Stocks I'm Looking At - Is Impax Impossible?

Impax Labs (Nasdaq: IPXL) could be the best of stocks ... or the worst of stocks. Or both. And therein lies the problem - this stock has such volatile prospects, it is exceedingly hard to figure out what constitutes a fair price.

What They Do
On the surface, this starts off looking like an interesting and straight-forward idea. Impax is largely a generics company, but one that develops some its own compounds as well. So far, so good - Teva (Nasdaq: TEVA) does that too and it is probable that more generics will look to blur that line.

What makes Impax stand out is their specialization in controlled release formulations. CR drugs are trickier than regular formulations, and pharmaceutical companies used to rely upon CR formulations to both extend patent protection and stave off generic competition. More recently, though, CR formulations are not so scary or difficult for generics (due in part to the efforts of those like Impax) but they are a major opportunity as CR formulations are often more desirable for the user.

Impax offers generic versions of Adderall, Tricor, Flomax, and Effexor - all major drugs in their day.

Also, the company recently signed a deal with Endo Pharmaceuticals (Nasdaq: ENDP) that ended some litigation; Impax will launch a generic of Opana ER in 2013, and Endo gets the rights to develop Impax's CR version of carbidopa/levidopa for Parkinson's.

The Problem
The biggest issue with Impax is the very nature of the generics business model. Generic companies race to be "first to file" with their compounds so as to secure the 180-day exclusivity period, but that requires going up against Big Pharma and challenging their patents. That is not only expensive, it is hit-or-miss; not all challenges succeed (and not all fail).

Even when these challenges are successful, there is only that 180-day window to enjoy exclusivity; after which the generics company finds still more generics coming in to compete with them.

So, you have uncertainty from whether the company will in fact be first to file, uncertainty in whether the patent challenge will succeed, and uncertainty in the timing of rival introductions. And that's all after the company successfully develops a bioequivalent drug; something that does not always happen on schedule.

The Result
Because of the uncertainties of the filing race, the patent battles, and the vagaries of "authorized generics", the revenue and profit projections for a company like Impax go all over the place. It's feast, then famine, then feast again, then some more famine. On and on, ad infinitum -- or at least until the company grows to a point where there is a consistent base of business that smoothes the volatility  (though even Teva's profits are still quite volatile).

In this particular case, analysts are expecting the company to double their revenues from 2009, but then face a 25%+ drop next year. When I've looked at some longer-term models/guess from analysts, it continues in that sort of up/down/up/down pattern for years to come. 

Ultimately, that leaves me looking at more traditional valuation metrics like EV/EBITDA. There, Impax looks pretty cheap (3.3 times trailing EBITDA) consdiering the company's past success in developing CR drugs. So, in principle, you're paying less than 4x EBITDA for a company that has a recognized niche in the large-and-growing generics market. On the other hand, you are buying all-but-guaranteed volatility along the way.

It's a puzzling mix for me ... but one that is at least worth a closer look. The real trick, I suppose, is whether I can find enough reasons to trust that the company's technological edge will endure an provide long-term success as an investment.