By Ivan Deryugin
Since our report on Alexion Pharmaceuticals (ALXN) in early December, shares are virtually flat; outperformance through mid-January has been replaced by underperformance as expectations of a back-end loaded 2013 have been met with selling pressure. A negative reimbursement decision in the United Kingdom, which was unexpected given the medical need for Soliris, has also pressured shares. And, concerns about the company's Rhode Island manufacturing facility serve to highlight Alexion's dependence on Soliris and the negativity that stems from any headlines suggesting supply chain risks. But, we believe this concern over Soliris supplies will abate, as Alexion is well prepared to weather disruption, and the concerns raised by the FDA are not difficult for Alexion to address. As focus shifts to Alexion's potential in the 2nd half of 2013, shares of the world's largest standalone orphan drug company are poised to outperform.
Addressing Manufacturing Concerns
On March 27, Alexion reported that it received a Warning Letter from the FDA related to its Rhode Island manufacturing facility, one of two locations where Soliris is manufactured. The FDA's concerns stem from issues regarding Alexion's inadequate investigational procedures related to bacterial contamination of certain Soliris batches, as well as concerns over the robustness of Alexion's overall quality control system. The key point of concern for investors, however, is the company's warning that should the FDA not be satisfied with the corrections it will make, the agency may restrict Alexion's ability to export Soliris manufactured at the Rhode Island facility until it is satisfied with the changes that Alexion has made. Unsurprisingly, investors reacted negatively to this development. Given Alexion's dependence on Soliris, combined with the stock's high P/E multiple (well over 40x 2012 earnings), Alexion must have a steady flow of Soliris if its share price is to be sustained. We believe the issue is not as material as it appears at first glance.
First, the company has ample reserves of Soliris ready to mitigate any supply interruption. Alexion ended 2012 with $94.521 million in inventories, which, according to the company, is equivalent to 4,000 patient years of supply. Estimates compiled by Merrill Lynch conclude that this is enough for over a year of treatment for the Soliris patient population. Secondly, Alexion's Rhode Island facility is not the company's only source of Soliris. Soliris is also manufactured in a facility owned by Lonza Group, and Alexion is in the process of bringing online another manufacturing facility in Singapore, with approval slated for Q4 2013. It's also important to note that while the FDA has sent a warning letter, at this time, the agency has not restricted the manufacturing or flow of Soliris from the Rhode Island facility. Alexion has pledged to rectify the issues raised by the FDA (issues that Merrill Lynch notes are not unique to Alexion, even if they are amplified in this particular case), and the company should provide an update on the situation when it reports Q1 2013 results in May. When this issue is put behind Alexion, investors are likely to return their full focus to Alexion's financial & operational performance. And on these fronts, Alexion has shown solid execution, poised to continue to do so.
Q4 Review & 2013 Guidance: Worldwide Expansion & A March to Diversification
For Q4 2012, Alexion posted revenues of $320.526 million (up 40.85% year-over-year), and EPS of 60 cents per share, up 46.34% year-over-year. While EPS did benefit from a falling tax rate (down to 24.52% from 34.97% a year ago), Alexion's EPS growth was also driven by continued expansion in the company's margins, at both the gross and operating level.
Alexion Margin Structure: 2012 vs. 2011
As the table above shows, Alexion has shown progress in margins at all levels in Q4 & 2012 as a whole, even as the company makes meaningful investments in R&D, which surged by over 86% to $59.9 million in Q4 2012 as Alexion drove multiple clinical programs through the development process. However, for the time being, Alexion's "story" is one of commercial expansion, and Q4 was no exception
Soliris saw meaningful growth in the core markets of the United States, Western Europe, and Japan as Alexion's efforts to expand awareness of PNH (Paroxysmal nocturnal hemoglobinuria) and new diagnostic initiatives serve to increase the number of PNH patients that are identified by physicians. Revenues in the United States grew 52%, driven in large part by the launch of Soliris for aHUS, however CFO Vikas Sinha did note that PNH was still a solid driver of growth in the domestic market. Revenues in Western Europe grew by 27%, and the company's Asia-Pacific revenues grew by 40%, driven by continued uptake of Soliris in Japan. In Q4, Soliris was also launched in Russia as Alexion began deploying its salesforce and operational teams to the country. While David Hallal, Alexion's head of Global Commercial Operations, forecast a slowing rate of growth in Russia through the course of 2013, he stated that Soliris growth would become steadier through the course of the year.
For 2013, Alexion is guiding for revenues of $1.4975 billion at the midpoint of guidance, which represents growth of 32.04%. The company's EPS forecast of $2.90 represents growth of 36.15%, even as Alexion pledges to maintain R&D spending at around 19% of revenues as it moves its pipeline through development. Revenue growth in 2013 should be driven by continued geographic expansion of Soliris. Alexion's record of successful commercialization reflects the unique advantages of Soliris as a product. Alexion has, relative to many biotechnology companies, an easier time securing reimbursement for Soliris, even if it holds the record as the most expensive drug in the world, at $409,500 per year. In 2013, the market for Soliris will expand on numerous fronts. Sales in Russia have commenced; the company's rollout of Soliris (for PNH) in South Korea is set for late 2013; and in both Turkey and Brazil, Alexion is expanding its diagnostic and awareness programs, with Soliris patient additions expanding "steadily" over time. Importantly, Alexion will use its Brazilian operations as a launching pad for expansion into other Latin American markets, with the company's initial focus on Colombia, Mexico, and Argentina. It is important for investors to note the dual-track nature of Soliris. Even as Alexion makes progress in expanding the PNH market in the aforementioned countries, it's expanding the market for Soliris in treating aHUS (atypical Hemolytic Uremic Syndrome). Alexion guided for in-patient reimbursement for aHUS in Germany by the end of Q1, but has not yet provided an update on that front. Negotiations in France are ongoing, with an update set for mid-2013. In early March, Alexion received approval to begin commercializing Soliris for aHUS in Canada, and the drug is also under review in Japan, set to launch in 2014. While these are positive developments, concerns emanating from the United Kingdom have served to overshadow them.
In January, despite a positive recommendation by AGNSS (Advisory Group for National Specialised Services) on Soliris reimbursement, Britain's health ministry overruled the panel it created to evaluate ultra-orphan drugs and instead referred the decision to NICE. This decision has served to mar the sterling reputation that Soliris has built up since first securing FDA approval as the only approved treatment for both PNH and aHUS. Stifel analysts have noted that this puts Soliris into an "undefined" evaluation process, and that this could be indicative of growing concern over the price tags of ultra-orphan drugs. The decision has puzzled industry observers, as the British government's own review concluded that Soliris offers "transformational" benefits for a disease that they called "devastating." And for aHUS patients, Soliris is the only treatment option. Without Soliris, patients must turn to plasma infusions (which have not been shown to be effective in clinical studies, and often leads to circulatory overload) and plasma exchanges. New data released by the British health ministry in March suggests that the opinion of AGNSS was rejected because Soliris was, in essence, too effective. Minutes of the health ministers' original deliberations showed that while there was consensus that Soliris was both effective and necessary for aHUS patients, its level of effectiveness would lead to an expanding aHUS patient population, and if and when Soliris' label expands to cover new indications, the cost of reimbursement would grow even higher. There are few, if any, known cases of reimbursement being rejected because the drug in question is, in essence, too effective.
NICE plans to begin its review of Soliris this month, and the drug will be the first to be evaluated by the HSTEC (Highly Specialized Technology Evaluation Committee), with a decision set for spring 2014. Alexion, on the other hand, has insisted that Soliris would be made available much sooner. The company has said that, through an "unprecedented access program," Soliris would be available as early as Q2 2013. Through the use of local/regional NHS trusts, Alexion will be able to provide aHUS patients with Soliris and, according to Merrill Lynch, do so at current prices (per conversations with the company's executives in late March). This episode has unnerved Alexion investors, and the fact that the debate over Soliris is occurring out in the open has served to highlight one of the perceived risks of Alexion's orphan strategy. Few, if any industry participants (regulators, investors, patients, or physicians) can deny that Soliris meets a significant medical need. But, as the world's most expensive drug, Soliris' reimbursement is often a more difficult facet than its medical benefits imply. In our view, Soliris is serving as a poster child for a broader debate about the trade-offs between the levels of healthcare spending and patient benefits. It's an unpleasant conversation, and becomes even more unpleasant when it plays out as publicly as this. The risk to Alexion is in finding the proper price point for Soliris that serves to make reimbursement a relatively easy decision and to fuel the growth its investors expect. In most countries, Soliris' price tag has been able to meet both of these requirements. In England, however, this has proven to be more challenging. But, at these levels, we believe the risk is priced in. Shares of Alexion are down over 17% from their 52-week highs as of this writing, and Soliris should launch through local/regional NHS trusts, thereby helping patients in the near-term as Alexion continues its work at the national level with NICE and HSTEC.
Pipeline Review: A Story to Remember
For 2013, Alexion's commercial performance will be the key story, as the company expands its PNH and aHUS addressable market, and works to resolve its issues in the United Kingdom. However, that does not mean that Alexion's pipeline should be ignored. 2013 is set to feature several incremental catalysts for Alexion's pipeline [which currently consists of 9 different clinical programs (5 new indications for Soliris and 4 new compounds], which will serve to highlight the durability of the Soliris franchise and Alexion's long-term trajectory. Unsurprisingly, each program targets an extraordinarily rare disease. R&D spending rose to $208.19 million in 2012, up nearly 64% from 2011, and the company's expense guidance for 2013 implies R&D spending of $284.525 million, an increase of nearly 37%.
Filings of approval for the use of Soliris in STEC-HUS (Shiga-toxin producing E. Coli Hemolytic Uremic Syndrome) are set for the 2nd half of 2013, with the company awaiting control data from an epidemiological data from a 400-patient study. For investors not aware of Soliris' development path in STEC-HUS, Alexion's development of Soliris in STEC-HUS began in 2011, when, by chance, physicians discovered that Soliris could help treat patients in Germany's deadly Enterohemorrhagic E. Coli outbreak. Soliris is also being tested in 2 kidney transplant disorders (acute humoral and delayed graft rejection), with new Phase II studies set to complete enrollment this year. New studies of Soliris in NMO (Neuromyelitis Optica), an ultra-rare nervous system disorder affecting a patient's spinal and optic nerves, are also set to begin. After receiving solid data from an investigator-sponsored trial, Alexion is now in discussions with regulators on how to proceed with a multi-national Phase II trial of Soliris in NMO, with the goal of commencing a trial in the 2nd half of 2013. The same timeline exists for Soliris in MG (myasthenia gravis), an ultra-rare autoimmune disorder involving the failure of neuromuscular transmission; patients first lose ocular muscle strength, and the disease eventually moves on to respiratory, spinal, and limb muscles as well.
Asfotase alfa, acquired through the $610 million (plus up to $470 million in milestone payments) takeover of Enobia Pharma in December 2011, is perhaps Alexion's most important pipeline program, with peak sales estimates reaching $1.1 billion. Asfotase alfa is designed to treat HPP (hypophosphatasia), an ultra-rare metabolic disorder in which a patient's' ability to regulate calcium and phosphate intake is impaired, due to a defect in a patient's gene-encoding TNSALP (tissue non-specific alkaline phosphatase). HPP leads to a variety of complications, including muscle weakness, seizures, bone destruction, and respiratory failure, and often strikes infants. Mortality is thought to be as high as 50% within the first year of life, although adult cases of HPP do occur. Asfotase alfa is an enzyme replacement therapy designed to directly target phosphatase to the tissues that lack it, thereby normalizing the metabolic processes of calcium and phosphate. Alexion is working on ramping up its manufacturing capabilities for asfotase alfa, with process development work completed in Q4 2012. The company's natural history study of asfotase alfa in infants is set to be complete this year, and a new placebo-controlled trial of in older children will begin in the 2nd half of 2013. As expected, asfotase alpha has been granted orphan drug status by the FDA and EMA, as well as fast track status here in the United States. Alexion expects to file for approval of asfotase alpha for pediatric patients in 2014 in both the United States and European Union. Outside of those markets, Alexion has initiated enrollment in clinical trials of asfotase alfa in Japan, with full enrollment in 2014.
At under $100, shares of Alexion Pharmaceuticals present a buying opportunity. The company's growth prospects for 2013 are solid, and as the 2nd half of the year begins, Alexion should see the market for Soliris continue to grow in both PNH and aHUS with geographic expansion. With $840.501 million in net cash & investments, Alexion has the capital it needs to continue ramping up R&D spending, as well as make acquisitions. While Alexion is not as active on the M&A front as some large-capitalization biotechnology companies are, it has proven itself to be a shrewd acquirer, having taken control of Enobia as well as Taligen Therapeutics, which gave the company control of ALXN-1102, an alternative pathway complement inhibitor (ALXN-1103 is a subcutaneous formulation of ALXN-1102) currently in Phase I dose-escalating safety and pharmacology studies. Alexion has not let its lack of competition render it complacent. The company is moving aggressively to expand the market for Soliris and is making meaningful investments in R&D to do so, as well as diversify its revenue base in the long-term. Those investments are likely to pay off in the years to come, as is an investment in Alexion Pharmaceuticals.
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