By Ivan Deryugin
Within the history of the biotechnology sector, few franchises have gone from blockbuster status to peak to decline as quickly as that of Incivek, Vertex Pharmaceuticals' (VRTX) blockbuster treatment for Hepatitis C (HCV). Once it was approved in May 2011, sales of Incivek quickly soared past $1 billion as patients sought new methods of treating HCV, now set to decline in 2013 as new HCV treatments, led by Gilead Sciences' (GILD) sofosbuvir, supplant it. However, as the sun sets on Incivek, it's rising on another two franchises, which are poised to deliver profits to Vertex investors in 2013 and beyond.
Wrapping Up 2012 and Preparing for a Future Without Incivek
Vertex's Q4 2012 results highlight the decline of Incivek. Q4 Incivek sales of $222.8 million fell by over 51% from the year-ago quarter as fewer patients chose to use Incivek; newer, more advanced HCV therapies are on their way to FDA approval. On the company's Q4 call, Chief Commercial Officer (CCO) Stuart Arbuckle freely admitted that "in 2012, we saw treatment rates change in anticipation of the potential for new, more convenient regimens that may treat hepatitis C. This led to a reduced number of HCV patients initiating treatment, beginning in the second quarter and continuing through the rest of 2012." The fact that Incivek must be combined with interferon makes it, in essence, a stopgap treatment until the next generation of HCV therapies receives FDA approval. Vertex expects that demand for Incivek will be sustained by two groups: patients who cannot wait to receive HCV treatment and patients who have above-average motivation to treat HCV. However, while Incivek revenues will decline in 2013, the drug will still contribute to the company's revenue base. Despite Incivek's declines, VRTX reported a 22% increase in full-year 2012 sales to $1.1618 billion. Vertex's guidance for 2013 implies total revenue of $1.175 billion at the midpoint of guidance, with just $300 million expected to be generated by Kalydeco, Vertex's cystic fibrosis (CF) drug - more on guidance below. The remaining revenue is set to be generated by Incivek, as well as royalty and collaboration revenue.
The inherent deficiencies of Incivek relative to next-generation treatments for HCV are well-known, therefore investors have been aware for some time that this HCV treatment will not be a long-term growth driver. However, Incivek can generate cash to position Vertex for the next stage of its corporate life-cycle, and the company's 2012 financial results demonstrated just that. Vertex posted adjusted EPS of $1.18 for all of 2012, and grew operating cash flow to $267.841 million, an increase of 86.34% relative to 2011. Vertex ended 2012 with $1.32 billion in cash and investments, and $400 million in convertible notes due in 2015 (which translates to $4.22 per share in net cash). Incivek has helped Vertex amass a war chest of hundreds of millions in net cash that it will use to invest in its pipeline of cystic fibrosis and influenza treatments (to say nothing of its next-generation HCV treatments). And the company's guidance for 2013 will serve to further support the company's financial position.
For 2013, Vertex is forecasting total revenues of $1.175 billion and non-GAAP expenses of $1.12 billion at the midpoint of guidance. Utilizing Vertex's adjusted 2012 gross margin of 92.23% (adjusted to account for an Incivek inventory charge), the company will post a pro forma operating loss of less than $37 million for all of 2013, even as pro forma R&D expenses are set to rise from $718.7 million in 2012 to $770 million at the midpoint of the company's 2013 guidance (a year over year increase of 7.14%). With well over $1 billion in cash in investments, and debt that is not due until 2015 (the notes are convertible into shares of Vertex at $48.83 per share, and may be called at any time after October 1, 2013), Vertex has ample capital to reach sustained profitability, which will be achieved due to a focus on two follow-on CF compounds.
Kalydeco And Cystic Fibrosis: Expanding the Market Opportunity and Patient Pool
Kalydeco, which received FDA approval in January 2012, is already becoming a meaningful source of revenue for Vertex, generating $171.645 million in sales during 2012, with $58.5 million in sales during Q4 2012. Kalydeco, priced at $294,000 per year, targets a rare form of cystic fibrosis; the drug is designed to treat CF patients who have the G551D genetic mutation. This highlights both the opportunities and challenges of orphan drugs. Because the G551D mutation affects only about 4% of CF patients, Vertex is able to price Kalydeco at an annual cost of $294,000, making it among the most expensive drugs on the market. But, there are only about 1,200 G551D patients in the United States, meaning that for Vertex, growth will come from international expansion. The company essentially admitted on its Q4 earnings call that its domestic Kalydeco revenues (totaling $171.6 million in 2012) have reached their likely limit. Almost all CF patients eligible to take Kalydeco here in the United States are already doing so, and while Kalydeco revenues are unlikely to decline in 2013, the pace of Vertex's international expansion, which should make progress in 2013, are expected to drive Kalydeco revenue growth.
Vertex is currently in negotiations to secure reimbursement for Kalydeco around the world, and it is making progress. Reimbursement has been secured in England (where the G551D mutation also affects 4% of CF patients), and Vertex is working with the government of Scotland (where 11% of CF patients have the G551D mutation) to overcome the rejection of Kalydeco by the Scottish Medicines Consortium, largely on the grounds of cost. However, the recent launch of a Scottish fund designed to specifically cover the cost of orphan drugs should go a long way towards making Kalydeco a part of the Scottish CF treatment landscape (it is set to launch this month). Vertex is also working to secure Kalydeco reimbursement across the remaining major European markets, including France, Germany and Ireland (these 3 countries, along with the United Kingdom contain 80% of Europe's CF patient population). In fact, Kalydeco is already available in Germany on an interim basis, with the key remaining point of negotiation being the long-term price of Kalydeco. And Ireland approved Kalydeco in early February. Arbuckle expects that reimbursement discussions covering these major European markets will be complete this year, with Australian reimbursement a possibility in 2013 as well (given the nuances of Australia's reimbursement and approval process, this may be pushed out into 2014). As a result, investors should not base their long-term assumptions on Kalydeco's quarterly performance in 2013. Vertex repeatedly reminded investors on its Q4 call to expect volatility in quarterly revenue growth for Kalydeco, as it will be driven by reimbursement decisions that could potentially have a material impact on one quarter's revenue growth. Vertex is beginning to build a long-term CF franchise. And although Kalydeco will serve as its foundation, it will not be the franchise's long-term driver. The C551D population is likely too small to turn Kalydeco into a blockbuster franchise (ISI, for example, models peak sales at just $550 million under its current label). However, Vertex's ongoing clinical trials of two new CF drugs aim to expand the addressable market to a much broader population.
In late February, Vertex initiated a pivotal Phase III trial combining Kalydeco and VX-809, which targets the F508del mutation that is present in around 90% of CF patients. Vertex will evaluate 2 different dosing levels of a combination of Kalydeco and VX-809 in patients that have at least 2 copies of the F508 del mutation (a Phase II trial in patients with only one copy of the mutation is also planned). The studies, TRAFFIC and TRANSPORT, will study 501 patients older than 12 over the course of 24 weeks (167 patients in each dosing arm and 167 patients in the placebo group), and Vertex expects to file for FDA and EMA approval of VX-809 in 2014 (work on regulatory approval for use in children under 12 will begin after filing for approval in patients older than 12). It is notable that VX-809 has been granted orphan drug status and fast-track review by the FDA, and in January, the FDA granted Vertex breakthrough therapy designation for the combination of VX-809 and Kalydeco. Existing clinical data for this combination treatment is solid, with patients in Phase II trials seeing statistically significant improvements in FEV1; patients saw as much as a 9.2% increase in FEV1 relative to placebo by day 56 of the trial (p-value=0.004). Phase II safety data showed that VX-809 and Kalydeco were well tolerated (both on a standalone basis and in combination), with only one patient discontinuing treatment due to an adverse event (most adverse events were respiratory in nature).
With fast track and orphan drug status, as well as breakthrough therapy designation, I believe that Vertex has good probability of reporting positive Phase III results and securing FDA approval for VX-809 in combination with Kalydeco. And with peak sales estimates easily reaching $4 billion on a global basis, the fact that Vertex maintains full global rights to VX-809 should not be glossed over (a small royalty is owed to the Cystic Fibrosis Foundation). However, VX-809 is not Vertex's only CF drug. Vertex is hedging its bets with VX-661, which is currently in Phase II trials in patients with 2 copies of the F508del mutation, with data set to be released in the first half of 2013. Vertex's CF franchise serves to highlight the strength and opportunities afforded to it by a strong balance sheet. Even as Vertex conducts multiple clinical trials for its CF product candidates, it is conducting multiple trials to expand Kalydeco's label, and Phase III trials of patients with the R117H mutation (affecting around 3% of the U.S. CF patient population) are ongoing, as is a Phase III trial of Kalydeco in CF patients with a non-G551D gating mutation (affecting around 1% of the U.S. CF patient population). The company is also enrolling children ages 2-5 in a Phase III study with gating mutations, and a Phase II proof-of-concept study is underway to determine if Kalydeco is safe and effective in patients who have evidence of residual CFTR function (the company estimates that 5-10% of the U.S CF patient population has residual CFTR function). Vertex has stated that preliminary data from these trials will be available in the second half of 2013, and that if successful, the total patient pool for Kalydeco will expand to 7,000 on a worldwide basis (Vertex's current estimates place the number of CF patients ages 6 and older with the G551D mutation at around 2,000).
As the sun sets on Incivek, it is rising on Kalydeco and VX-809/VX-661. Vertex is moving quickly to position itself as the market leader in CF, which is likely to be the company's most important long-term treatment market. However, Vertex recently reminded the market that its pipeline contains more than just a promising CF franchise - it contains a promising influenza treatmen as well.
VX-787: Another Potential Franchise
The vast majority of Vertex investors have been focused on its HCV franchise, and the speed with which it can develop its CF franchise to take Incivek's place as a driver of revenue growth. However, Vertex's pipeline contains more than just a CF franchise. It also contains what could be the beginnings of another large franchise: influenza treatments.
On March 4, Vertex released data from a Phase II challenge study of VX-787, the company's investigational influenza treatment that targets influenza by directly inhibiting the virus' ability to reproduce. The study met its primary endpoint, and patients saw a statistically significant reduction in viral shedding. At the highest dosing regimen, there was also a statistically significant reduction in flu symptoms; at the median, symptoms lasted for 1.9 days, versus 3.7 days in the placebo arm. 93% of patients saw no clinical influenza symptoms after just 3 days of treatment, versus 41% in the control arm. VX-787's safety profile was clean, the drug was well tolerated, and no patients discontinued treatment. Analysts have already begun to take note of VX-787: William Blair notes that VX-787's data is promising and that in some ways, it is superior to Roche's Tamiflu. The firm believes that the market has wrongly assigned no value to VX-787. And Wells Fargo sees VX-787 as a "hidden pipeline" for Vertex, given that it has shown superiority to Tamiflu in terms of both dosing and efficacy. Vertex is in the process of exploring collaborative opportunities to further the development of VX-787, and I believe that once focus shifts away from the decline of Incivek to Vertex's pipeline, VX-787 will be received in a positive light.
Takeover Target? Not So Fast
It would seem that Vertex has all the makings of a ripe takeover target. The company has a clean balance sheet with which to fund the development of its pipeline and take it to sustained profitability. And the company has a drug portfolio that is largely un-partnered. Aside from Incivek (marketed as Incivo outside the US), which is the product of a collaboration with Mitsubishi and Johnson & Johnson (JNJ), and a collaboration with both Johnson & Johnson and GlaxoSmithKline (GSK) to test VX-135 (a successor treatment to Incivek), Vertex has shied away from commercial collaborations. In CF, Vertex is collaborating with the non-profit Cystic Fibrosis Foundation, and VX-787 is wholly owned by Vertex, as is VX-509, Vertex's experimental autoimmune drug, which has successfully completed Phase II trials in rheumatoid arthritis. It would seem that Vertex is a logical takeover candidate. However, several factors work against this thesis. Johnson & Johnson has little incentive to take control of Incivek given the outlook for the drug's future sales, and VX-135, while a promising candidate, has not emerged as a clear leader in the next-generation HCV landscape. In addition, Vertex's size works against it as well. On a standalone basis, Vertex's market capitalization is already well over $11 billion, and when the premium needed to acquire the company is factored in, the total price tag may easily approach or surpass $15 billion. Acquisitions of this size are not a common occurrence in the healthcare industry, and any potential acquirers (Johnson & Johnson, Bristol-Myers, and Gilead Sciences have all been cited as possible suitors) will have to approach an acquisition of that size with a great deal of scrutiny.
Vertex's lower odds of a takeover relative to other biotechnology companies in no way diminish the standalone outlook for its shares. The company has a clean balance sheet with hundreds of millions in net cash and therefore, ample capital to carry it through to sustained profitability (consensus estimates call for profitability in 2016, when Vertex is forecast to post EPS of $2.33). Even as the sun sets on Incivek, it is rising for its CF franchise, where Vertex is positioning itself as the market leader. And VX-787 presents further upside potential, with existing clinical data supporting the drug's continued development. With data from multiple clinical trials set to be released during the course of 2013, there are multiple opportunities for shares of Vertex Pharmaceuticals to continue their climb higher.
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