients (APIs) in US$ and the payment of US trial costs.

A leading position in oral Super Generics

An extensive distribution network

Depth of management

Margin leverage

A strong Balance Sheet

Main risks relate to:

- Generic competition for Doryx

- Delays in entry into new markets

- Continued currency weakness

A spread of growth opportunities

Attractive valuation


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Full Year 2010 Result

The EBITDA result, including an 8 month contribution from Mayne Pharma, was in line with the

acquisition forecasts of $12.3m, and annualised EBITDA of $18.2, despite currency impacts.Adjusting for currency over the 12 months (using an average rate of US$0.89), the annualized

Revenue and EBITDA result would have been around $61.0m and $20.0m, against forecasts of

$60.6m and $18.2m.

Year ended 30-Jun ($m)Mayne

PharmaHalcygen 2010

Annualised

ResultAs at 30-Jun ($m) 2009 2010 % inc

Total Revenue 36.6 0.1 36.7 55.1 Current Assets 8.0 32.5

Cost of Goods Sold -18.8 -0.3 - 19.1 -28.2 Non Current Assets 0.0 38.6

Operating Profit 17.8 -0.2 17.6 26.9 Total Assets 8.0 71.1 785.4

Expenses -2.3 -3.1 -5.4 -8.7 Current Liabilities 0.3 23.2

EBITDA* 15. 5 -3. 3 12. 2 18. 2 Non Current Liabilities 0. 0 8. 0

Depreciation & Amortisation -1.3 0.1 -1.3 -2.0 Total Liabilities 0.3 31.2

EBIT 14.2 -3.3 10.9 16.3 Shareholder Funds 7.7 39.9 418.4

Interest (Net) 0.1 -0.5 -0.4 Return on Equity (%) 30.6

Pre-Tax profit 14.3 -3.9 10.4 Return on Assets (%) 27.4

Tax -0.6 -2.5 -3.1 Net Debt ($m) 0.0

Net Profit 13.7 -6.4 7.3 Gearing D:D+E (%) 0.0

Significant Items -5.6 1.7 -4.0 Interest Cover (x) 25.6

Reported Profit 8.1 -4.7 3.3 Net Debt / EBITDA (x) 0.0

Gross Margin (%)* 48.6 47.9 EV: EBITDA (x) 5.4

EBIT Margin (%) 38.8 29.6 Current ratio (x) 1.4

Effective Tax Rate (%) 4.2 29.2 NTAV (cps) 17.4

EPS (cps) 5.8 Price / Book (x) 1.9

Cash Flow (cps) 8.1 Inventory Turn 2.9

DPS (cps) 3.0 Receivables Turn 12.2

Franking (%) 0.0 R&D 5.3 71.0

Dividend Payout Ratio (%) 52.2 R&D / Revenue (%) 14.4

* Excludes Amortisation of Intangibles from the Mayne Pharma acquisition

Profit & Loss Balance Sheet

Key features of the result were:

CurrencyThe result was heavily impacted by currency with:

The acquisition price effectively lower, with the A$ increasing from US$0.80 to an actual

settled rate of US$0.89.

Lower revenue (forecast of $42.2m), especially the contribution from Doryx, due to the

stronger A$.

RevenueThe major contributor to revenue was the outsourcing of proprietary products, mostlyroyalties on US sales of Doryx (60% of revenue) by Warner Chilcott. For FY2010, US sales of

Doryx increased by 15.6% to US$216.7m, helped by a price increase in the December quarter and

increased marketing, resulting in an 8% increase in revenue to Mayne Pharma to around $21.5m

(around $35m for FY2010). The lower proportional revenue contribution from Warner Chilcott

was due to the high sales level of the lower margin 150mg formulation, now 90% of Doryx sales.

The other growth areas were: Its contract manufacturing of liquids and crmes (Betadine,

Parachoc, FESS and Painstop), comprising 15% of sales, with an 8% increase in sales; and sales

of Astrix, comprising 10% of revenue, which grew by 7%.

Margins- Gross and EBIT margins were healthy, helped from March 2010 by HGN receiving full

margin on the marketing and distribution of proprietary products into the Australian and Asian

markets, although partly offset by some set-up costs.

Tax- The low tax rate reflects the R&D tax deduction and the $17.6m of carried forward useable

tax losses, with a carryover of a further $5.4m to FY2011.

Result in line with expectations

Despite a strong A$

Doryx the main growth contributor

Margins improved with change distribution


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Cash FlowNet cash flow of $11.7m was after the acquisition of Mayne Pharma (for US$15m +

A$2m in working capital + A$1.0m in deferred consideration) and a US$2.5m pay down of debt

associated with the purchase.R&D- Increased by 70% to $5.3m, with a focus on SUBA-Itraconazole ($3.0m) particularly

following the Mayne Pharma acquisition, with Mayne Pharma increasing by 20% over FY2009.

Significant itemsWe have excluded the following items from the Net Profit result:

Significant Items $m

Notional Share based payments 1.0

Acquisition Costs 0.3

Inventory Valuation Adjustment 0.3

Non-recurring SUBA-Itraconazole R&D 2.0

Amortisation of Intangibles from Mayne Pharma acquisition (client contracts) 5.3

Notional Interest on future Earnings Sharing Arrangement payments 0.9

Total 9.9

DividendsHGN has declared a maiden final dividend of 2 ps and a special dividend of 1 ps,

both fully franked. HGN has a target Dividend Payout ratio of 25% to 30% on ordinary dividends.

Balance Sheet- Remains strong post the $13.7m equity raising and option exercise in 1H

FY2010 to help fund the Mayne Pharma acquisition, with gross debt of $8.6m and net cash of

$11.1m (7.5 ps). HGN repaid US$2.5m of its US$10.0m during the 2H FY2010, with the balance

of $7.5m expected to be repaid by during CY2011. Other financial liabilities of $20.9m included

the discounted value of the potential Hospira earn-out.

Growth Opportunities

HGN has outlined the following growth opportunities:

Source: Halcygen

Within these, the key items are:

Expanding sales of Doryx through introduction to new territories (EU and Asia) and

continuing its life cycle management. This includes developing new formulations and

dosages necessary to offset any revenue loss if generic competition is introduced against its

150mg formulation.

Rebrands and relaunch of existing products in Australia and Asia.

Increasing utilization of its Salisbury plant, through new manufacturing opportunities.

Achieving new registrations for SUBA-Itraconazole in the EU, Asia and the US.

Robust cash flow

R&D Boost

Maiden Dividend

Net cash of $11.1m (7.5 ps)

Key growth items are:

Expanding sales of Doryx

Relaunch of existing product range

Increased capacity utilization

Development pipeline


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Forecasts

HGN expect FY2011 underlying EBITDA to be at least equal to or greater than the pro-rata

annualized FY2010 results ($18.2m) at current exchange rates.

This is based on

Organic growth, including expanding sales of Doryx above the $35m in sales for FY2010.

The Bloomberg US concensus figures for Warner Chilcott show total sales growth for Doryx

of 8% to 9% pa over the next few years.

Expanded sales in its product portfolio and increased margins, with the assumption of

distribution and marketing rights. This includes the distribution agreement with Pan-

Malaysian Pharmaceuticals for the distribution of Doryx, Astrix and Eryc into Singapore.

Increase efficiency and other savings related to its manufacturing and marketing activities.

We believe this is conservative, with a variety of growth options, from increased contract

manufacturing, further geographical expansion for Doryx and its promotion in the treatment ofsevere acne and new dose formulas for Doryx under development.

Further out, the major boost will be from registration of Doryx in Europe and Asia, the early

release of SUBA-Itraconazole into Europe and FDA approval for SUBA-Itraconazole.

Our forecast of profit growth of 68.1% and 15.0% in FY2011 and FY2012 to $12.4m and $14.1m

is based on:

Constant A$:US$ exchange rate of $0.89.

No change to the Doryx patent position, with growth of 8% to 9% for Warner Chilcott in

FY2011 and FY2012 to around US$235m and US$255m. There may be pressure on FY2012

sales if there is generic competition in the 150mg dosage, on the overturning of its patents.

R&D spend of around $3.0m in FY2011, with SUBA-Itraconazole falling to around $1m, and

an increase to $3.6m in FY2012.

Capex of around $2.0m, mainly for the gear-up of Salisbury for a next generation Doryx

formulation and SUBA-Itraconazole.

Exclusion in FY2011 and FY2012 of the Amortization of Intangibles of $6m and $3m and

Notional Interest on the Earnings Sharing Arrangement of $1.0m and $0.8m. The

accelerated amortization, utilizes recent tax concessions relating to customer contracts.

A further paydown of US$ debt of US$1.25m per quarter.

The earn-out for Hospira, accounted for as adjustments to cash and other financial liabilities

in the Balance Sheet, taken on an annual basis, paid in February.

No contribution for Doryx into the EU in FY2011 and a minor 2H FY2012 contribution, withno contribution from SUBA-Itraconazole.

A ordinary DPR of around 30%, although additional special dividends are not ruled out.

Valuation

Our price target of $0.85 ps is based on:

An EBITDA (excluding Amortisation) multiple of 3.5x for FY2012, equating to a PE multiple

of 9.0x, on a 25% discount to the S&P/ASX Small Cap Industrial Index.

A Discounted Cash Flow valuation of $0.88 ps.

The above valuation basis reflects a discount to local and international peer valuations, reflectingperceptions on the risks on Doryx and the roll-out of SUBA-Itraconazole. However, with further

results and news on regulatory matters, we expect a significant re-rating.

orecast profit growth of 68.1% and 15% in

Y2011 and FY2012

Price target of $0.85 ps


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Current Price

F IN A N C IA L P ER F OR M A N C E C A SH F LOW

Year e nded 30-J un 2009A 2010E 2011E 2012E Year e nded 3 0-J un 2009A 2010E 2011E 2012E

Sales Revenue $m 0.0 36.7 58.2 63.3 Operat ing EB IT D A $ m -4.6 12.2 19.5 19.5

Cost o f Goods Sold $m 0.0 -19.1 -29.9 -31.9 Net Interest Paid $m 0.4 -0.1 -0.3 -0.3

G ro ss Operat ing P ro fit $ m 0.0 17.6 28.3 31.4 Tax Paid $m 0.4 0.0 -3.1 -3.1

Expenses $m -4.6 -5.4 -8.8 -9.4 Chg WorkCap & $m 0.0 -8.8 -6.1 -6.1

EBITDA* $m -4.6 12.2 19.5 22.0 Other $m 0.1 10.7 -2.0 -2.0

Depreciation & Amort* $m 0.0 -1.3 -2.5 -2.9 Operat ing C ash F lo w $ m -3.7 3.3 10.0 10.0

E B IT $ m -4.6 10.9 17.0 19.1 Capex $m 0.0 -0.4 -1.0 -1.0

Interest** $m 0.4 -0.4 -0.3 0.1 F ree C ash F lo w $ m -3.8 2.9 9.0 9.0

Pre Tax Profit** $m -4.1 10.4 16.7 19.2 Acquis it ions/Asset Sales $m 0.0 -18.4 -6.5 -6.5

Tax $m 0.4 -3.1 -4.4 -5.1 Dividends Paid $m 0.0 0.0 -3.0 -3.0

M inorities $m 0.0 0.0 0.0 0.0 Equity $m 0.0 13.4 0.2 0.2

N ormal ised P rof i t $m -3.8 7.3 12.3 14.1 Debt $m 0.0 8.0 -7.1 -7.1

Significant Items & Costs $m 0.0 -4.0 -5.2 -2.8 Other $m 0.0 -1.1 0.0 0.0

Repo rted P ro fit $ m -3.8 3.3 7.1 11.3 C hange in N et C ash $ m -3.8 4.8 -7.4 -7.4

Gro wth 2009A 2010E 2011E 2 012E B A LA N C E SH EET 2009A 2010E 2011E 2012E

Revenue % -47.6 8437.8 58.5 8.8 Cash $m 7.9 19.7 10.3 15.6

Expenses % 6.1 18.2 63.4 6.8 Receivables $m 0.0 6.0 9.5 10.3

EBIT % 6.1 -338.3 56.6 12.4 Inventory $m 0.0 6.5 10.3 11.2

Normalised Profit % 8.3 -294.1 68.1 15.0 Other Current Assets $m 0.0 0.3 0.8 0.8

EPS % 8.3 -216.4 43.4 14.9 C urrent A ssets $ m 8.0 32.5 30.9 37.9

Property, Plant & Equipment $m 0.0 21.0 19.5 17.6

Rat io s 2009A 2 010E 2011E 2012E Intangibles $m 0.0 14.2 13.3 13.3

EBITDA / Sales* -1059.3 33.2 33.5 34.8 Other NC Assets $m 0.0 3.3 1.5 1.5

EBIT / Sales % -1059.3 29.6 29.2 30.2 N on C urrent A ssets $ m 0.0 38.6 34.3 32.4

Effective Tax Rate % 8.8 29.2 26.5 26.5 T o tal A ssets $ m 8.0 71.1 65.3 70.4

Interest Cover** x na 25.6 56.7 na Payables $m 0.2 3.9 5.1 5.5

Current Debt $m 0.0 7.6 1.5 0.0

P er Share 2009A 2010E 2011E 2012E Other Current Liabilit ies $m 0.1 11.7 4.8 4.8

Issued Shares (Wt Avg) m 76.1 126.9 148.8 148.9 C urrent Liabilit ies $ m 0.3 23.2 11.4 10.3

EPS ps -4.9 5.8 8.2 9.5 Non Current Debt $m 0.0 1.0 0.0 0.0

EPS (dil C/No tes & Opts)* ps -5.1 5.5 8.2 9.4 Other NC Liabilities $m 0.0 7.0 9.6 8.2

Operating Cash Flo w ps cps -4.7 8.1 5.4 11.0 N o n C urre nt Lia bit ie s $ m 0.0 8.0 9.6 8.2

Free Cash Flow ps -4.8 7.8 4.7 10.3 T o tal Liabilit ies $ m 0.3 31.2 21.0 18.6

DPS ps 0.0 3.0 2.5 3.0 Shareho lder F unds $ m 7.7 39.9 44.2 51.8

Franking % 0.0 0.0 0.0 0.0

Dividend Payout Ratio % 0.0 52.2 30.3 31.6 R at io s 2009A 2010E 2011E 2012E

Receivables turn x 10.0 12.2 7.5 6.4

P arameters 2009A 2010E 2011E 2012E Net Debt $m 0.0 0.0 0.0 0.0

PE Ratio x -10.5 9.0 6.3 5.5 Gearing (D:D+E) % 0.0 0.0 0.0 0.0

Enterprise Value / EB ITDA x -6.9 5.4 3.5 2.8 Current Ratio (CA / CL) x 25.2 1.4 2.7 3.7

Enterprise Value / P ro fit x -8.4 9.0 5.6 4.4 Net Assets ps 10.1 27.0 29.7 34.8

Cash Flow ratio x -11.0 6.4 9.7 4.7 Net Tangible Assets ps 10.1 17.4 20.8 25.9

Dividend Yield % 0.0 5.8 4.8 5.8 Price to Book Value x 5.1 1.9 1.7 1.5

Return On Assets % -46.2 27.4 24.9 28.2

M ajor Shareholders Return on Equity % -39.3 30.6 29.2 29.4

Bruce M atieson et al m 11.5 8%

Dr. R Aston m 9.6 6% VALUATION

Top 20 (31/08/09) m 65.0 44% Valuat ion M ethod ps

PE Relative 88.0 69.2

* Excludes the Amortisation of Intangibles from the M ayne Pharma acquisit DCF 89.2 71.5

** Excludes notional interest on Mayne Pharma Earn-out Current Price 52.0

Premium/Disco unt (%)

$0.52


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The Acquisition of Mayne Pharma

On 25/9/09, HGN agreed to acquire Mayne Pharma International (MPI) from Hospira Australia, on

the following basis:

An upfront payment of US$15m.

An earn-out component based on gross sales, capped at A$41.6m over the following 6 years.

The A$41.6mEarnings Sharing Arrangementallows Hospira to receive a percentage of gross

sales of existing products in the US only, in excess of certain target threshold revenue levels for

MPI. The payment is based on revenue for HGN above A$40m pa, capped at A$65m, with a cap

of A$7.8m pa until 31/12/11 and $6.5m for the following 4 years. The earn-out is applied against

the Balance Sheet, with a decrease in other financial liabilities offset by a reduction in cash.

The sale reflects a decision by Hospira to divest of non-core businesses, with a decision to focus

on its core Specialty Injectable Pharmaceuticals and Medication Management System businesses.

The acquisition was funded by:

A US$10m bank facility (a coupon of 5%) with the National Australia Bank, to be repaid

within two years.

A A$13.7m equity raising at $0.20 ps through a $9m placement and a $4.5m SPP and $0.2m

option exercise, providing the balance of the purchase price and working capital for

operations and to accelerate drug development.

The acquisition covered all manufacturing, filling, packaging, analytical services and sales

operations, including:

The original FH Faulding facility at Salisbury, South Australia, covering the 30 acre site, all

buildings and a GMP compliant facility certified by the FDA and TGA, with mutual recognition

by UK, European, Canadian and many Asian regulatory agencies. The replacement value ofSalisbury has been estimated to be over $100m.

The oral drug portfolio, including Doryx, Eryc, Astrix and Kadian/Kapanol.

Third party manufacturing contracts.

Mayne Pharma brands, logos and trademarks.

Around 150 employees, including key management, and part time contractors.

The attractions of the acquisition for HGN include:

It gives HGN critical size, immediately adding full year revenue of over $60m and EBIT of

around $16.5m.

The acquisition is on an attractive multiple of 3.2x EBITDA, assuming the full earn out ofA$58.4m. However, the full Earnings Sharing Arrangement only applies when US sales of

Doryx exceed US$400m, 85% above current levels. The acquisition also gives the

immediate ability to utilize $15m in accumulated losses.

It gives HGN global reach with distribution partners in Australia, USA, Europe and Asia, and

customers that include Sanofi Aventis, Pfizer, Abbott, Cephalon, GlaxoSmithKline and Care

Pharmaceuticals.

Growth opportunities within the current portfolio, especially Doryx, a product development

portfolio, centred around SUBA-Itraconazole, with a total target market of over US$0.6b.

Manufacturing capability and the rights to manufacture and distribute SUBA-Itraconazole.

It also gave HGN the opportunity to expand direct distribution of its products.

With utilisation of only 35% of the Salisbury site, there are development opportunities.

Acquisition multiple is extremely

attractive at under 3.2x EBITDA

Total acquisition cost form Mayne

Phatrma of around A$58m

Acquisition funded by $13.7m

equity raising and US$10m debt

facility


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BACKGROUND

Mayne Pharma International was originally part of the long established FH Faulding & Co Limited

(Faulding), which opened its first pharmacy in Adelaide in 1845. Faulding commencedmanufacturing its own proprietary lines by 1850. Faulding was acquired in October 2001 for

around $2.8b by the Mayne Group, an operator in the healthcare and logistics industries.

Following the acquisition of Faulding, Mayne significantly rationalised its businesses to focus on

healthcare, with the non-healthcare logistics business and the private hospital business divested in

2003. Further rationalisation occurred in November 2005 with the demerger of the healthcare

business into Mayne Pharma (oral and injectable products) and Symbion Health (pharmacy

services, medical centres, pathology, radiology and consumer products).

Hospira acquired the ASX listed Mayne Pharma in January 2007 for $2.6b, operating it as part of

its global healthcare business, until sale of the oral pharmaceutical business to HGN in October

2009. The sale allowed Hospira to concentrate on its specialty injectable pharmaceuticals

HGN was listed on 29/6/06, through a $12.5m IPO, comprising 25.0m shares at $0.50 ps. HGNsoriginal strategy was to develop and market two products (SUBA-Itraconazole and Minocycline)

licenced from the Mayne Pharma / Hospira, with Hospira retaining first right of refusal to

manufacture products and market the products in Australia and New Zealand.

On 25/9/09, HGN agreed to acquire Mayne Pharma from Hospira Australia, for an upfront

payment of US$15m and anEarnings Sharing Arrangement capped at A$41.6m over the

following 6 years. The acquisition was funded by cash and a $13.5m placement and SPP, 67.5m

shares at $0.20 ps.

On 15/12/09, HGN provided notice to Hospira, for HGN to assume the marketing and distribution

of products in the Australian and Asian markets (from 15/2/10), predominantly DORYX, ERYC,

MAGNOPLASM and ASTRIX.

On 26/8/10, signed a distribution agreement with Pan Malaysian Pharmaceuticals for the

distribution of DORYX, ERYC, MAGNOPLASM and ASTRIX.

OPERATIONS

HGN is focused on the development of Supergenerics or "Improved Chemical Entities, which are

novel proprietary modifications of generics, based on an improved side effect profile, optimised

delivery and dosage, efficacy and safety.

The attractions of this sector are:

Faster regulatory approval, compared to proprietary pharmaceuticals.

A pricing premium to generics.

The ability to renew patent protection and extract a price premium.

HGNs core technology platforms are around controlled release delivery systems (Dorx, Eryc,

Kadian/Kapanol and Astix), improved bioavailability (SUBA-Itraconazole) and taste masking

(Cleantaste). While Cleantaste was successfully developed, at significant costs (written down to

zero by Hospira), it has yet to be implemented.


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Mayne Pharma operations comprise:

Manufacturing and Outlicensing of Proprietary products60% of Revenue

Outlicencing of its product range (Doryx) in the USA, Australia, Canada, South Korea, Europe,

Malaysia, Japan and Sri Lanka.

Manufacture and Sale of Proprietary Products25% of Revenue

Distribution of its products (Doryx, Astrix, Eryc and Magnoplasm) to wholesalers in Australia and

Asia.

Contract Manufacturing15% of Revenue

Manufacture of Betadine, Epsom Salts, FESS, Parachoc, Painstop, Xylocaine and the Oxy range on

behalf of customers such as Sanofi Aventis, Pfiser, Abbott, Cephalon, GlaxoSmithkline and Care

Pharmaceuticals.

PRODUCTSDORYX- Currently Mayne Pharmas lead product contributing around 60% of total revenue.

Doryx is a delayed release antibiotic, initially developed in the 1980s, used in the treatment of

infections caused by micro-organisms, including: primary atypical pneumonia, Rickettsial

infections, psittacosis, trachoma and inclusion conjunctivitis, lymph granuloma, venereum,

donovanosis, cholera, brucellosis, tularaemia, bartonellosis, STDs and the severe acne.

Doryx is distributed in the US under a partnership arrangement with Warner Chilcott. Sales of

DORYX have grown steadily from US$69.5m in CY2004 to $210m in CY2009, although not

necessarily at a consistent rate. HGN receive around 18% of US sales by value.

0.0

10.0

20.0

30.0

40.0

50.0

60.0

0

10

20

30

40

50

60

70

Q3FY06

Q4FY06

Q1FY07

Q2FY07

Q3FY07

Q4FY07

Q1FY08

Q2FY08

Q3FY08

Q4FY08

Q1FY09

Q2FY09

Q3FY09

Q4FY09

Q1FY10

Q2FY10

Q3FY10

Q4FY10

%

Change

SalesUS$

Sales of Doryx by Warner Chilcott

Sales (US$) % ch Source: Warner Chilcott & Veritas Securities

Quarterly performance varies with inventory pipeline adjustments, including use of loyalty

bonuses and seasonal conditions (a weak June quarter ahead of summer vacations). The

strength in Q1 to Q3 FY2009 was an inventory buildup with release of the 150mg formulation,

while the spike in Q2 FY2010 was from higher prescription numbers ahead of a price increase.

While Doryx has a US market share of around 33%, this is under threat after patent

circumvention by generic competitors for the 75mg and 100mg tablets, and applications by

generic manufacturers to enter the 150mg market. While the US FDAs 30 month stay of approval

for generic entry to the 150mg market expires in October 2011, Warner Chilcott and Mayne

Pharma have filed lawsuits asserting infringement of its patents for all three strengths. The case

is expected to be heard in the 2H CY2011. As these patents expire in CY2022, upholding the

patents would give a major boost to Warner Chilcott and HGN.


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To improve its competitive position, Warner Chilcott has been aggressively marketing the 150mg

prescription as the preferred format (now 90% of sales), and offered discounts on repeat

prescriptions, resulting in a substantial increase in market share of prescriptions.HGN has continued its active lifecycle management of Doryx, developing new formulations,

including an oral adjunctive therapy for acne, a cleantaste formulation and new dosage levels,

maintaining a differential against competing products. This has the potential to offset any loss of

market share to generics, should it lose the court case.

HGN is looking to seek registration for Doryx in the European Union and Asia (new formulations),

both sizeable potential markets. While these markets are currently underdeveloped (only

doxycycline is sold) at US$80m and US$70m, there is an opportunity to build these markets,

especially with the acne formulation.

We would expect a meeting soon with the MHRA with regard to filing for registration, with

potential sales 6 months after registration. There is potential for distribution through Warner

Chilcott, who has acquired the global operations of P&G Pharmaceuticals. Registration for newDoryx formulations in Asia would likely follow soon after.

Other Current Products

Kadianand Kapanol(morphine sulfate) - Sustained morphine releases for pain management.

Astrix(enteric coated aspirin) - A low dose aspirin for patients with potential blood clotting

disorders, and an analgesic to relieve minor aches and pains.

Eryc(enteric coated erythromycin)An antibiotic similar to penicillin.

MagnoplasmA magnesium sulfate-glycerol paste, commonly known as a 'drawing ointment'

used to treat boils carbuncles and whitlows.

Development of these products was largely ignored by Mayne Pharma and Hospira. Given brandawareness, HGN is looking to relaunch or reformulate these products, following its assumption of

the marketing and distribution in the Australian and Asian markets from 15/2/10. To assist with

these relaunches, HGN has appointed a dedicated marketing and two sales representatives.

Development Portfolio

Core technology platforms around controlled release delivery systems, improves bioavailability

(SUBA-Itraconazole) and taste masking.

SUBA- Itraconazole

SUBA-Itraconazole is a patent protected reformulation of Itraconazole,a synthetic broad-

spectrum orally active anti-fungal agent developed and marketed worldwide by Janssen

Pharmaceutical Products (Johnson& Johnson) under the brand name Sporanox.

SUBA-Itraconazole offers improved absorption (bioavailability) and pharmacokinetics and has

been under development for 6 years, following the release of generic versions of Itraconazole.

The SUBA-Itraconazole reformulation has patent protection until 2022. HGN has undertaken 9

separate pharmacokinetic clinical trials for SUBA-Itraconazole, demonstrating that half doses of

SUBA-Itraconazole are equivalent to Sporanox.

While the anti-fungal market is around US$2b, the target market for SUBA-Itraconazole is in

excess of US$600 million, with sales in CY2008 of US$620m (IMS, Datamonitor). HGN is now

undertaking a dual registration strategy, involving:

USAAn initial Investigative New Drug Application (INDA) to the FDA in June CY2008. Following

guidance from the FDA, HGN has completed 4 bioequivalence programs of SUBA-Itraconazole

to Sporanox. HGN has recently completed a US phase II clinical trial, with the aim of achievingaccelerated regulatory registration of the product, with the results expected in the December

Quarter 2010. This will be followed by a review meeting with the FDA.

Development opportunities for Doryx in

acne treatment and cleantaste

Market opportunities in EU and Asia

Release of Doryx expected in CY2011

Growth opportunities within its existing

product range, previously ignored

Positive trial results for SUBA

Target Market of over US$600m

Phase II trial results expected in Q4 CY2010


11/12

- 11 -

Source: Halcygen

European Union (EU)Following guidance and approval from EU regulatory agencies, HGN

completed a single Pharmacokinetic study, with result received in March 2010 showing

bioequivalence within EU guidelines. HGN expect to file an application with the UK Medicines and

Healthcare products Regulatory Agency (MHRA) in the December Quarter utilizing data from the

US Phase II clinical trial. If approved, HGN will apply for registration in the various European

Union territories. The EU market for Itraconazole is worth US$120m

Other- Following EU approval, the dossier can be used for fast tracking approval in many Asian

markets, especially Japan and South Korea, where sales of Itraconazole are around US$200m pa.

Others

While these form part of its pipeline, they are low current priorities.

Minocycline - A broad-spectrum tetracycline antibiotic being reformulated to minimise side

effects to the central nervous system, used preventing the growth and spread of bacteria. It is

marketed under several trade names, including Minomycin, Minocin, Arestin, and Dynacin, with

current global sales in excess of US$400 million.

Oxycodone -An opioid analgesic medication used to treat moderate to severe pain, sold

under a number of brand names, such as OxyContin,often combined with other products,

such as aspirin, Ibuprofen and Acetaminophen

Diclofenac- A nonsteroidal anti-inflammatory drug used to treat pain and inflammation

associated with arthritis, soldunder the brand names of Cambia, Cataflamand Voltaren.

Directors

Dr Roger Aston(Chairman & CEO)A background of 20 years in pharma and biotech in the UK

and Australia, including negotiating global licence agreements, registration activities with the FDA

and fund raising. Currently a director Clinuvel Pharmaceutical, with previous roles with Ascent

Pharma, Glaxo SmithKline, Cambridge Antibody Technology, Peptech Advantogen, and pSivida.

Bruce Mathieson(Non-executive Director)Currently a Director and CEO of Australian Leisure

and Hospitality Group (JV with Woolwoths), with a strong background in the hospitality industry.

Ian Scholes(Non-executive Director)Extensive experience in the financial and corporate

advisory in Australia and offshore, including roles with Merrill Lynch and National Bank.Ron Best(Non-executive Director)A former member of the Victorian Parliament, including

Shadow Ministry roles in Health, and a background in the food and food distribution sector.

Expects UK filing in Q4 CY2010

Asia to follow soon after


12/12

- 12 -

Sales

Tony Bonello +61 2 8252 3230

Robert Scappatura +61 2 8252 3240

Andrew McCauley +61 2 8252 3260

Patrick Ford +61 2 8252 3211

Clay Melbourn +61 2 8252 3220

Bryce Reynolds +61 2 8252 3215

Stephen Murphy +61 8 9380 8351

Research

Industrials

Brent Mitchell +61 3 8605 4830

Resources

Piers Reynolds +61 3 8601 1196

RATING

BUYanticipated stock return is greater than 10%

SELLanticipated stock return is less than -10%

HOLDanticipated stock return is between -10% and +10%

SPECULATIVEHigh risk with stock price likely to fluctuate by 50% or more

This report has been issued by Veritas Securities Limited A.B.N. 94 117 124 535, Australian Financial Services Licence Number 297043.

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financial situation, particular needs and investment objectives. This document has been prepared from sources which Veritas Securities Limited (Veritas) believes to be

reliable, but none of Veritas, its directors, employees and associates (Veritas Parties) give or make any representation or warranty that any such information is accurate,

complete, reliable or up-to-date, and Veritas disclaims all liability for loss or damage, direct or indirect, suffered by any person arising from any use of or reliance on such

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inform you of any matter that subsequently comes to its notice, which may affect any of the information contained in this document.

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