By Ivan Deryugin
For biotechnology investors, a biotechnology company's "pivot" period -- the time frame when it transitions from a development-stage company to a solidly profitable company -- can often be quite rewarding. And few companies display this trend as profoundly as Regeneron Pharmaceuticals (REGN). Its shares are up over 224% in 2012 alone, and over the past five years they have risen over 700%, driven by sales (and profits) from Eylea -- the company's macular degeneration drug -- as well as sales of Zaltrap and Arcalyst. But with shares having risen so far, is there more room to rise? Should investors not yet in the stock consider adding it to their portfolios? That is the issue I will explore in this article.
For the record, unless otherwise noted, financial statistics and management commentary used in this article will be sourced from one of three places: Regeneron's Q3 2012 earnings release, its Q3 2012 earnings call, or its latest 10-Q filing.
Q3 2012 Overview
In its latest quarter, Regeneron posted revenue of $427.687M, an increase of 315.90% from the year-ago quarter. Soaring sales of Eylea, which launched in November 2011, drove Regeneron's revenue growth. Product revenue grew by 4,456.91% to $249.172 million. Eylea sales grew by 26% sequentially as well, as Regeneron expanded its commercial operations. The remainder of Regeneron's revenue came from its collaboration agreements with Sanofi (SNY) and Bayer, which we will discuss later in the article. With Eylea sales soaring, Regeneron is now solidly profitable. The company posted a gross margin of 91.92% in Q3 2012, up slightly from the 91.77% gross margin it posted a year ago. And the company's operating margin of 47.32% is also solid. These margins led to pro forma EPS of $1.89 (GAAP EPS was $1.72), and Regeneron raised its annual sales forecast for Eylea yet again; the company now sees sales between $790-$815 million, up from a previous range of $700-$750 million. The third quarter was also one with several milestones. The FDA approved Zaltrap, Regeneron & Sanofi's drug for metastatic colorectal cancer, and the company submitted its approval application to the European Medicines Agency, which also approved the sale of Eylea in the European Union on November 27. Bayer is Regeneron's commercialization partner for Europe, and Eylea is also set to launch in Japan, Australia, Brazil, and Colombia. There was, however, a setback in the third quarter. The FDA denied approval for Arcalyst in the treatment of gout, and Regeneron has discontinued development of the drug for that indication. However, this setback does not detract from a very successful third quarter.
Eylea has now captured 20% of the AMD (age related macular degeneration) market, and Bob Terifay, Regeneron's Senior Vice President of Commercialization, is confident about the drug's future trajectory relative to Lucentis and other treatments. Regeneron took some time on its third-quarter conference call to address the role of Avastin (manufactured by Roche) in the role of treating AMD. Avastin was originally approved by the FDA to treat certain cancers (including breast cancer until November 2011). However, researchers discovered that Avastin had an ability to treat AMD as well, and the off-brand use of Avastin is quite popular, due to its price. This has been a source of concern for analysts that cover Regeneron. Annual treatments with Eylea costs just $50 per dose (or $1,850 per dose), whereas Avastin costs just $50 per dose (Avastin, however, has had costs just $50 per dose). On its conference call, Bob Terifay stated:
So we do have a program in place that will cover practices if they do use EYLEA in a patient and then the patient turns out not to have insurance coverage. So that has not deterred physicians from using EYLEA at the initial dosing. Most of the Avastin use quite frankly is in patients who do have insurance, who could benefit from both EYLEA and Lucentis, but the physicians have chosen to use Avastin because of its price. So, that's a surprising point. We might have thought if you're already going into this that Avastin was being reserved only for patients who can afford a branded product, but that is clearly not the case. So there is an opportunity to be able to convert patients and we are seeing, we have been even before this episode, switching from Avastin to our products.
It does not appear that pricing is an issue in expanding the market for Eylea, and the drug is not having difficulty capturing market share. Assuming that trends in Europe, Japan, and Eylea's other markets play out in a similar fashion to the United States, Regeneron's sales of Eylea will likely continue to grow at solid rates.
A Word on Compounding Pharmacies
The 2012 meningitis outbreak was tied to a New England compounding pharmacy, and the FDA is likely to tighten oversight of this market segment. A hearing is scheduled for December 19, to address the issue of compounding pharmacies, and if the FDA increases regulation of the industry, Regeneron is likely to be a direct beneficiary. Avastin, one of Eylea's primary competitors, has already warned for use in treating AMD by compounding pharmacies, and the FDA has already warned NECC (the compounding pharmacy implicated in the recent meningitis outbreak) about its reformulation of Avastin. If Avastin supplies are restricted, Eylea could be a direct beneficiary. An analysis done by Credit Suisse shows that there are several ways in which Regeneron could benefit.
- While the idea of one prescription per patient is the currently accepted medical practice, this is largely ignored within this particular market, which allows doctors to stock large quantities of Avastin (something that is essentially impossible to do with either Eylea or Lucentis). As Credit Suisse notes, the wide availability of Avastin creates an incentive to inject patients with Avastin on their very first visit. However, if a "specific prescription" is required, physicians could simply choose to start their patients on Eylea from the very beginning.
- Should compounding pharmacies face stricter regulation from the FDA, the burden to meet those regulations could cause many to exit the business, and the time needed to meet higher FDA standards is almost certain to restrict the supply of Avastin, thereby forcing doctors to choose between either Eylea or Lucentis.
- There has been talk of requiring physicians to provide their patients with informed consent, and make them aware when they are being given a drug that was reformulated in a compounding pharmacy. It is likely that many patients who take Avastin for AMD do not even know that the drug has moved through a compounding pharmacy, and if they knew this to be the case, it is possible that they will make a conscious choice to switch from Avastin.
While increased FDA regulation of compounding pharmacies is likely to benefit Regeneron, it does carry some risk, albeit long-term risk. Credit Suisse notes that a potential outcome of the FDA's examination of its regulatory framework for compounding pharmacies would be the creation of an FDA "sanctioned" product, something that would not reach the level of full FDA approval, but could still allow Medicare and private insurance companies the scope they need to force greater usage of Avastin. But, as analyst Jason Kanter notes, "This is more long term and speculative than the likely near-term upside we expect from increased regulation, so we think it is too early to make this the focus of concern." It is possible that by the time that Avastin use becomes an issue for Regeneron, the company will likely no longer be relying on Eylea to fuel sales and profits, as it will have made a great deal of progress in diversifying its revenue base.
Expanding Eylea's Market & Developing the Pipeline
Few companies are able to thrive on the sale of just one drug [Alexion Pharmaceuticals (ALXN) is an exception to that rule]. And while Eylea is not Regeneron's only drug, it is what is currently driving the company's financial performance. Of Regeneron's $249.172 million in product revenue in Q3 2012, $244 million came from sales of Eylea. The remainder came from sales of Arcalyst, Regeneron's treatment for Cryopyrin Associated Periodic Syndromes, a rare (affecting about 1 in 1 million people) series of auto-inflammatory disorders. Arcalyst sales were $5 million in both Q3 2012 and Q3 2011, reflecting the rarity of this condition.
Regeneron's future success hinges on two things: expanding the market for Eylea, and developing its pipeline. Fortunately, the company has been moving forward on both fronts. Regeneron has submitted its application to have Eylea approved in Europe for the treatment of macular edema. And Regeneron is making progress on other drugs as well. ZALTRAP has received a positive opinion from the CHMP for its use in treating metastatic colorectal cancer, and Regeneron expects a final decision within the first quarter of 2013. As the company works to expand the markets for its existing drugs, Regeneron is also working diligently to commercialize the compounds in its pipeline, which is currently led by REGN-727. REGN-727 is a monoclonal PCSK9 antibody currently in Phase III trials. It has been shown to be a potent cholesterol fighter, and in Phase II testing, a combination treatment of REGN-727 and SAR236553 lowered LDL cholesterol in patients by an average of 73%, versus 17% of patients who switched to atorvastatin. 90% of patients who stayed in the REGN-727/SAR236553 arm in the trial met the pre-specified target of 70 mg/dL, versus just 17% in the atorvastatin arm. Sanofi and Regeneron are also currently enrolling 18,000 patients into a long-term cardiovascular outcomes study, and the two companies expect to file for approval of the drug in 2015. Regeneron is facing competition from several companies, including Amgen (AMGN), Pfizer (PFE) and Roche (OTCQX:RHHBY) in this area, but Regeneron's drug is the closest to securing FDA approval. Analysts are upbeat about the drug's prospects, with peak annual sales estimates ranging between $3 billion and $6 billion.
While REGN-727 is the "flagship" compound in Regeneron's pipeline, it is by no means the only asset that Regeneron has. Sarilumab, an IL-6R antibody that is designed to treat rheumatoid arthritis, is now also in Phase III trials. George Yancopoulos, Regeneron's Chief Scientific Officer, stated on the company's Q3 earnings call that he expects Phase III data on Sarilumab sometime in 2014. The company has 10 other antibodies in its pipeline, and six of them are collaborative projects with Sanofi. In September, Regeneron initiated a Phase I combination trial of ZALTRAP and REGN-910, an angipotein-2 inhibitor, in patients with "advanced malignancies." And REGN-1400 has now entered the clinical stage. The company has also announced that it is working with the FDA to move forward with development of REGN-475, which is currently halted in Phase II trials. REGN-472 is a NGF antibody designed to treat osteoarthritis of the knew, as well as other pain indications, but has been on clinical hold since late 2010 due to safety concerns regarding a tanezumab, a similar drug under development by Pfizer. Earlier in 2012, an FDA panel voted unanimously to begin moving forward the development of REGN-475, and the company is now working with the FDA on how best to move forward. I expect more color on REGN-475 when Regeneron reports its Q4 2012 and full-year 2012 results. CSO George Yancopoulos also stated on the company's Q3 call that Regeneron is working on other early-stage projects, which the company will provide updates on in 2013. In my view, Regeneron's has a deep pipeline of drugs to lean on, and as Eylea sales continue to grow, it will have more and more financial resources to invest in its pipeline.
Financials & Valuation
For development-stage biotechnology companies, an analysis of the financials is rarely a requirement. What matters more is the quality of the clinical data that they release regarding their pipeline assets. However, for companies in the "post-approval" stage, financials become much more important. Will they have the resources needed to build out their pipelines? In Regeneron's case, the answer is a resounding yes.
Regeneron ended Q3 2012 with $575.152 million in cash and investments, versus debt of $290.959 million (these are convertible notes). Regeneron also has $160.746 million in lease obligations (there is debate as to whether or not such obligations should be included in net debt calculations). And while Regeneron is still cash-flow negative for the first nine months of 2012 (with cash burn coming in at $167.8 million), this is due primarily to a surge in accounts receivable, which mirror the acceleration in sales of Eylea. At the end of 2011, accounts receivable stood at $28.254 million. At the end of Q3 2012, the total stood at $506.682 million. As these receivables become converted into cash, I expect Regeneron's financial position to strengthen even further. Based on its Q3 2012 balance sheet, Regeneron has a current ratio of 5.31, giving it ample liquidity.
I would like to turn now to the issue of Regeneron's valuation. While this is not as material of a factor in the biotechnology sector as other sectors (after all, investors will tolerate unprofitability for years in this sector), investor "tolerance" in this sector is not unlimited.
Regeneron Trailing-12 Month Earnings
Based on its December 14, 2012, closing price of $179.71, Regeneron currently trades at 92.16x TTM GAAP EPS, and 64.41x non-GAAP EPS. While these multiples can hardly be called cheap, they are not outrageous for a company that posted sequential EPS growth of 145.71% on a GAAP basis, and 110% on a non-GAAP basis in its last quarter. And Regeneron's earnings estimates reflect continued growth.
Based on Reuters consensus data, Regeneron is expected to grow its EPS by 40.51% in fiscal 2013 to $4.89. Based on those estimates, Regeneron is currently trading at 36.75x, a level that I do not deem to be expensive given the company's growth trajectory.
While it is true that Regeneron has rallied sharply in 2012, as well as over the past five years, there is still upside to be realized. Eylea sales continue to grow, and the drug's market is expanding, both here in the United States and across the world. Regeneron is now solidly profitable, with good gross and operating margins, and it has the financial resources to continue to invest in its pipeline, which boasts several promising drug candidates. And the company stands to benefit from several FDA actions, including a likely increase in regulatory scrutiny of compounding pharmacies, as well as the lifting of the clinical hold on REGN-475. And while the company's stock may not fit the classic definition of "cheap," Regeneron has the growth profile needed to support its valuation, and its pipeline provides ample scope for growth to accelerate. Based on the company's Q3 results, as well as its outlook and pipeline, Regeneron is likely to continue to generate profits for its investors for many years to come.
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