Put a Barr on buying drug maker Galen

Time to dispose of Rotork; Shadow hanging over Spirent
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The Independent Online

There is a lot we don't know about Galen, the Irish drug manufacturer which specialises in women's healthcare and which attracted, but failed to consummate, a bid from the US company Barr Laboratories last month.

We don't know when it is going to face copycat competitors to some of its biggest drugs, although we know such generic rivals are in the pipeline to four of Galen's top 10 drugs. A rival has told US regulators it is challenging Galen's patent on its biggest seller, Sarafem, for pre-menstrual tension, and similar disputes are in prospect for two other recently purchased hormone replacement products.

Ovcon, the contraceptive pill, has no patent protection and a rival could appear on the market any day. We don't know exactly what Galen's plans are for Ovcon because, although the company has said it is working on a new version of the pill, it won't say what is different about the new product, arguing this is commercially sensitive. Galen is defensive and unhelpful on the issue of generic competition, and this doesn't help its reputation in the City.

We also don't know yet if Galen can turn around sales of recently acquired products such as Sarafem. And we don't yet know if the newly launched vaginal ring for hormone replacement therapy will be as big a seller as hoped.

What do we know for certain? We know that figures for the third quarter of Galen's financial year were better than expected again, with profit before tax of $39.5m, up from $4.5m (excluding the sale of an old business) last time. The US sales force boosted revenues from long-standing products up to 38 per cent. With acquisitions, pharmaceuticals sales were more than double last year's third quarter.

But what we also know is that Barr didn't want to pay up for Galen shares, even though speculators talked the stock up to £8 at one point. Galen is theoretically worth more to Barr than to anyone else, since it is that US company which is a pole position challenger to most of the Galen drugs under generic threat. Galen shares are difficult to value (depending on whether you use earnings before or after writing down product acquisitions) and appear cheap relative to the sector. But they are too risky by far. Avoid.

Time to dispose of Rotork

Something unpleasant is happening in the world of liquid waste. The municipal authorities that run water and sewage businesses in the US are finding themselves strapped for cash as the economic downturn feeds through into reduced tax receipts. And that means infrastructure projects in the water industry are being delayed, perhaps even put on hold.

Rotork - which makes industrial taps used in such water systems - warned that meeting profit expectations for the rest of the year depends on what happens in that market in the coming months, and Bill Whiteley, the chief executive, cannot have been surprised that shareholders headed for the floodgates, selling the stock down 12.5p to 332.5p.

The company unveiled first-half results showing a pre-tax profit of £13.2m, up from £12.1m and was reassuring on the question of cashflows from the business, which have been strong despite the difficulties. The group has no debt and therefore room to grow through some modest acquisitions.

Its main business is electric actuators, or valves, with the oil and gas industries taking the majority of the company's sales. Demand has improved after a wobble at the end of last year when some of the oil giants rethought their strategies. Sales in the first-half were back to the levels in the first six months of 2002. Long-term oil exploration in the Far East and the former Soviet Union should boost demand for Rotork's products, as should oil companies' increased investment in downstream activities such as oil refining.

There is also long-term opportunity in water, with developing countries extending systems and the West driven to improve water quality. But yesterday's downbeat outlook is a signal to trim holdings of Rotork shares.

Shadow hanging over Spirent

Until telecom equipment makers and phone operators start splashing out again, Spirent, is going to find life hard. The company sells kit that tests telecoms equipment and networks, and Nick Brookes, the chief executive, says equipment makers around the world and the US operators cut spending by 30 to 40 per cent in the first half of this year.

Spirent seems to be making the best of a bad situation. Turnover from continuing businesses in the six months to 30 June dropped 5 per cent to £224.4m while operating profits rose 6 per cent to £14.6m. Mr Brookes reckons the company is winning market share from rivals.

It is also reassuring to see Spirent maintaining its spending on product development at about 14 per cent of turnover, or £33m - a move designed to ensure it remains well positioned for an upturn.

The shadow hanging over Spirent is City talk the company could be in danger of breaching its bank covenants. Mr Brookes said that, at the end of June, the company was comfortably within its limits. Assuming life stays as bad as it is now, with a similar earnings result in the second half, he reckons the same will be true at the end of the year.

Spirent is not banking on a recovery this year, after listening to gloomy noises from customers who include Cisco, Nortel and Nokia. But nor is it expecting life to get any worse.

Analysts are forecasting earnings of around 1.7p a share for this year, which puts the stock on a forward multiple of around 20 times. Until more signs of an upturn, that seems high enough. Avoid.

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