Generics Embarking on Forest

Forest Laboratories, Inc. (FRX - Analyst Report) turned in a very strong 2008, but we are concerned over the potential shortfall in revenue contribution of the company’s late-stage pipeline relative to the exposure of antidepressant Lexapro and Namenda, for Alzheimer’s disease, to generic competition beginning in 2012. We rate the shares a Hold.

The company’s 2009 earnings will be negatively impacted by higher selling, general and administrative expense to support the launch of hypertension drug Bystolic as well as the expected launch of milnacipran, for the treatment of fibromyalgia, in late fiscal 2009. Research and development expense is also expected to dramatically increase to support the pipeline, and as a result higher milestone payments to development partners.

We model Lexapro to account for about 50 percent of total revenue in 2011. With the drug losing patent protection in March 2012, that means roughly half the company’s top-line will be at risk to generic competition. While Bystolic and milnacipran should be very meaningful contributors by that time, we expect their combined sales in 2012 to be only a little over one-third that of Lexapro at that time. Namenda will face generic competition by 2013, at the latest this puts another $1+ billion at risk.

However, given the relatively cheap valuation (10.6x 2009 EPS versus peer group of 13.6x) and the potential for Forest to beef up its pipeline with additional licensing deals, we think the shares remain attractive as a core-holding.

Jason Napodano, CFA, contributed to this report.

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