Wednesday four U.S. senators asked the Senate Judiciary Committee to launch an investigation into Allergan's (AGN) sales of Restasis patents to St. Regis Mohawk Tribe:

Four U.S. senators have asked the Senate Judiciary Committee to launch an investigation into a deal drugmaker Allergan Plc (AGN.N) struck with a Native American tribe to protect some of its patents from generic challenge, according to a letter seen by Reuters.

Democrats Maggie Hassan, Sherrod Brown, Bob Casey and Richard Blumenthal in the letter to Judiciary Committee Chairman Chuck Grassley and Ranking Member Dianne Feinstein on Wednesday called Allergan’s deal “a blatantly anti-competitive attempt to shield its patents from review and keep drug prices high.”

I always assumed the odd arrangement would eventually draw the attention of lawmakers. Below is my takeaway on a potential Senate probe.

Parsing The Patent Sale

The timing of the patent sale is curious given that Allergan’s growth is dead and Restasis makes up 9% of the company’s total revenue; according to Bernstein, the drug accounts for 15% of profits. I interpreted Allergan's odd attempt to protect Restasis as the equivalent to yelling, “We are desperate and our R&D capabilities are weak." Bringing attention to the company's shortcomings also appeared to be a dangerous move. It could draw investors' attention to the company's reliance on Restasis and the uncertainty over the quality of its near-term pipeline. It could also potentially prompt lawmakers to take a closer look at the $1.8 billion U.S. dry eye market where Allergan enjoys pricing power with limited competitors.

Restasis dominates the $1.8 billion dry eye market with over 70% market share. Shire's (SHPG) Xiidra controls about 20%, and the two treatments are priced at about $5,000 per year. The entrance of Xiidra last year might have offered customers another alternative, but there was no improvement in price. In fact, the price for Restasis has doubled since 2008. Allowing generics to enter the market could potentially help drive down prices and make it more affordable to the millions of consumers infected with dry eye, but lack a prescription. Why would Allergan want to draw attention to these dynamics?

How Far Is The Senate Willing To Go?

Mylan recently called Allergan “desperate” and Senator Sherrod Brown vowed to remove any loopholes the company could use to thwart competition. The Mohawk Tribe filed to the U.S. Patent Trial and Appeal Board ("PTAB") to have Mylan's challenge dismissed. Due to its status as a sovereign government, it cannot face litigation in an administrative court unless [i] it waives its immunity or [ii] Congress abrogates immunity.

A Senate investigation could potentially prove the patent sale is an attempt by Allergan to shield patents from review and keep drug prices high. The question remains, "What would the Senate do about it?" Would it be willing to abrogate St. Regis's sovereign immunity in order to stop Allergan's anti-competitive behavior? That could create a public relations nightmare, but not doing so could encourage other companies to follow Allergan's path. The other option could be to help accelerate FDA approval of other dry eye drugs. Alreyda's ADX-102 recently showed improvement in a midstage trial for the treatment of dry eye. Accelerating this drug's approval (or others like it) could make the dry eye landscape more competitive, and help drive down prices for the treatment.

How Far Could Allergan Fall?

A senate investigation could not only create negative sentiment for Allergan but delay a verdict on its patent challenges. The longer the patent review remains in limbo the higher the likelihood investors begin to price in a loss of the Restasis patents. Allergan currently trades at 14.6x EBITDA. The universe of hedge fund hotels - AGN, Valeant (VRX), Teva (TEVA), Mallinckrodt (MNK), and Endo (ENDP) - trades at a mid-point of 7.4x EBITDA.

Allergan's Q2 organic growth was around 1%, which is unbecoming of a growth stock. Given the Restasis risk I do not believe Allergan's growth prospects exceed other firms I just mentioned. Even if investors assigned an 11.1x EBITDA multiple (50% above the median multiple for hedge fund hotels) to Allergan, the stock would trade around $140 - more than 30% below its current value. If the market begins to price in a loss of Restasis then I believe AGN could begin to trade closer to its peers.

Conclusion

Senateate investigation of Allergan's patent sale could create negative headlines for Allergan. I believe the longer the patent review is in limbo the higher the likelihood investors will price in a loss of Restasis.