Drug & Biotech Companies with Undervalued Pipelines: Updated (and Expanded) List

Written July 6th, 2015 by

Phase 2 and earlier pipelines account for more than a third of larger biopharma companies’ market values; however because the market knows much less about these ‘hidden’ pipelines than about companies’ ‘non-hidden’ operations (e.g. existing, filed, or phase 3 projects), we believe hidden pipelines drive substantially more than a third of relative share price performance

Using patent data, we can better determine what’s actually in companies’ hidden pipelines, and by extension whether share prices fairly account for hidden pipelines’ contents. Since 2Q13, stocks identified as undervalued using this method have outperformed the peer group by 1.6x – and have in fact outperformed the peer group in every quarter

Our patent-based method is very good at establishing the relative amounts of innovation in companies’ pipelines, but does little to establish where companies stand on the timeline of bringing these innovations to market

To fill this gap, we’ve begun using a systematic analysis of data to identify products that are moving along in clinical development, but not yet captured by consensus or reflected in share prices. On a back-tested basis, stocks selected using our method outperformed peers by 2.9x over the last 8 quarters, as compared to the 1.6x prospective outperformance achieved with the patent-based method

The patent-based and methods tend to choose different stocks; in effect each method tends to choose stocks the other method would likely miss. Accordingly, we intend to publish portfolios of both methods separately, as well as a combined portfolio of all stocks selected by either method

Stocks presently screening as undervalued using the patent-based method are BMY, SNY and VRTX; stocks presently screening as undervalued using the method are AMGN, CELG, and GILD

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

CVS/TGT: What Does the Store-In-Store Strategy Mean for RAD?

Written June 23rd, 2015 by

If we assume CVS cannot repeat the TGT store-in-store deal with other major mass merchants, but can do such a deal with a single supermarket (who would likely impose limits on further deals with other supermarkets), its next best option is a store-in-store deal with KR. A CVS/KR deal would increase by 5.9% the share of the US population living in areas in which CVS cannot be excluded from pharmacy networks

If we assume WBA can complete deals with one major mass merchant and one major supermarket, its best options are WMT and KR. WMT would increase WBA’s ‘cannot-be-excluded’ percentage by 7.6%, and KR increases the percentage by 5.0%, for a total theoretical gain of 12.6%

If we assume WMT will not give up control of its pharmacies (we don’t think they should) and that KR is unavailable to WBA (perhaps having gone to CVS), WBA’s best store-in-store strategy would be SWY plus Kmart, for a combined 4.7% gain in the share of the population living in areas where WBA cannot be excluded from retail pharmacy networks

By way of comparison, a RAD acquisition would increase CVS’s ‘cannot-be-excluded’ percentage by 8.5%, and WBA’s by 9.7%. Acquiring RAD is a better option than any single store-in-store deal, and if WMT keeps control if its pharmacies, RAD is a better option than any feasible combination of store-in-store deals

In theory, the store-in-store strategy has the advantage (relative to a RAD acquisition) of eliminating outlets that likely would have been used as loss leaders to drive front store traffic by their supermarket and/or mass merchant operators. In truth, we doubt WBA and CVS can soak up enough of these outlets to have an effect

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

A Strategic Look at CVS/TGT; Why We’re Still Bullish on RAD

Written June 16th, 2015 by

CVS’ acquisition of TGT’s pharmacies raises from 17.6% to 22.7% the percent of the US population living in areas where CVS cannot be excluded from a retail pharmacy network (at least one that complies with commonly-used proximity standards). And, the transaction also takes a major mass merchant out of the business of operating retail pharmacies

Both accomplishments are crucially important. CVS has reduced its exposure to markets in which it can be excluded from narrow networks, and eliminated a major competitor who likely would have priced aggressively as retail networks narrowed

This is a very clever strategy – but to work it must be pressed much further. Before the TGT transaction, persons living within a commutable radius of a CVS store could choose from an average of 9.2 supermarkets or mass merchants who operated pharmacies in that same radius – now the number is down to 7.9 – still a very large number. The average distance from a CVS outlet to a competing mass merchant or supermarket with a pharmacy was 1.9 miles, now it’s 2.0

Because of FTC/DOJ limits on pharmacy market share (generally 35%), CVS cannot acquire control of enough supermarket and/or mass merchant pharmacies to eliminate these outlets as a major source of pricing pressure. WBA also would need to get into the act, and potentially RAD as well (note that the effect of eliminating TGT as a pricing competitor benefits WBA and RAD just as much as CVS)

We can’t rule out that CVS and WBA will methodically seek control of the pharmacies that currently exist within supermarkets and mass merchants, and that they’ll pursue this strategy instead of acquiring RAD. If they do, RAD shareholders never benefit from an acquisition premium; however RAD shareholders would benefit (arguably as much as CVS and WBA) from the reduced presence of supermarkets and mass merchants – still a bullish outcome, just not so bullish as an outright acquisition

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

ACA at the Supreme Court: Subsidies Are Here to Stay, Even if SCOTUS Finds for King

Written June 7th, 2015 by

Congress cannot repeal the ACA; the President would almost certainly veto a repeal bill, and Republicans lack the two-thirds votes required in both chambers to overturn. (Republicans have 56 percent of House and 54 percent of Senate seats)

And, Congress almost certainly cannot pass ‘post-King’ measures that fail to restore subsidies. Assuming all House Democrats oppose the Republicans’ post-King ACA reform measure(s), House Republicans can afford to have no more than 30 of their own number opposing. The trouble here is that 30 House Republicans are from districts in which at least 12% of voting age persons are currently receiving subsidies – so whatever post-King reforms Republicans might pass, ongoing subsidies (although potentially in some different form) almost certainly will be included

Congress only gets ‘control’ of the ACA if a sufficient number of states refuse to make their own ‘post-King’ deals with the Administration. It seems reasonably clear that the Administration has options to allow willing states to configure their exchanges so that subsidies continue – but the states have to be willing

In the immediate wake of a SCOTUS finding for King, we believe most of the FFM* states would refuse to make deals with the Administration, specifically in order to hand Congressional Republicans an opportunity to pass ACA reforms. However the FFM states’ willingness to give Congressional Republican a shot at ACA reforms only lasts as long as post-King subsidies are extended. If and when the FFM states begin to believe Congress cannot pass reforms in time to ensure subsidies flow uninterrupted, we would expect these states to make deals with the Administration, ending Republicans’ shot at substantive reforms

Thus on net, if SCOTUS finds for King, Republicans cannot repeal the ACA, and they almost certainly cannot pass any type of ACA reforms that do not continue subsidies. With very limited time to work, the scope and scale of what can be achieved is severely limited

This being said, the Republicans’ draft proposals, once stripped of plainly unworkable clutter (ACA repeal, tort reform, etc.) contain politically and economically feasible reforms which could, ironically, save the ACA’s health insurance exchanges (HIEs) from the very real likelihood of collapse as a result of adverse selection

If the Court finds for King, we would view falling share prices for providers (e.g. Hospitals), suppliers of consumable goods to hospitals, and/or insurers as a buying opportunity

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

US Drug Pricing Stalls. Uh-Oh …

Written June 2nd, 2015 by

Growth in US brand pharmaceuticals’ list prices has accelerated – but discounts are growing even faster. As a result, on average US brands’ net price growth is very nearly zero

Net price growth is negative in 6 of the 10 therapeutic areas where we have detailed price tracking. In all cases, falling net price is the result of sharp increases in average discounts

Unsurprisingly, each of the markets with falling net prices have 2 or more products that are at least somewhat interchangeable. But this is nothing new – the existence of multiple viable alternatives has been a feature of most therapeutic areas in the US drug market for decades. With only two exceptions (multiple sclerosis and HCV) the acceleration in discounting has occurred among entrants that have all been in the market for at least 3 years. We see two overlapping explanations – both of which point to continued US price weakness

First, the proportion of US beneficiaries subject to co-insurance instead of co-pays is rising; this means beneficiaries newly prefer drugs with lower list prices, and in particular this means that manufacturers’ co-pay card programs must offer these beneficiaries’ larger subsidies in order to keep out-of-pocket (OOP) costs at manageable levels. Co-pay card subsidies, quite obviously, reduce net prices

Second, with the apparent blessing of plan sponsors, it appears that US formulary managers are more frequently excluding non-preferred brands, rather than simply relegating them to higher tiers. This obviates the utility of manufacturers’ co-pay card programs, and intensifies the need for manufacturers to have their brands in preferred formulary positions – for which higher rebates must be paid

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

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

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