DuPont – A Slim Victory but Have Any Lessons Been Learned?

Written May 20th, 2015 by

DuPont may have won the battle, albeit by a small margin, but in our view it is still very much in danger of losing the war.  Beating Trian in the recent proxy fight may be a cause for celebration in the DuPont board room, but if the board does not address a couple of key issues raised by Trian, it may be the last celebration for a while. DuPont’s complexity is hindering the company and is likely causing excessive optimism, resulting in misplaced allocation of capital and broad underperformance both on the earnings front and from a total shareholder return perspective.  Broadly, complex companies fail to achieve meaningfully lower earnings or return on capital volatility, but they do a fairly good job of underperforming their less complex peers, as shown in the chart below.


DuPont has to address two issues that, in our view, arise from complexity, and impact many other companies as well as DuPont; an inflated cost structure, and undervalued specialty businesses.  The cost issues, again in our view, stem from the difficulty of trying to pursue a growth strategy and a low cost strategy under one roof.  More commodity focused competitors push the low cost agenda and drive down the cost curve – this has happened to DuPont in TiO2 and to Dow in ethylene and polyethylene and we can come up with countless other examples.  The erosion of these cost curves and many others have drowned any R&D/”growth initiative” driven gains.

The undervalued specialty business problem is currently acute for DuPont and possibly Dow, as we may be seeing the beginnings of a game of musical chairs in the Ag chemicals space.  Neither DuPont nor Dow can compete in the bidding for Syngenta because their multiples are too low because of the diversity of the portfolios and the additional complexity stock multiple penalties they have been given.  An attempt to buy Syngenta from DuPont today would be a highly dilutive move for shareholders – had DuPont management listened to Trian on day 1, DuPont “Growth Co” would be an independent company today and a much better suitor for Syngenta than Monsanto.

If DuPont returns to business as usual and pays no heed to the advice offered by Trian, we fear that it will be a case of more of the same – poorly thought through investment, both R&D and M&A, leading to more earnings disappointments.  It this scenario there is no reason to own the stock today as it is already expensive on a “business as usual basis”.  Our positive stance on DD relies on the board and management making some major changes to the cost base and major changes to focus, resulting in a more appropriate strategic path or strategic paths.


A WBA/RAD or CVS/RAD NEWCO as a Counterweight to Narrowing Retail Pharmacy Networks

Written May 4th, 2015 by

This note updates our argument that US retail pharmacy networks are likely to narrow, compressing pharmacy dispensing margins – and in particular focuses on our belief that a WBA/RAD or CVS/RAD NEWCO is better able to withstand such margin pressures

If we assume no payor is willing to construct a retail pharmacy network that violates the TriCare/CMS standards for pharmacy proximity, then as of today 19.1% of the US population lives in a geography where WBA must be included in pharmacy networks (because to exclude WBA would require violating minimum access standards). For CVS this value is 17.6%

After controlling for divestitures, 28.8% of the US population lives in a geography where a WBA/RAD NEWCO could not be excluded from the pharmacy network, and 26.6% live in a geography where a CVS/RAD NEWCO could not be excluded

We reiterate our viewpoint that RAD is a highly valuable strategic asset to either WBA or CVS, and so is reasonably likely to be acquired. We further reiterate that either deal is likely to be highly accretive, despite RAD’s recent outperformance

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

SSR Health New Product Approval Portfolios & Supporting Data Update

Written May 4th, 2015 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 (63% v. 40%) with a lower standard deviation of annual returns (11% v. 16%) 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 (82% and 98% v. 40%), though at higher s.d. of returns (23% and 46% v. 16%)

We expect US real pricing power for pharmaceuticals to fade, increasing 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

ABC/CAH/MCK: US Generic Inflation Continues in 1Q15

Written April 21st, 2015 by

On a sales-weighted basis, prices (paid by retailers) for US generics rose 4.7% in 1Q15, substantially faster than in 4Q14 (0.5%), and on par with the average pace of inflation (5.1%) seen since early 2013

All else held equal, generic price inflation aids the gross margins of drug wholesalers (e.g. ABC, CAH, MCK), thus the healthy generic inflation observed in 1Q15 is a bullish early indicator for these names’ 1Q15 results. Despite carefully trying, we observe no correlation between generic manufacturers’ participation in US price inflation and either the quality of their immediate earnings or their relative share price performances

In a February note we showed that US generic inflation isn’t about supply disruptions or small numbers of manufacturers producing the products whose prices inflate. Instead, we found two patterns: one in which manufacturers of products with very low prices inflated these products’ prices toward the median price for all generics (explaining ~75% of inflation); and, another in which manufacturers of products with median prices but very low volumes (and thus very modest sales) inflated these products’ prices beyond the median (explaining the remaining ~25% of inflation). Inflation in 1Q15 also is explained by these two patterns, thus whatever’s driving inflation continues apace

A plausible explanation is that generic manufacturers, having fallen to near historic low levels of financial performance (e.g. ROA, GM), are cooperating to raise the prices of products whose characteristics (low sales due to either very low prices or very low volumes) accommodate price inflation. An alternative and/or over-lapping explanation is that wholesalers, who benefit from generic inflation and who have recently taken responsibility for the majority of US generic purchasing, are at the very least passive with regard to generic inflation

If inflation is explained largely by strapped generic manufacturers cooperating, then it can’t last very long – the manufacturers’ financial results are improving, and the number of manufacturers required to cooperate is far too large for the cooperative spirit to remain stable

Conversely, to the extent generic inflation is the result of wholesalers’ actions, generic inflation is likely to continue until and unless such actions are challenged

We intend to publish an index of US generic inflation at least quarterly, and anticipate that as long as the inflationary trend continues, that US wholesalers’ gross margins will expand, with commensurate gains in earnings

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

ABBV/PCYC: Imbruvica and ABT-199 are Synergistic

Written April 16th, 2015 by

ABBV’s acquisition of PCYC raised eyebrows, both because of the valuation placed on PCYC, and because ABBV has a promising lead compound (ABT-199) being developed for the same B-cell malignancies treated by PCYC’s main product (Imbruvica)

Much debate centers on which is better – Imbruvica or ABT-199. We think this misses the point; the drugs are far more likely to be used together than in lieu of one another

Imbruvica is a leap forward in the treatment of B-cell malignancies, but complete responses are rare, and patients have shown resistance. Malignant B-cells adapt to Imbruvica by altering the shape of Imbruvica’s target, altering the shape of the protein cleaved by Imbruvica’s target, and/or relying on alternative mechanisms to carry out the functions of the pathway blocked by Imbruvica. Imbruvica needs a partner

At least six teams of investigators have shown that Imbruvica and ABT-199 in combination are synergistic, and/or that ABT-199 remains effective even after cells develop resistance to Imbruvica. At least two teams of investigators have analyzed multiple potential partners for Imbruvica, and both have identified ABT-199 as the best choice

The evidence that Imbruvica and ABT-199 are synergistic sheds important light on the ABBV/PCYC transaction. Treatment of B-cell malignancies is plainly going to be multi-modal. Owning just one of the promising components of the multi-modal treatment doesn’t guarantee commercial success – witness the jockeying among antivirals for inclusion in the standard of care for HIV and HCV, and the reality that highly effective components failed to be included in the prevailing standard(s)

Conversely, owning the first two ‘dominant’ components of multi-modal B-cell therapy makes it far more likely that ABBV plays a controlling role in developing and commercializing the multi-modal standard of care for B-cell malignancies

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

SNY: The (multi-faceted) Bull Case

Written April 13th, 2015 by

We believe SNY is undervalued, for 3 independent reasons, any one of which is sufficient to show the shares are undervalued

With partner REGN, SNY is one of two entrants (the other being AMGN) in the emerging PCSK9 class. Our forecast for the class (as much as $15B in peak sales for the US alone) is more than 2x consensus. And, because the SNY/REGN entrant (alirocumab) has efficacy equivalent to AMGN’s entrant (evolocumab), but requires a smaller injection volume and is likely to have a COGS advantage, we expect SNY/REGN to take more than half of the category. Consensus assumes SNY/REGN take less than a third

Despite rising volumes, rising share, and rising prices, consensus expects SNY’s US insulin franchise to undergo a steady decline – essentially consensus reflects a pricing war that doesn’t exist. SNY does face the challenge of switching an undifferentiated replacement (Toujeo) in for Lantus before the latter faces generic competition (no sooner than mid-’16). This can be done by making Toujeo more profitable for PBMs and HMOs than Lantus, which is in turn done by raising Lantus’ net price to create headroom for a lower (than Lantus, but still rising) net price. In other words, the Nexium v. Prilosec playbook

By calculating the NPV of approved, filed, and phase 3 assets (using consensus forecasts), we estimate the market capitalization of phase 2 and earlier assets (by subtracting the NPV of the phase 3 and later assets from EV). Using quality-adjusted patent metrics, we then estimate the actual amount of innovation in phase 2 and earlier pipelines, and compare the market value of the pipeline to its contents. SNY’s phase 2 and earlier pipeline contains more than 7x the amount of innovation its share price implies. For its pipeline to be fairly valued, SNY’s share price would have to increase 39% relative to its peers

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

CVS, MCK, RAD, WBA: How WBA or CVS can fight narrowing retail networks – buy RAD

Written April 6th, 2015 by

US retail pharmacy dispensing margins have grown to a point at which forcing them lower is a priority for drug benefit designers. Because the US has roughly 34% more pharmacy outlets than it needs, this can be (and is being) done by moving beneficiaries into narrower (or at least tiered) drug benefits

A logical countermove from the perspective of drug retailers is to become an ever more essential part of any region’s retail pharmacy network – simply by increasing average market shares in key regions

A WBA acquisition of RAD would grow the NEWCO’s population-weighted market share (per metropolitan statistical area or ‘MSA’) by 7.8%; a CVS acquisition of RAD would increase population weighted market share of the NEWCO by 6.1%

Because WBA would be required to divest a smaller percentage of the acquired RAD outlets (9.9%) than CVS (24.2%), net of transaction costs RAD is ‘worth’ more to WBA than to CVS

The margin structure of RAD’s pharmacies is substantially less healthy than either WBA’s or CVS’s, and because efficient central sourcing plays such a key role in outlet profitability, it’s reasonable to expect that the margin structure of an acquired RAD outlet would migrate to very nearly that of its WBA or CVS siblings. This fact alone is sufficient to make RAD affordable to either WBA or CVS at substantial premia to RAD’s current share price. And, the likelihood that gross margins for a WBA/RAD or CVS/RAD NEWCO would remain higher longer than for WBA or CVS alone only serves to make the strategy more compelling

As RAD’s primary wholesaler, MCK (which does not service either WBA’s or CVS’s retail outlets) loses the most from a WBA or CVS acquisition of RAD. We estimate that RAD accounts for roughly 12 percent of MCK’s revenues

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


Written March 30th, 2015 by

Three distinct drugs or drug classes are in late stage development for treatment of lipid abnormalities: PCSK9’s (AMGN, SNY, REGN), CETP’s (MRK, LLY), and ETC-1002 (ESPR). This raises the question of which drugs fit where if all or most are approved

Using population-based data (NHANES*) data which includes the lipid levels (LDL-C, HDL-C, triglycerides) and risk factors needed to establish appropriate therapy, we estimate the numbers of US patients eligible for each of the three drugs or drug classes

Assuming all 3 classes are approved, and that physicians target an aggressive LDL-C goal (40 mg/dl), we find that 12.9M patients are eligible for PCSK9’s, 10.8M are eligible for CETP’s, and 160k for ETC-1002. Notably 9.9M patients are eligible to simultaneously use both PCSK9 and CETP therapy. The point here is that PCSK9’s and CETP’s overlap far more often than they compete

As long as physicians treat LDL-C aggressively (pursue 40 mg/dl rather than 70 mg/dl), whether CETP’s are approved (yielding 12.9M PCSK9 eligible patients) or not (yielding 13.8M PCSK9 eligible patients) has little bearing on demand for PCSK9’s

Conversely, whether CETP’s are or are not approved has an enormous impact on the number of patients eligible for ETC-1002 – 160k if CETP’s are approved, v. 650k if CETP’s are not approved

Whether PCSK9’s or ETC-1002 are approved has little bearing on patient eligibility for CETP’s – all that matters is the level at which LDL-C and HDL-C goals are set

Given the relative sizes of the eligible patient populations and the relative amounts of remaining approval risks faced by PCSK9’s and CETP’s, all else equal (i.e. no CETP-specific risk discount) we would expect CETP consensus to be about one-half PCSK9 consensus. In reality, CETP consensus is about one-fifth PCSK9 consensus. We think PCSK9 consensus is far too low (please see last week’s note), and our preliminary reaction is that CETP consensus – even accounting for class risks – also is too low

*(National Health and Nutritional Examination Survey)


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

Relative Price & Value of pre-Phase III Pipelines for the 22 Largest Drug & Biotech Companies – Updated View

Written March 18th, 2015 by

Using patent data we estimate the amount and quality of innovation in companies’ pre-phase III (aka ‘hidden’ pipelines), and 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 1.5x (cap wtd) to 1.7x (equally wtd)

We believe that the duration and consistency of our performance validates our approach – the odds against achieving this level of performance through random selection of candidate stocks are roughly 44,000:1

Because of large misvaluations in hidden pipelines, shares of VRTX, BMY, SNY, and ROCHE 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

AMGN, REGN, SNY: Bull Case for PCSK9’s; COGS a Major Advantage for SNY/REGN

Written March 17th, 2015 by

We see peak US sales potential for PCSK9’s in the $5.5B to $8.5B range before outcomes data, and in the $9.6B to $15B range after outcomes data are available. By comparison, consensus expects combined 5th year global sales (our estimates are US-only) for the two products of just $4.2B

We suspect our US forecast calls for much higher patient volumes at much lower average net prices (we expect net US pricing of only $252 – $340 per month). Our conservative pricing estimate has much to do with formulary managers’ considerable leverage over the class: there will be no outcomes data at launch; the patient population can be finely segmented by risks and LDL-C’s, enabling restrictions; the PCSK9’s are likely to be on specialty tiers with higher co-pays; and, a large percentage (+/- 51%) of treatment candidates are on Medicare or Medicaid (where co-pay cards cannot be used, and average rebates run much higher)

Because the PCSK9’s are monoclonals their COGS will be relatively high, especially for chronic use products in our predicted net pricing range. Most patients on SNY/REGN’s alirocumab have reached their LDL-C goal on 75mg every 2 weeks (1,950mg annually); all patients on AMGN’s evolocumab require at least 140mg every 2 weeks (3,640mg annually) and those using the 420mg monthly dose will consume 5,460mg annually

At the lowest COGS we know of for a monoclonal (Erbitux, $0.30/mg), annual COGS for the lower alirocumab dose would be $576 and for the higher dose $1,161; annual COGS for the lower evolocumab dose would be $1,075 and for the higher dose $1,612. At our assumed net pricing, this would equal a COGS/sales ratio ranging from 14% to 38% for alirocumab, and from 26% to 53% for evolocumab

This affords SNY/REGN a distinct advantage. Because most patients will reach goal on the starter 75mg every 2 week regimen, SNY/REGN’s ‘workhorse’ dose is the one with the lower ($576 rough estimate) COGS. By comparison, AMGN’s starting dose – 140mg every 2 weeks – presumably has nearly twice the COGS ($1,075 rough estimate). SNY/REGN can sell their starting dose for $500/year ($42/month) less than AMGN’s, and still earn the same gross profits as AMGN

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

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