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Following rejection by its board of an offer by Royalty Pharma, a privately held firm, to buy all its shares, Irish firm Elan Corporation PLC (ELN) announced a $1 billion deal with Theravance Inc. (THRX) for 21% of royalty that it gets from GlaxoSmithKline plc (GSK).

At the heart of the deal are four COPD (chronic obstructive pulmonary disease) drugs, but the question is who stands to gain what from the deal - who is the real winner?

The deal

The deal is for participation interest in future royalties that Theravance will receive from GlaxoSmithKline from sale of four COPD drugs. One out of the four, Breo Ellipta is about to hit the market as it has been approved by the FDA. Another of the four drugs, Anoro Ellipta is awaiting regulatory approval from the FDA and EMA. The remaining two, MABA (Bifunctional Muscarinic Antagonist-Beta2 Agonist) monotherapy (GSK961081, or MABA '081) and vilanterol (VI) monotherapy are being evaluated (late-stage testing).

Elan will pay $1 billion for what is basically a 3% stake (best case scenario) in these four drugs for which Theravance has a collaboration agreement with GlaxaSmithKline, which will do the marketing. Theravance gets royalties ranging from 5% to 10% on sales, 15% if sales cross a threshold and Elan gets 21% of that in return for the one-time payment of $1 billion.

Theravance Inc. and GlaxoSmithKline partnership

The Theravance/GlaxoSmithKline partnership for developing treatments for COPD started a decade earlier, in 2002. At that time, Glaxo already had a blockbuster COPD medicine, Advair, a combination formulation of fluticasone/salmeterol that contributed roughly $7 billion in annual revenue to the company. The partnership was evidently an effort on the part of Glaxo to prepare for Advair going off-patent in 2010.

At the center of the partnership is vilanterol, which when combined with fluticasone, a corticosteroid and anti-inflammatory compound, forms an inhalable powder, Breo Ellipta. Anoro Ellipta, the other formulation for which applications for approval have been filed is a combination of vilanterol and umeclidinium bromide, a bronchodilator. Theravance is also planning to file for approval of vilanterol as a monotherapy.

According to a Bloomberg report, Theravance is considering splitting itself into two independent companies - a royalty management company with minimal staff that will manage the partnership with GlaxoSmithKline and another company that will continue with the operations related to drug discovery, development and commercialization.

Chronic obstructive pulmonary disease

COPD is a nonreversible lung disease that is a combination of emphysema and chronic bronchitis. These are commonly co-existing lung diseases that cause shortness of breath due to narrowing of airways. As against asthma, COPD gets worse over time and is poorly reversible. It is currently the third leading cause of death in the U.S.

The threat of generic versions appearing for this type of drug is minimal. There is still no generic version of Advair as the FDA has not determined a standard for bioequivalence of such drugs -dry powder inhalers. However, it can be safely assumed that the hunt for a generic version will continue.

In 2007, COPD was responsible for $42.6 billion in healthcare cost and productivity loss in the U.S. Investment bank and asset management firm Piper Jaffray estimates Breo Ellipta and Anoro Ellipta annual sales to be around $2 billion and $4 billion.

Did Elan pay too much?

Elan needed to build its portfolio particularly because it has converted itself into a royalty management company. In the last ten years or so, it came up with a blockbuster multiple sclerosis drug, Tysabri, which it sold in an equal partnership with Biogen Idec (BIIB). Earlier this year, Elan sold its interest in Tysabri for $3.25 billion plus royalties.

However, it did not find any success in its research in Alzheimer's disease. The company purchased bapineuzumab, a candidate for treatment of Alzheimer's well into its late-stage testing but saw partners Pfizer (NYSE:PFE) and Johnson & Johnson (NYSE:JNJ) ending their partnerships when they found that it did not work better than placebo.

However, the COPD deal with Theravance plugs the hole created by the sale of the Tysabri interest. It also strengthens the company's position in the $11 a share (later raised to $11.25 a share) hostile takeover bid by Royalty Pharma. The deal is seen as Elan's attempt to retain its independence as Royalty Pharma would now be forced to rethink whether buying Elan now is worth the investment.

Breo is a safer drug and could well turn out to be a blockbuster and prove to be Elan's savior, especially when seen in the context of Moody's decision to place the company's credit rating, which is already three notches to junk status, to review for a possible downgrade.

Theravance's gain

Theravance is a clear winner in the deal. It gets the money and also another sponsor. It is a handsome amount for a company with annual revenue of $135.76 million. The company has only one drug in the market - Vibativ for treatment of complicated skin and skin structure infection (cSSSI) including methicillin resistant staphylococcus aureus (MRSA). The money will help Theravance in funding its pipeline products and discovery of new candidates in its field of operations.

The deal robs GlaxoSmithKline of the option of waiting and buying the balance interest in the COPD drugs at a lower price. The deal now spreads the royalties across two owners making it difficult for Glaxo to get full ownership of the entire COPD portfolio of Theravance.

Investor's point of view

  • Theravance

Approval of Breo triggers a milestone payment of $30 million and the Elan deal brings in $1 billion. These are big positives for Theravance. Nevertheless, the deal has to be approved by Elan's shareholders who have 35 days to decide.

However, FDA approval of Breo was announced on May 10, 2013 and the Elan deal was announced on May 13, 2013. Between these two dates, shares of the company have soared almost 34%. This suggests that the market has factored in most of the positives.

Breo is expected to hit the counters by Q3 2013. FDA decision on the other COPD drug, Anoro is expected by December 13, 2013. If I was to invest in Theravance I would wait for the euphoria to die down and the stock to correct a bit.

  • GlaxoSmithKline

The deal does not affect GlaxoSmithKline as its commitment to Theravance remains intact. Its tiered royalty structure in the original agreement with Theravance remains as it was. Also, the deal does not disturb Glaxo's original plan of investing in COPD treatments to protect revenue loss due to Advair going off patent. It is important to mention here that with 27% ownership, Glaxo is the largest single stakeholder in Theravance.

Glaxo is a global healthcare giant and a good dividend play and a buy as long as its dividend yield remains at the current levels of above 4.5%.

  • Elan Corporation

I would keep away from this stock until the time FDA approves Anoro. Clinical stage trials of the other mid-stage COPD drugs in the deal also need to throw positive results. A strong launch of Breo Ellipta would be a big positive for the company.

Source: The Billion Dollar COPD Deal: Who Gains The Most?