Over the past few years M and A activity in Biotech has accelerated, with large players such as Pharma, Biotech, along with foreign Pharmaceuticals scrambling to get access to proprietary blockbuster recombinant drugs and associated platform science. There are now many more large potential buyers seeking out the very few remaining prospects. Big Pharma faces an epic patent cliff that will see brands coming off patent double from $20 billion to $50 billion in 2011 and another $42 billion in 2012. With this looming dark cloud the market has punished them with single digit multiples and 5% yields suggesting no organic growth prospects. Cost cutting can only take you so far. To maintain their market caps ranging from +$40 billion- $130 billion, Big Pharma must now shoot for the fences having run out of development time, and can no longer hit for singles and doubles.
Japanese companies armed with the strongest Yen ever and 1% borrowing rates, make US assets relatively cheap. Japanese pharmas favor biotechs with a commercial sales force. I counted 6 recent acquisitions. Big Pharma and Large Cap Biotech (over $20 Bill Cap) broaden their focus to include late stage biotechs with a potential blockbuster in phase 3. Generic companies producing chemical entities and biotechs that have no significant in-house technology whose product was in-licensed but developed elsewhere, are not sought after.
Since the 2007 bull market top, I am aware of 20 biotechs acquired: DNA, MEDI, MLNM, IMCL, OSIP, MOGN, TLCR, VMSI, PHRM, ABII, SEPR, MEDX, CVTX, SCRX, CGRB, FACT, SIRT, IDEV, OMTI and now GENZ. Every single pure recombinant biotech were taken out at a median of almost 9X sales. Narrowing down the 15 Biotech companies, their takeover metrics were:
GENZ by Sanofi 4.2X 35% premDNA by Roche 7.6X 27% prem
MEDI by Astra Zeneca 10.6X 70% prem
MLNM by Takeda 15.6X 86% prem
IMCL by BMY 9X 73% prem
OSIP by Astellas 8.1X 68% prem
MOGN by Eisai 9.5X 37% prem
PHRM by CELG 10.8X 53% prem
ABII by CELG no sales 60% prem
MYOG by GILD no sales 50% prem
MEDX by BMY no sales 93% prem
CGRB by JNJ no sales 19% prem
FACT by ABT 10X 75% prem
SIRT by GSK no sales 91% prem
IDEV by ENDP 6.6X 232% prem
Acquirers seem to favor companies with a) strong IP with a long patent life, b) strong bench strength with proven ability to develop INDs in-house, c) a platform technology that could have indications in other therapeutic areas because of a unique treatment pathway via recombinant technology, and a d) potential block buster either launched or in late stage development that has already cleared the pivotal data hurdle. ONXX hits a bullseye on all points.
WHAT IS SO SPECIAL ABOUT ONXX?
Last year Onyx filed suit against partner Bayer for violation of property developed under a collaborative JV. The stock was slammed and that triggered my investigation into what was going on. I wasn't sure whether it would yield an opinion to Short ONXX or an opportunity to Buy ONXX.
ONYX's approved drug, Nexavar, for Liver and Kidney cancer has been approved for 3 years, partnered with Bayer, and Net Sales are split 50-50. On 2010 estimated sales of $950 million at 70% gross margin, that will amount to $950 x 0.7 x 0.5 = $332 million topline sales to ONXX. Furthermore, ONXX is reimbursed for COGS on Nexavar sales it makes, and additionally receives a single digit royalty on Japanese sales.
Onyx was on pace to earn $2 per shares, when it was broadsided by Bayer's actions and realized it could no longer trust its future to the Bayer partnership and had to take matters into its own hand. Accordingly, Onyx ramped R and D by $65mm when it astutely acquired the Proteasome Inhibitor drug Carfilzomib.
ONXX TECHNOLOGY:
Onyx's Multiple Kinase Inhibitor platform that has already produced a blockbuster Sorafenib (Nexavar), addresses the abnormal phosphorylation that is the basis for many cancers and diabetes. That is why research into Kinase Inhibitors have accelerated everywhere. Because ATP binding by KI's is hit or miss - some work well like Nexavar, while others like Pfizer's Sutent have missed multiple times. How much more does that make Nexavar worth given its proven activity? In addition to be a RAS pathway inhibitor, Sorafenib also inhibits RAF, VEGFR and PDGFR receptors, and tyrosine kinases c-KIT, RET and FLT.
Bristol Myers and Lilly both chased Imclone (IMCL) for its platform Extracellular anti-EGRF ERBITUX, and Astella paid a 70% premium for OSI's Intracellular Tyrosine Kinase Inhibitor TARCEVA. Similarly, Sorafenib's potential extends to NSCLC, Thyroid, Breast, Ovarian and Colorectal cancer - on top of already being a billion dollar drug in Kidney and Liver Cancer with big markets in Asia where incidence is higher, and selling into those markets are still ahead.
A decade ago, another holding, Centocor, was acquired by JNJ even though it was already partnered with LLY. Even though Reopro was Centocor's approved drug, JNJ figured out that anti-TNF platform that yielded Remicade in its pipeline would be the bigger drug in Crohn's, RA and Psoriasis. Its now a $3 billion dollar drug.
Now count on your hand how many late stage or commercial biotechs are left out there with a proven platform technology, a blockbuster drug, and another blockbuster for which an NDA will be filed in a few months, and NOT burning Cash? And for all this the enterprise value is $1.3 billion? Pure late stage development companies that exceed ONXX's value include REGN, INCY, THRX, while early stage SGEN is just below. It doesn't make sense to me.
ONXX IS MUCH MORE VALUABLE TO BAYER THAN THE MARKET IMPLIES:
As mentioned, Onyx shares net revenues with JV and marketing partner Bayer. The JV after COGS ($100mm) and Marketing ($240mm) amounts to a 70% margin on $950mm in sales. So Bayer must pay out over $300 mm of pure profit to Onyx in 2010 and rising every year forward. Bayer, given its history of dealing truthfully and honorably with development partners, is assumed to pad the cost of sales and marketing, so the margins are probably even higher than reported. Based on analyst estimates, over the next 5 years (2010-2014) Bayer is expected to pay out to Onyx $330mm, $378mm, $390mm, $410mm and $480mm for a total of $2 Billion. COGS and Marketing will plateau and margins will rise to 80%.
During this period that Bayer will be paying out $2 billion profit to Onyx, how many drugs will Bayer simultaneously succeed in developing that will also a) yield similar profitability b) without further R and D or c) Clinical risk and d) drug failures along the way? You get the picture. With drug development cost growing rapidly and risk of failure no less than in the past, isn't a bird in hand worth much much more than two in the bush given this scenario? Now add to that a potential +$400mm myeloma drug in Carfilzomib?
LITIGATION WITH BAYER:
15 years ago, Bayer partnered with ONYX to get access to its much desired RAS Pathway Inhibitor compound Sorafenib. In May 2009 ONYX filed suit against Bayer over 2 patents Bayer filed in Dec 20, 2005 - US # 7,351,834 and US # 7,234,576. Essentially, Bayer took the Sorafenib compound Onyx had developed, and despite the collaborative research agreement with ONYX, Bayer separately developed Fluoro-Sorafenib - a compound that came out of the original patent. Under the filing of the patent, Bayer used Fluoro to substitute for other elements but preserve the Sorafenib compound functionality. In other words, create a new compound to mimic the old compound except which Bayer controls and doesn't have to share with ONYX. When you are dealing with a billion dollar drug, I guess any sociopathic behavior is permissive to Bayer. Talk about violating the spirit of collaboration.
Given Bayer's long history of paying fines for predatory and collusive behavior, nothing should be surprising. Look at Bayer's actions according to Onyx documents: 1) Bayer didn't disclose the 2003 patent filing to Onyx, but in 2005 Bayer announced trials in a cancer drug referred to as DAST. 2) Bayer withheld the chemical formula and gave Onyx no chance to work on trials or review data. 3) Bayer didn't mention its Fluoro -sorafenib trials during a presentation to Onyx in April 2007, yet a couple months later Bayer announced DAST as among their cancer therapies in development, and 4) Bayer continued to deny Onyx's subsequent request to reveal the structure of DAST.
The suit was precipitated when a Bayer executive revealed that Bayer postponed further testing until AFTER the final cutoff date for recognizing compounds synthesized, identified or discovered under the collaborative agreement with Onyx so that Bayer could have the right to develop and market fluoro-sorafenib "unrestrained" by Onyx.
I am not a lawyer but a very similar situation emerged in a former life with my IGEN holding, when it was embroiled in a suit with Roche who had integrated IGEN property into its diagnostic equipment, and tried to get away with it. After a lengthy battle, the court returned all the rights to IGEN, forcing Roche to buy them out rather then pay damages and royalties. Similarly with Onyx, because of the JV, a court could potentially rule that Onyx similarly has rights to Fluoro-Sorafenib. However, because of the clear intention to deceive, I imagine a settlement will be reached long before.
UPCOMING ONYX DEVELOPMENTS TO WATCH FOR:
* Submit an accelerated NDA filing for Carfilzomib in relapsed/refractory Myeloma by year end.
* A settlement with Bayer for the Fluoro-sorafenib litigation hope to be reached by yearend
* Nexavar reimbursement in South Korea by year end & in China by mid 2011.
* Significant growth opportunity in HCC (Liver) even as Kidney plateaus.
The value of the Proteasome Inhibitors acquired by Onyx has delivered considerable value this summer. First, in July Carfilzomib revealed significant pivotal data in multiple myeloma with and overall response rate (ORR) of 24% exceeding the 20% threshold response rate and duration over 7 months. However, its primary benefit is the lack of peripheral neuropathy which addresses the unmet medical need for a tolerable proteasome inhibitor. Currently, 20%-30% of myeloma patients develop a neuropathy in the course of treatment. Carfilzomib provides patients failing current agents with cumulative neurotoxicity with an a better alternative. Secondly, the value of licensing its rights to Ono for Japan for $59mm up front plus milestones multiples of this, only underscores the additional value to come from licensing rights elsewhere in the world while perhaps holding on to US rights.
DEEP LATE STAGE PIPELINE:
ONYX pipeline has significant undervalued optionality as well. Outcomes pending for Nexavar include adjuvant RCC, HCC, TACE combo, Tarceva combo, NSCLC, and Thyroid cancer. Additionally, Carfilzomib for Myeloma results are still to come and early stage development of JAK 1 and 2 Inhibitors.
CONCLUSION:
Biotech is perhaps the riskiest investment sector in the universe with multiple factors working against the investment at any given time, much like being long Option premium: adverse binary outcomes, burning cash, constant funding needs, multiple approval and clinical trial hurdles, safety issues, is the market for the drug really there or will it gain re-imbursement upon approval, or embroiled in litigation to defend property rights - and on and on. So when you encounter a company for which many of these risks can be handicapped with reasonable accuracy and the outcome yields a favorable Risk/Benefit relative to its price, it is worth a closer look. Onyx Pharmceutical has exceeded the hurdle on most of these issues.
First, there are hungry large cap medical companies in search of mid- biotech companies with proprietary recombinant platform technology of which few remain. Secondly, it technology has already yield a commercial blockbuster with expectation of broadening into other indications. It has become the standard of care, and competing drugs Sutent and Brivanib will have a tough time proving superiority in Phase 2s. Third, Valuation is compelling given it is profitable, self funded, cash rich, and valued much less than more risky development stage biotechs. Third, it is not the defendant in IP litigation and cannot have existing property taken away. Having witnessed these litigations multiple times, from the documents it is clear where the burden of proof resides. Finally, the value to Bayer is considerably more than it is to Wall Street on an earnings basis. Wall St targets range from $31 to $41. To Bayer, ONXX is probably worth north of $45 given the math of what it cost Bayer to payout to ONXX in relation to the cost of separately developing an equivalent revenue stream at 80% margins.
Your blog is dense with mistatements. You obviously don't know anything about the history of Bayer and Onyx. Bayer did not license Nexavar from Onyx. Bayer scientists discovered Nexavar as part of a collaboration with Onyx. The gross margin of Nexavar is way higher than 70%. Net *sales* are not split 50-50. (Do you even know the definitions of "gross margin" and "net sales"??) Onyx has no platform technology. None of the scientists who had *anything* to do with the Nexavar discovery are still working for Onyx. If Onyx has any "bench strength" it is only from their acquisition of Proteolix, as they had no research scientists before that acquisition. In fact their entire pipeline has been acquired rather than discovered.
ReplyDeleteAnd on and on. There are many other errors, but I won't waste any more time your moronic blog.
Thanks for Bayer's point of view. Thanks for your correction on the semantics of margin, but for the analysis I will stay with 70% currently, then rising to 80% because from the point of view of the acquirer, that is the metric that matters, especially when comparing against the risk and replacement cost of developing an equivalent $2 billion pre-tax revenue stream over the next 5 years vs the lower risk revenue stream in hand. This is a financial analysis of a trade off. I have no loyalty to Onyx nor an axe to grind with Bayer. I am merely assimilating information on the situation having looked into both companies over the past year.
ReplyDeleteNaturally, I take it as a given you think the claims made by Onyx in its suit are spurious and a fabrication and accordingly might as well fold up their tent. If it is the case, Bayer would resist any attempt to settle given it's in the right.
Finally, what does the original Onyx scientists not being with the company any longer have anything to do with the economics of the trade-off decision facing Bayer? As far as I am concerned Onyx could be a shell of company with 5 employees, it has nothing to do with the risk of acquiring $2 billion in revenue. As for the pipeline, so what if it acquired it? Is Bayer or any other pharma or biotech at less saavy for all the tuck-in R&D acquisitions they make to acquire property and talent? So Onyx made an astute acquisition of Proteolix. Bayer did the same many times. If you have further details on the specifics of the suit, that would be worthwhile hearing from you instead of blind loyalty to a corporation.