Amylin: A Discounted Option on Byetta's Outcome

Amylin (AMLN) presents a stock opportunity with substantial optionality, and is currently in the sights of activist investor Carl Icahn. I believe Mr. Icahn may not only be trying to make himself a profit, but may also be trying to get Eli Lilly (LLY) a good deal on AMLN at the same time. This may be the win-win genius of Mr. Icahn's deal making.

Regulatory risk surrounds AMLN's key drug Byetta, but if one can come to terms with this risk, then perhaps the stock is a cheap option on Byetta's outcome, and is an option that has a strong chance of ending "up in the money". And perhaps this is how Lilly would view AMLN should the company end up doing a deal via Mr. Icahn.

After all, any R&D investment in the pharma world has substantial optionality. Thus buying AMLN as a discounted option, even in the face of FDA risk for its key product, wouldn't be unreasonable for LLY. Should it then be unreasonable for investors?

In the sights of Carl Icahn

Carl Icahn has most recently been pressuring the company to sell itself to Eli Lilly and Eli Lilly has said that it is open to making acquisitions in general, plus has had a historical relationship with Carl Icahn. Last October, Eli Lilly bought ImClone for $6.5bn, a company which had been controlled by Mr. Icahn. Lilly also has a relationship with Amylin, as it is a partner selling Amylin's key product Byetta and provides financial support to AMLN. This relationship is likely to deepen as Amylin seeks approval for a new and much improved once a week version of Byetta. Amylin expects to seek approval with this new formulation during 2Q09.

While Carl Icahn is pushing for a near term sale, Amylin management is concerned that any near term sale would undervalue Amylin since the shares have been hammered by market concerns over the outcome of Byetta. AMLN's shares are near $10, down from $30 and higher last year.

Byetta faces safety concerns

Byetta, a Type 2 diabetes drug, is awaiting an FDA decision to put a warning label indicating the risk of a rare pancreatitis, or worse, a more severe Black Box warning. In addition, there are also some salient concerns that Byetta contains risk of thyroid tumors. This has all cast a shadow over Amylin's most visible future profit driver, the soon to be commercialized once a week Byetta.

Sales of Byetta, which is made in partnership with Eli Lilly, have been lagging since being linked to cases of acute pancreatitis in 2008. That has raised concern on Wall Street over the chances of approval for exenatide LAR (the new once a week version of Byetta).

Thus we have risk of a safety warning on the original Byetta, hurting its future sales or keeping them stagnant, and then potentially the rejection or delay of the new once a week Byetta. Note that once a week Byetta is a substantial improvement on the original Byetta, since the older version requires two injections a day. Patients will clearly see a higher quality of life with the newer formulation, i.e. far fewer needle jabs.

Mr. Icahn pushing for sooner, rather than later

Back on the activist investor front, Carl Icahn is currently trying to place five nominees on a 12-member board and has called for the Amylin board chairman's resignation. At the same time another activist investor, Eastbourne Capital, is trying to add its own directors. Thus it appears Carl Icahn would rather not wait for FDA results on Byetta or its new version, and is pushing for a near term sale.

Assuming Mr. Icahn gets his way, and assuming Amylin's Byetta franchise remains intact post any FDA ruling, Lilly would likely be getting AMLN at a good price should it close a deal soon, since the shares are currently down about 70% from pre-safety-concern levels in 2008. So not only would Mr. Icahn and any recent AMLN invesors likely make a profit, but Lilly might end up pretty happy too, buying AMLN at depressed levels. Let's not forget that Icahn has sold companies to Lilly in the past, perhaps Icahn's genius is to create win-win relationships of this sort and that's what he's trying to deliver now.

Who might lose from a near term sale? Historical AMLN shareholders who bought the stock at much higher prices, and perhaps management. These parties might be more interested in seeing the hopefully successful launch of once a week Byetta and AMLN's return to $30 share price levels or higher.

Mike Huckman, of Pharma Market, thinks that a buy out by Lilly makes sense given the close relationship already shared between the two companies:

LLY and AMLN are partners on the twice-a-day injectable diabetes drug Byetta. And they're working with Alkermes to bring a first-ever once-a-week version of the drug to market. ...

But the second that a Lily exec publicly acknowledges that the company might be interrested in an Amylin buyout, AMLN shares are going to rally and the price tag for LLY will go up.

David Kliff, who writes "The Diabetic Investor" newsletter, has been insisting for the longest time that it's not a matter of if, but when Lilly buys Amylin. But for now it looks like we've got a standoff.

All roads lead to regulatory risk

Thus the majority of the AMLN risk lies in FDA rulings and how patients react to potentially harsh safety labeling. If Byetta ends up doing well, AMLN will likely be bought at some stage.

On this front, a promising sign is that Byetta is a rather unique treatment, without direct peer, as it both helps to control glucose and promote weight loss. Being overweight is a challenge for 80-90% of American type 2 diabetics, as per Amylin. Because of its unique profile, and even after FDA safety concerns arose, the treatment was endorsed by major medical institutions at end-2008:

BYETTA has not only been accepted by patients, but also by advocacy groups and key opinion leaders. In their upgraded treatment guidelines published at the end of 2008, the American Diabetes Association and the European Association for the study of diabetes endorsed the approach of treating diabetes with glucose controlled therapies that promote weight loss without increasing hypoglycemia. ...

These treatment guidelines have not been updated in over two years and were written after careful consideration of the efficacy, safety, tolerability, cost and ease of use of currently available medicines. BYETTA was the only new edition to the revised guidelines.

To me this puts a decent probability on the prospects for Byetta. AMLN management's reluctance to jump the gun on any buy-out also indicates confidence in the drug's prospects, and Lilly even appears confident in Byetta's prospects since A) they are supporting AMLN already and B) Carl Icahn's behavior, and previous relationship doing deals with Lilly, implies that he suspects Lilly would be keen to buy AMLN, despite the FDA risks.

AMLN as a discounted option on Byetta

As for any investor, for LLY there is risk that safety issues scuttle Byetta's profit potential, assuming that the company were to buy AMLN in the near term. But with AMLN shares near $10, amounting to only $1.5bn in market cap, and down from $30 or more last year, perhaps it would still be a good deal. For Lilly, Amylin could be a cheap option on Byetta's (and the rest of Amylin's) prospects, a cheaper option than say... pharmaceutical R&D. And perhaps that's how other investors should look at AMLN as well, as a stock with cheap optionality, i.e. one that has a strong chance of ending up "in the money" vs. its downside risk.

A lot of people close to the details appear to be confident in Byetta's FDA prospects. The market, given AMLN's share price, clearly isn't. Such a dichotomy could end up providing an excellent opportunity for current investors, and if Carl Icahn can get his way, for Eli Lilly as well.

As a voluntary disclosure, I do not directly own any AMLN or LLY shares.

Comments

[nova]

Unfortunately, the author does not know what he is talking about.

The present AMLN Board and Sr. management are highly malignant and toxic to the company. This cancerous tumor has to be removed ASAP.

2009 Apr 23 11:12 AM

[Vincent Fernando]

Thanks for the comment. Please explain where I referred to AMLN management as something opposite to the claim you have made. I can't find it.

2009 Apr 24 03:26 AM

[peter wolff]

mr. fernando - you have already hypothesized that icahn would broker a sale to lilly that would both make him a profit and give lilly a cheaper price than amylin after fda approval of lar. you then seem to be recommending this course of action. why would you not instead recommend that the best course for investors and amylin management is to wait until after approval to allow major changes in the management and/or ownership of the company?

peter wolff

2009 Apr 24 09:30 PM

[Vincent Fernando]

I am not recommending that AMLN accept a lower price than they should. I am simply explaining what the current situation might be between the three different entities, AMLN, LLY, and Mr. Icahn.

I am then trying to understand if there is an opportunity for new investors to make money in AMLN shares. I am not recommending a course of action for AMLN as a company, I am recommending a course of action for potential new investors in its shares. There is a difference.

If Mr. Icahn were to broker a sale at say $25, and new investors buy at $11, then while AMLN might not be getting the best price it can, new investors will do very well and their risk will be off the table. And if AMLN does indeed end up getting a higher price, one that it perhaps deserves, then new investors will do even better.

My point is not to preach what is best for AMLN as a company, but rather to try to see what the real situation is. My perspective is that of a potential new investor, and to understand the different scenarios that can play out with AMLN shares.

Nevertheless, things have changed a little since I wrote this piece. Mr. Icahn has come out and said that he wanted at least $30 a share for AMLN, and that AMLN misrepresented him when it said he was trying to broker a quick sale. So perhaps then even a near to mid term sale would have to be $30 or more, which would be excellent for new AMLN investors.

Mr. Icahn has pointed out that he has a record of fighting for high buy-out prices when he owns a company. I'm sure he wants to maximize his profit. But at the same time, one must imagine he is cognizant of the fact that if he screws Lilly over, then future deals might not be possible. Thus I am sure he plays a balancing act between making good returns on his investment and also delivering decent pricing to the acquirer. He is not a one-time hit and run kind of deal maker. Don't forget he buys below his perceived fair value, this selling at or a little below fair value still delivers him a strong profit. And if its win-win for both himself and the acquirer, well then he can count on future deal opportunities with that acquirer.

But back to your original question. Let's say theoretically Lilly is worth $40 at fair value as a buyout candidate, yet I can buy it today at $11. Now let's say I can wait for who knows how long for the $40 to be realized as the market price, OR I can push for a quick sale at $30. Or maybe even just at $25. I'll take the quick sale over waiting. The quick sale is done quickly, and the risk is off the table, the return is realized, and you can deploy the capital into a new opportunity. But if rather I hold, waiting for the market to realize fair value of Lilly, risking negative surprises, more health issues with their drugs, etc, then I am leaving myself exposed to an element of risk and a longer investment horizon, dragging down my IRR.

Thus I think in this situation, from the perspective of a NEW investor, one must think in terms of risk-adjusted returns and IRR. On that basis, for AMLN I'll take $25 tomorrow over a potential $40 in one to two years. I do think AMLN likely has a great long term story. But a bird in the hand is worth two in the bush.

2009 Apr 25 03:33 AM

[ebeng]

Thanks for the good analysis. A few more details would help the decision. How much did Icahn pay for Amylin shares? How much are Byetta sales down as a result of newly discovered Byetta side effects? What is the likelihood of pancreatitis and thyroid tumors? What is the profit sharing agreement between Amylin and Lilly for Byetta? Where is Byetta with respect to capturing the diabetes market? What is the profit sharing agreement between Alkermes, Amylin and Lilly for extended Byetta?

2009 May 04 02:30 AM