Controlled substance - Lannett's hidden growth engine

According to management, the controlled substance business is key to the growth of Lannett ("LCI").

In July 2008, the Drug Enforcement Administration ("DEA") granted Cody Labs, a subsidiary that LCI acquired in 2007, a license to directly import concentrated poppy straw for conversion into opioid- based APIs for use in various dosage forms for pain management.

From LCI's 10Q, we read:

"The value of this license comes from the successful development of patentable processes. Cody Labs' expertise in API development and manufacture, allows the Company to perform in a market with high barriers to entry and limited foreign and domestic competition."

Key Takeaways:
- Controlled substances are highly regulated
- LCI's poppy straw importing license and development expertise could be an edge 
- Revenue growth for last 4 years has been decent, but not enough


#1) what are controlled substances?

(Morphine, an example of controlled substances, can be extracted from Opium. Source: The Internet)

Controlled substances have a high potential for abuse which may lead to severe psychological or physical dependence. Thus this market is highly regulated by FDA and DEA. Manufactures/Distributors have to register with DEA on an annual basis.

Furthermore, the controlled substance drugs are protected from foreign competition as long as a source is available in the United States.

#2) What's the prospective in controlled substance business?

Sub-questions: 

a) What's market size of this business?

b) what's the barrier of entry in this business?

From the data above, we found the controlled substance market is $10+ billion in size, with limited players.

If we cross check with other data source, some data suggest the market size for Schedule II APIs is $500~$600 million, while there are five schedules in total. The sales for Hydrocodone/Acetaminophen Combo Market was ~$1.2 billion in 2015.

I haven't got good data on penetration rate yet, but this market has been growing quickly, from only ~$5 billion market size in 2005.

#3) Does LCI have an edge in this industry?

From what we get so far, the controlled instance industry seems a growing playground that haven't been crowded yet.
- Cody Labs has a license to directly import concentrated poppy straw, while only 7 producers has that license
- The management of Cody Labs sounds capable: the president, Mr. Opitz, worked for 20 years with the Bayer group in Germany and Italy in Engineering, Manufacturing, and Product Development, and in the US as SVP Engineering
- The management of LCI has ambitiously expected Controlled Substances will constitute 50% of LCI's revenue in 2019, which will be a great growth booster.

Since 2012, we see a decent growth of this segment in LCI's revenue stream, in spite that the branded drug had some issues with FDA since 2015. However,  the growth was not enough to meet management's ambitions (See Figure above).

To sum up, I believe that controlled substance could be a booster of LCI's top-lines, but we need more information of this niche market. 

Related articles:

• Lannett, a mini-version of Valeant?
• Generic insulin and Chinese partner - another turnaround story of Lannett?
• The generic pharmaceutical market – what’s the competition landscape for a middle-sized player?
• Will Lannett lose another customer? 
• The valuation on Lannett 
• The Lannett and JSP story
• Lannett's C-topical story
• Section 338(h)(10) Election on Lannett