Should Biopharma Companies Buy Innovation?
Pfizer(NYSE: PFE) andAstellas(NASDAQOTH: ALPMY) share profit on the blockbuster prostate cancer drug Xtandi, andAbbVie(NYSE: ABBV) andJohnson & Johnson(NYSE: JNJ) split profiton the blockbuster lymphoma and leukemia drug Imbruvica. However, these companies took very different paths to adding these drugs to their portfolios.
Pfizer and AbbVie waited until these medicines were alreadytop sellers before they bought their way in, whileAstellas and Johnson & Johnson took the risk of licensingthem while they were still in clinical trials. Why did these companies approach these drugs differently, and is oneapproach better than the other? Analyst Kristine Harjes is joined by contributor Todd Campbell to discuss how pharmaceuticals are diversifying their product lines in this edition of The Motley Fool's Industry Focus: Healthcare podcast.
A full transcript follows the video.
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This podcast was recorded on Oct. 20, 2016, and released on November 2, 2016.
Kristine Harjes:Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm your host, Kristine Harjes. It iscurrently Oct. 20. If you listened to last week's episode, you know that Todd Campbell, our regular healthcare contributor to this show, is in the house for a writers' conference, so we want to pre-record a couple episodes. By the time you're listening to this, it will probably be at least Nov. 2. Todd, welcome again to the show!
Todd Campbell:It's fantastic to be here. It's just wonderful to be able to sit with you and talk about some really cool stuff that's going on in healthcare, and helping our listeners figure out how to make the most money from it all.
Harjes:It's been fun. It's also been interesting to do two episodes in a row. We've never done this before. We record each week, day of.
Campbell:I know! This is new territory for us, so bear with us.
Harjes:Yeah, there are a couple of podcasts I listen to where they regularly record a couple shows in a row, and they're very open about it. It's like, oh, OK, yeah, that makes sense. It's efficient. So here we are, being all efficient and professional. So on today's show, we wanted to talk a little bit about the merger-and-acquisition landscape. It's something that's a really hot topic, particularly in healthcare, where you see a lot of consolidation, a lot of bigger companies snapping up small ones, trying to boost the revenue by buying out a company that's doing something great. But there's also a lot of talk about is the space getting too hot? Is it too expensive? Are companies overpaying? What are your thoughts on a broad level there?
Campbell:I think they've gotten less expensive than they were, say, a year ago. We've seen some dramatic push-back on drug prices all over the political landscape in the course of the past year.
Harjes:Yeah, election season has wrecked this industry.
Campbell:Yeah, and it's taking a big toll on share prices for the market valuations of some of these companies. It certainly makes you think that, while you didn't want to pay through the nose last year, maybe you'll be more willing to step up and make an offer now. But on the other end of that, if you're the person owning the company that has now lost value, you're still looking at last year's valuation thinking, "No, I'm worth this." So it may be harder to get deals done. It could get cheaper,but they might be harder to execute. We have still seen some deals get done. You alluded to a few of them. That's exciting to think about -- how are these companies going out and expanding themselves into oncology, maybe broadening themselves out. Americans are getting older. And as we get older, we're more likely to get diagnosed with chronic illnesses that are going to require treatments. So there are long-term, long-tail reasons to still be interested in biopharma stocks. The question for each of these companies that they're trying to figure out is, is it better to license, or is it better to buy outright?
Harjes:Absolutely. There's a lot of pressure to use your cash to do something. I think one company that comes to mind here isPfizer. Pfizer has been very actively acquisitive for a while now. We have talked about several of their deals. The first one that comes to mind isAllergan, which fell through. And that was a huge, splashy story, because it would have been an enormous acquisition, but alas, it didn't happen, so I don't want to spend too much time on it. Perhaps a better one to talk about would be theMedivationdeal,which was a lot more recent. This was a $13 billionpurchase essentially just for one drugname, Xtandi.
Campbell: Fifty percent of one drug.
Harjes: Yeah,let's be very specific there. Medivation was only getting 50% of the revenue from this drug, and so nowPfizer will only get 50% of the revenue from this drug. So if you look at the peak sales there, estimates are about $4 [billion to] $5 billionpeak annual sales. This is a drug that treatsmetastatic castrate-resistantprostate cancer. So, Medivation and now Pfizer would get, at most, $2.5 billion per year there, if you slice the $4 [billion to] $5 [billion] peak estimates there in half. And they paid $13 billion. That's a 5.2x multiple. That's a ton. That's expensive.
Campbell: Yeah. They'relooking at it and saying, "Well,there's patent protection on this drug that's going to stretch out forlong enough that we're going to get a good returninvestment, and we can leverage a lot of cost out of Medivation by integrating them with Pfizer." I mean,Pfizer is a Goliath. They already haveall the sales, the marketing,all the things that they would needto be able to make Xtandi sales jump. So theydon't really need a lot of that overlap, they can X-out a lot of costs. So, I think they looked at it and said, "OK, on a cash flow basis, we can make this deal be accretive, so let's go ahead and jump in and do it." But it's so much more money than, say, like, Astellas would have paid to get50% of the rightsto Xtandi whileit was still in clinical trials. I think that that'swhat it's really coming down to. You have two different approaches for these companies. You have the approach wherethey can pay out less up front, "We'llgive you an up-front payment, plus we'll offer youmilestones if the drugdoes well in clinical trials, or hitscertain sales thresholds, we'll pay you a little extra money for that." But you're taking on a big risk. Ninety percent of drugs in clinical trials fail. Theydon't make it to market. That's why you're able to buy them cheap. Or you can go the other waylike Pfizer, and say, "We'regoing to buy proven drugs that are already billion-dollar blockbusters, and they're de-risked, we can model them better." And sure,there could be competitors along the way that eat into that market share. So, there are twovery different arguments.
Harjes: Right, there'stwo different elements to this decision. You have, how early stagedo you want to go? Do you want tobuy the drug when it's just through phase 1 and it looks sort of promising, maybe,and you can probably get it for very cheap, because, as you mentioned, the failure rate is extremely high? Or do you wait until it's already in the hands of the FDA andthen go for it? Then, the other thing at play here iswhat sort of agreements you want to make. Do you want to buy the company with the drug outright,and therefore get 100% of itin your lap for you to deal with? Or do you want to do some sort of licensing deal,where you pay a little bit at a timeand you incorporate these milestones and you end up with, say, 50% of eventual profits?
Campbell: Right. And you know what that just reminded me of, there's a third leg to that stool, which is your own internal R&D. You can be developing a drug --Gilead Sciencestried to take on Imbruvica with Zydelig inchronic leukemia, certain types of rare forms of leukemia. I think one of the things they're also weighing is, to what degree do I want to invest in my own R&D versus, say, buy something, versus, say,license something? It's a juggling match that management is continuously making.
Harjes: Let's take another example and dig into it a little bit.Johnson & JohnsonandAbbVie, theiroverlap is a drug called Imbruvica. This is the first chemotherapy-free first-line treatment for CLL,which is the most common form of leukemia. Johnson & Johnson paid a company calledPharmacyclics $150 million upfront back in December 2011, when the drug was in phase 2.
Campbell: What a great deal.
Harjes: Yeah. This was to get a 50-50 profit-loss split -- $150 million, plus any milestones that came after that. But going back to thedynamics we were mentioning earlier,this was a kind of risky betbecause it was an earlier-stage drug,and they also chose to go the 50%-only route. So then,much later, March 2015, AbbVie pays $21 billion to buy Pharmacyclics outright,after the drug --I forget if it was already in the hands of the FDA, but it was much later stage.
Campbell: Yeah, it was out there,it was already starting to make moneyand generate revenue. And you're right, who got the better deal?
Harjes: It's kind of questionable who did. When you look at the risk thatJohnson & Johnson took there,I don't know, I think you would have to doa little bit of math, back-of-the-enveloping it. Ifyou look at drug success rates and you multiply that by peak sales -- I don't know.Looking at this thing, I think that Johnson & Johnson obviously got the better deal. But it might not have beenthat bad of a deal for AbbVie, either. They think its half of this share alonecould eventually bring in $7 billion a year in additional revenue.
Campbell: Yeah. And AbbVieneeded to make something happen, too,because they run the risk of losing patent protection soon on theirbest-selling drug that accounts for the lion's share of their revenue. So they want to be able to diversifyaway from autoimmune diseases, where Humira is such a Goliath, and be able to target other indications likeoncology. This really allows them to do that and gives themsomething they can build off of and really expand into new markets. It was an important deal for them to make,and I think it was the right deal for them to make. We talk a lot on the show about how important it is to diversify yourself. I was just thinking as we were talking,that's exactly what these companies are doing. They are diversifying their risks. In some instances, they're doing their own internal R&D. In otherinstances, they're licensing in,and if they're licensing it at $150 million up front,maybe they do 10 of those deals. And then, of course, the other end of that is, theygo out and buy things they know already work, that have already made it to the marketand are already blockbusters. So I think it's just smart management. I think you'll continue to see that happen. It'll be really interesting, though,to see how this plays out as far as acquisitions over the course of the next year.
Harjes: For sure. You mentioned the pressure that some companies feel to do something with their money and make acquisitions. A lot of them havesuccumbed to this pressure, so they're shelling out a ton of moneyto try to diversify. Onecompany that is a strongstandout in the opposite direction is Gilead Sciences (NASDAQ: GILD). We talk about them all the time. Listeners, you may already realize they have a lot of cash they're sitting on, and quarter after quarter, in their earnings conference calls, you hear analysts saying, "Hey, guys, what are yougoing to do with this cash? When are you going to make an acquisition?" And every time, their answer is like, "We'reevaluating what to do with our cash. We'll do the right thing with it when the time comes."
Campbell: Right deal, right price.
Harjes: Yeah. And if history shows you anything, Gilead has been very,very good at acquisitions. As a shareholderand a big fan of the company,I trust them to sit on it a little bit more and have patience to make the right move. But there is that pressure. It's weighed on the share price, too.
Campbell: We'vebecome quarter-to-quarter investors as a whole. So people aren't looking capital-"f" Foolishly when it comes to their portfolios. They're looking foolishly, lowercase, where they say, "OK,I'm going to go in and out and in and out and in and out." I went back andlooked at Gilead Sciences' share-pricereturns over the course of the last decade. There were over 20 instances where thestock fell more than 5% in any given month. Yet if you stuck with the stock, you're up 378%. So yes, there are going to be stumbles and bumps and bruises along the way, and we're seeing that right now because there's competition that's eating into their sales for theirhepatitis C drugs,because it's affecting prices, driving prices lower, all that stuff. But I feel like that's kind oftemporary. What we've seen in the past is,this is a company that knows how to innovate and knows how to buy smart. I think what you'll find is, five years from now, this will be a stronger stock that's growing again. I always try to encourage people to think further out. Don't worry too much about what we're seeing over the course of the last 12 months, the last three months. Think more about where you think these companies could be five years out, 10 years out. I think when you do that, you look at this and you say, "Wow, Gilead has deep pockets, it's got plenty of cash flow rolling in. It's an attractive investment,especially now that it has a dividend yield of 2.5%." That'spretty compelling when you consider the alternative, Treasuries, the yield is very low.
Harjes: Yeah, andwhen you look at how cheap they are, too,for me, this is kind of a no-brainer of a stock. But you did a great job of laying out the capital-"f" Foolish way of looking at it.Of course, people on the program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against them, so do your own research, don't buy or sell based solely on what we're saying here today. Todd, thank you so much for joining me in studio.
Campbell: It's my pleasure.
Harjes: It's been fun. For Todd Campbell, I'm Kristine Harjes. Thanks so much for listening, and Fool on!
Kristine Harjes owns shares of Gilead Sciences and Johnson and Johnson. Todd Campbell owns shares of Gilead Sciences. The Motley Fool owns shares of and recommends Gilead Sciences. The Motley Fool recommends Johnson and Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.