SSR Health New Product Approval Portfolios & Supporting Data Update

Written December 8th, 2014 by

Drug, biotech, and research-based spec pharma stocks tend to outperform their peers in the year or so before and after regulatory actions (‘PDUFA’ dates) on major new products, with a large portion of total risks being concentrated in the days immediately preceding and following the PDUFA date

Since November of 2011 we’ve run model portfolios consisting solely of names with pending (i.e. ‘pre-PDUFA’) or recent (i.e. ‘post-PDUFA) major-product regulatory actions, respectively. Within each broader ‘pre-‘ and ‘post-PDUFA’ portfolio are three sub-portfolios that differ only in terms of how large the new product is as a percentage of the company’s total sales forecast. E.g. the ‘1% pre-PDUFA’ portfolio consists of all names with pending regulatory decisions on products that account for at least 1% of the company’s total sales forecast, and so on for the ‘5%’ and ‘20%’ pre- and post-PDUFA portfolios. To moderate risks, all portfolios follow rules to limit long positions in the days immediately before and after regulatory actions

Since inception the 1% pre-PDUFA portfolio has produced greater annualized returns (64% v. 34%) at a lower standard deviation annual of returns (11% v. 15%) than an ‘innovator index’ of nearly the entire universe of biopharmaceutical stocks. The 5% and 20% pre-PDUFA portfolios have outperformed by even greater margins as compared to the innovator index (86% and 100% v. 34%), though at higher s.d. of returns (23% and 43% v. 15%). Over the last twelve months, the 1%, 5%, and 20% pre-PDUFA portfolios have returned 72%, 115%, and 184%, respectively, versus 21% for the innovator index and 51% for the BTK, while also significantly reducing relative risk

We expect US real pricing power for pharmaceuticals to fade, which will increase the importance of new product flow to relative performance. Thus screening for names with attractively priced new product flow is an appropriate first step to stock selection across the drug, biotech, and spec pharma sub-sectors. We offer two related tools, the first being these portfolios of names with major pending or recent regulatory actions (published monthly); the second being our Hidden Pipeline series of reports that identify undervalued phase 2 and earlier pipelines (published quarterly)

For our full research notes, please visit our published research site

The Bull Case for SNY’s Diabetes Franchise

Written December 5th, 2014 by

2017 consensus for SNY’s US basal insulins fell from $9.9B to $7.5B after the company warned 2015 sales growth would be flat, citing price competition. We believe estimates have fallen too far, and imply an unstable pricing environment with significant downside risks. In contrast, we believe current levels of US net pricing are at the very least stable, and may improve

Key facts: there are only two entrants in the basal insulin market; the market laggard (NVO’s Levemir) is an imperfect substitute for the market leader (SNY’s Lantus); SNY’s pending Lantus replacement (Toujeo, 1Q15) makes Levemir an even less perfect substitute; the entrants cooperate on price rather than competing on price; absolute net pricing levels are relatively low (about $60 / month); and, total basal insulin sales are only about 3% of total US drug spending

Because average Rx prices and total category spending are relatively modest, and because Levemir is an imperfect substitute for Lantus (and ultimately Toujeo), it is extremely unlikely that a large number of US payors will attempt to shift a large number of US patients from Lantus (or Toujeo) to Levemir. Having no reasonable prospect of large unit share gains NVO has no motive to price Levemir below Lantus

Instead, NVO has cooperated (and in all likelihood will continue to cooperate) on price. All of the US list pricing actions on Lantus and Levemir have fallen within 25 days of each other since at least 2009; on average the companies have raised list prices within 12 days of one another. The most recent price increases occurred in early November; both companies raised US list prices by 11.9%

SNY’s problem isn’t NVO – NVO couldn’t possibly be more cooperative, and they’ve done nothing to undercut pricing recently. SNY’s problem is payor frustration with the rate of price increase in the category. Being the category leader, SNY’s Lantus is the natural target of that frustration

Lantus lost less than 2 percent new unit share to Levemir in any given year from 2010 to 2013; however as price increases accelerated to more than 40% in 2014 (from more than 20% in 2013) a small but meaningful group of payors pushed back, and Lantus lost more than 4 percent new unit share to Levemir in the first 3 quarters

SNY increased its Lantus rebates in response, so that Lantus’s net price is now about 7% greater than Levemir’s as opposed to the 15% premium Lantus carried in 2013. It was SNY who blinked, not NVO

NVO almost certainly will not lower Levemir’s price (list or net), and SNY almost certainly will not move to a price (list or net) below Levemir’s. Payors cannot mount a wholesale shift of patients from Lantus to Levemir, because Levemir isn’t the right drug for the majority of patients, and the resulting non-Rx medical costs from a wholesale Lantus to Levemir shift would more than outweigh any savings from lower drug prices. The worst case scenario is that Lantus’s net price (currently $63.54 / month) falls 7% to the Levemir level ($59.12), and that list price growth in the category simply ends

The more likely scenario is that Lantus’s net pricing falls to the Levemir level, but that category list price growth falls at most to the industry rate (+/-13%) rather than ending altogether. Toujeo should at least stabilize SNY’s basal insulin share, and in all likelihood should regain modest share from Levemir

All in, SNY’s US basal insulin sales in 2015 could be +/-8% lower than 2014 (assuming zero list price growth), or more likely at least roughly flat (assuming some degree of list price growth is preserved). After 2015, stable market share and net price growth at the industry rate imply high single digit to low double digit sales growth, leading to 2017 sales potential of roughly $9B – $1.5B above current consensus

For our full research notes, please visit our published research site

December 1, 2014 – Twitter: Black and Blue, but Read All Over

Written December 1st, 2014 by

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Twitter: Black and Blue, but Read All Over

For the past year, TWTR has been whipsawed on the volatility of its monthly active user growth and the revolving door of the company’s management ranks. While many investors are skeptical, the company recently outlined a narrative by which its revenues could rise tenfold in the intermediate term. We believe that the scenario, which relies on doubling its monthly active users, increasing user engagement, boosting ad density and monetizing unregistered users, is conservative. TWTR’s vast unregistered user base will be tapped as the company resolves functional problems in its app design and communications strategy. Moreover, a powerful secular shift toward digital advertising and rich new ad formats will support both higher ad loads and better ad pricing. We are more skeptical on TWTR’s ambitions to monetize unregistered users, but note that the potential to leverage the platform into new products is considerably greater than has been implied by management’s new narrative. Given less intensive infrastructure requirements than either GOOG or FB, we expect TWTR to deliver superior profitability as it gains scale, and project better than 80% GM and 50% EBITDA margins for 2019. Applying a FB like 19x multiple to 2018 revenues and discounting back at a 30% discount rate, reflecting considerable market and execution risk, we believe TWTR shares have more than 100% upside from current prices.

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US Ethylene Stocks – Too Early to Call

Written December 1st, 2014 by

While it is always tempting to upgrade a stock or a sector when ones competitors are finally throwing in the towel, it is too early to call for US ethylene. The two most exposed ethylene stocks, LYB and WLK, have had a terrible run and are now both trading below our normalized value, but we are still not ready to change our bearish view.

All things being equal, at $70 Brent, European ethylene economics should normalize at around $930 per metric ton cash cost of ethylene (which is around 42 cents per pound) – see Exhibit.  To move US ethylene into Europe as derivatives, we would need a US price lower than that – by 4-5 cents for PVC and by 7-8 cents for polyethylene.  If US ethylene settles at 40 cents on average and derivatives fall in line we would be looking at a 15 cents per pound decline in margins versus 2014. This is roughly a $3.25 per share drop in earnings for LYB and $3.50 for WLK, versus 2014 with LYB possibly getting some offset from Europe.  LYB looks fairly valued on this basis today and WLK still looks expensive.

But…the world is short of propylene and butadiene.  These are major co-products for European ethylene producers and much less so for US producers these days given the strong ethane feedstock bias.  If propylene and butadiene prices remain robust – well above ethylene prices, these will provide a more significant cost offset in Europe and Asia as oil/naphtha prices fall, reducing the effective cost of making ethylene.  For every $100 per ton propylene and butadiene remain above “normal”, the cost of making ethylene falls by $70 per ton on a standard naphtha unit.

The risk to buying LYB and WLK today is that the markets for propylene and butadiene globally remain strong, increasing the co-product credits for both and lowering the cost of making ethylene in Europe and Asia further.  This lowers break-even pricing and US margins further.

This is a complex subject – please contact us directly for more details.


China – Look For The Commodities That Are Less Oversupplied

Written November 21st, 2014 by

China’s interest rate cut has got everyone’s attention today and the markets are rallying as are most commodities.  We have seen interest rate cuts all over the world over the last two years and their impact on economic growth/consumer spending has generally been positive, but not dramatic.  If we assume the same for China, some of these commodity moves may be premature, as even with increased demand in China we have so much global overcapacity that incremental demand from China may not be enough.

Iron ore, for example, is in such significant oversupply that incrementally better demand in China will likely not be enough to make a difference and any price response will be met with a supply response, as we saw with Aluminum through 2012 and 2013 – see chart.   It is unlikely that lower rates in China will lead to significant increases in infrastructure spending, so Iron ore and Steel are going to have to rely on consumer driven demand increases – for example in Autos.

Increases in consumer spending in China and possible also in Europe, as Draghi unlooses every tool in his belt to stimulate growth, would be good for Autos, but also for housing and other consumer goods.

We would focus first on Aluminum as a way to play this change.  We know from the way that prices have moved this year that the global Aluminum market is in better shape that it was a year ago, and growth rates are already strong.  Alcoa would be the big winner here and we still see significant upside in the stock: we continue to believe that it could double.

A second focus might be Titanium Dioxide; DD and HUN in our universe.  This is a commodity very much at the bottom of the cycle, but better autos and housing means better paint demand.  There is an oversupply here and it is focused in China, and it is not obvious how close we might be to a point of inflection.  There is still more capacity coming on line in China and while valuations are interesting for both companies they are not nearly as compelling as they were for Alcoa when we made the initial recommendation to own the stock.  DD is in the process of carving out its TiO2 business, either for sale or for spin, but it will remain part of DD most likely through the middle of 2015.


Relative Price & Value of pre-Phase III Pipelines for the 23 Largest Drug & Biotech Companies – Updated View

Written November 20th, 2014 by

We use patent data to estimate the amount and quality of innovation in companies’ pre-phase III (aka ‘hidden’ pipelines); we then determine whether companies’ share prices accurately reflect what’s in these hidden pipelines.  Since inception (November 2012), companies that screen as >= 20% undervalued have outperformed their peers by 1.4x (cap wtd) to 1.6x (equally wtd)

Because of large misvaluations in hidden pipelines, shares of VRTX, BMY, SNY, and GSK all appear at least 20 percent undervalued. Conversely shares of ALXN, BIIB, CELG, GILD, NVO, REGN, and SHPG all appear at least 20 percent overvalued

For more information on our pipeline valuation methods, and for related R&D productivity metrics covering the 23 largest publicly-traded companies (by R&D spending) please visit

For our full research notes, please visit our published research site

Quick Thoughts: Qualcomm Analyst Day – Hang On for a Bumpy Ride

Written November 19th, 2014 by

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-       China is a double-edged sword for QCOM – regulators and scofflaws plague QTL, while QCT is successfully competing for Snapdragon and baseband business.

-       Projected device ASP erosion of 9-10% will hit royalties, but will be offset by chipset unit volume growth driven by emerging market smartphone demand

-       QCOM is driving global wireless technology innovation, combining aggressive R&D spend with historical leadership and positioning itself to attack new opportunities.

-       The regulatory and licensing issues will take several quarters to resolve – meanwhile QCOM’s potentially dominant position may be temporarily immaterial to investors.

QCOM’s annual analyst day saw rookie CEO Steve Mollenkopf and his leadership team take the stage to persuade investors of the company’s dominant position in nearly all wireless markets despite headwinds from regulators in China. The company earlier in the day unveiled a new baseband chip pushing the boundaries of LTE-Advanced technology with 450 Mbps speeds in a more power efficient 20-nm package. It also revealed that it is planning on entering the server chip market, with Facebook a likely launch customer deploying QCOM’s ARM based server chips across its webscale data centers. Despite the company’s leading positions across mobile and plans to enter adjacent markets, growth over the next five years is expected to proceed at an 8-10% clip, fairly conservative guidance given the continued growth of smartphones and the likely size of emerging mobile opportunities. The prospect of Chinese regulators levying stiff penalties continues to haunt management and investors with Mollenkopf’s team giving only vague indications progress is being made for a resolution. Still, the company tried to allay China concerns with videos during the interludes between speakers featuring companies like Xiaomi, China Mobile, and foundry SMIC extolling the virtues of their QCOM partnership.

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Quick Thoughts – Implications of SnapCash for ACH and Person-to-Person (P2P) Payments

Written November 18th, 2014 by

With its announcement of Snapcash on Monday, Snapchat (with a $10bn valuation in its last funding in August[1]) enters the market for integration of social media and person-to-person (P2P) payments in competition with PayPal’s Venmo (which handled over $300mm in consumer payments in FQ12014 putting it on a par with the SBUX mobile app – see Chart); the back-end for Snapchat is provided by Square which expands the potential reach of its Square Cash product to the 100mm MAU’s of Snapchat. These direct-messaging services compete with bank P2P applications that use e-mail addresses or telephone numbers (through text-messaging) as tokens including PeopleMoney and PopMoney (white-labeled to banks from FIS and FISV respectively) and clearXchange (owned by BAC, JPM, WFC, and COF).

The Square Cash, and hence Snapchat, solution is distinctive because it uses the Visa and MasterCard networks while the other solutions use either: ON-US clearance (where the sender and receiver share the same bank); proprietary networks such as those run by FIS, FISV, clearXchange, and PayPal[2]; or the ACH network). The advantage for Square Cash is that it can promise next-day funds-availability whereas solutions that may need to use ACH often only promise funds within 3-5 days. The reason for the delay is that, while ACH is a next-day settlement system if a debit transaction is accepted by the receiving bank (“RDFI”), it can take 3 days for the originating bank (“ODFI”) to learn that the RDFI has returned, rather than accepted, a transaction (because, for example, the target account for the debit does not have funds available).  Zen Payroll provides a masterful explanation of the finicky return process that affects ~5% of ACH transactions.

SquareCash, however, can promise funds within 1-2 days because it uses the Visa or MasterCard networks rather than ACH and because the issuing bank in a Visa debit transaction (equivalent to the RDFI in an ACH debit) provides surety of payment at the time the transaction is authorized; as a result, the next-day settlement is not subject to a return. The challenge for SquareCash is that this faster settlement comes at a price: each debit transaction generates a cost of 30-35 cents (of which 25 cents is paid to the issuing bank as “interchange”) and , given neither Square Cash nor Snapchat are currently looking to recover the cost through a customer fee, the P2P offering is therefore a loss-leader. ACH involves a far lower fee of 1-2 cents paid by the ODFI.

The challenge for the banks is that their brands are being wrapped by app-providers whether Snapchat or Square in the case of P2P transactions or Apple Pay in the case of POS transactions. This is at a time when a strategic priority is to extend consumer engagement with bank-branded mobile apps beyond the initial use-cases of balance-checking and remote-deposit capture. As a result, the banks are looking to make the ACH-based solutions on which their P2P services are based (whether through clearXchange or white-labeled solutions from FIS and FISV) more competitive in terms of the timing of settled funds; the plans announced by NACHA this March to move ACH from next-day to same-day settlement would reduce the gap by one day and, combined with Secure Vault Payments which leverages the ACH network to offer real-time guarantee of good funds for participating banks, could make ACH-based solutions as fast as Visa-based solutions.

As discussed in our note of Monday “The Migration to Real-Time Payments in the US and Opportunity for ACIW”), we expect the NACHA plans to be ratified by year-end (in contrast to similar plans that were presented in 2012 and vetoed by large banks that November) catalyzing ACH-based solutions including from vendors such as ACIW, eFunds (acquired by FIS in June 2007) and Alaric (acquired by NCR in December 2003). While these will not provide issuing banks with the interchange revenue of a Visa-based solution, they will allow greater control of the bank brand and drive traffic to bank mobile apps. In addition, there is a potential revenue opportunity from customer fees with USB, for example, charging $3.50 for an instant payment, $0.75 for a next-day payment, and no fee for a standard payment within 3-5 business days[3]. The “instant” and “next-day” solutions require a bank to take settlement risk by irrevocably posting debits and credits to a customer account ahead of final inter-bank settlement although this risk will decline as ACH builds capabilities around same-day settlement and real-time funds verification through Secure Vault.


[2] Of course, a customer’s PayPal account may ultimately be funded by a Visa or MasterCard account



Hold-Out States Will Expand Medicaid – Just Ask History

Written November 17th, 2014 by

The original Medicaid program was passed in ’65, going into effect in ’66 – and only 26 states joined the program in that first year. By 1970 all but Alaska and Arizona had joined; Alaska held out until ’72, Arizona until ‘82

As with any large social program, Medicaid was born into political controversy. Yet as the program’s date of passage fell into the past, the framing of the debate shifted – from national politics to state politics and economics. Ultimately allstates chose not only to participate in Medicaid, but to expand their programs well beyond the federal minimums – at an average marginal cost of $0.43 per $1.00 of Medicaid spend

As the current Administration winds down, the Medicaid expansion debate again moves from national politics to state political economics. States can expand their programs at a marginal cost of $0.10 per $1.00 of Medicaid spend – good economics for even the most reluctant Keynesian. On average, states can expand to eligibility to 100FPL by raising their total state budgets by only 0.2%, or to 138FPL by raising total state budgets by 0.4%

We expect most ‘non-expansion’ states to expand to at least 100FPL in or around 2016; this raises enrollment by 6%, and total Medicaid spending by 4%. Full expansion to 138FPL would raise enrollment by 11%, and total Medicaid spending by 7%

Medicaid HMOs (e.g. CNC, MOH, WCG) are the primary beneficiaries of further expansion; of these CNC is by far the most exposed to the non-expansion states, and would benefit most from growth in these states’ programs

Hospitals (e.g. CYH, HCA, LPNT, UHS, THC) also are beneficiaries of further Medicaid expansion, mainly because of reduced costs for uncompensated care; of these HCA has the greatest share of its beds (86%) in states that have not yet expanded, and presumably would benefit most

For our full research notes, please visit our published research site

SCOTUS Round II: Does King Really Matter?

Written November 11th, 2014 by

The Supreme Court of the United States (SCOTUS) will hear arguments in King v. Burwell, in February or March of 2015, with a ruling likely in June of 2015. A decision to uphold King would mean persons buying health insurance on federally (rather than state) managed health insurance exchanges (HIEs) are ineligible for subsidies

If King is upheld, governors in affected states (those with federally managed HIEs) can keep federal subsidies flowing on their HIEs by simply taking over management of the HIE. We believe most are likely to do so

In the 27 states with federally managed HIEs, we count roughly 11.8M persons who are likely to favor state control of the HIEs in order to keep $12.2B in subsidies flowing; included in this number are 3.8M persons currently receiving subsidies (which average +/- $3,216 / year), 2M persons who are likely to need federal subsidies in any given year because of job loss, and 6.5M healthcare employees. In these same states we count roughly 6.8M persons who oppose state control of the HIEs in order to shield themselves from penalties for being uninsured, which average about $590 per person per year, and total about $4.0B in aggregate. On net, voters in favor arguably outnumber those opposing, and voters in favor arguably are more motivated (the dollar impact of subsidies gained is far larger than the dollar impact of penalties avoided) (see Appendix 1 for details by state)


Where we’re BULLISH: Biopharma companies with undervalued pipelines (e.g. VRTX, BMY, SNY): Biopharma companies with pending major product approvals (e.g. TSRO, ALKS, HLUY, EBS, BMY, BVRX, CBST, ACRX, BMRN, PCYC); ABBV and ENTA on sales prospects in Hep C; CFN, BCR, CNMD and TFX on rising hospital patient volumes; XRAY and PDCO on rising dental patient volumes and rising average dollar values of dental products and services consumed per visit; CNC, MOH and WCG on bullish prospects for Medicaid HMOs; and, DVA and FMS for the likely gross margin effects of generic forms of Epogen

Where we’re BEARISH: Biopharma companies with overvalued pipelines (e.g. GILD, ALXN, SHPG, REGN, CELG, NVO, BIIB); PBMs facing loss of generic dispensing margin as the AWP pricing benchmark is replaced (e.g. ESRX, CTRX); Drug Retail as dispensing margins are pressured by narrowing retail networks and replacement of AWP (e.g. WAG, CVS, RAD); and, suppliers of capital equipment to hospitals on the likelihood hospitals over-invested in capital equipment before the roll-out of the Affordable Care Act (e.g. ISRG, EKTAY, HAE, VOLC)


For our full research notes, please visit our published research site

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