Genzyme: The Next Big Biotech Machine

Rarely do I even acknowledge biotech equities due to the inherent risk and uncertainty in the industry. But as of late, one biotech firm has garnered my attention, due to extremely high margin of safety at their current market value. I have also watched this company grow over the last 4 years, and their successful execution of what has been an increasingly dynamic strategic vision.

Genzyme (GENZ), which had a very broad range of treatment catering to numerous “niche” markets, is the company I’m making reference to. This strategy was unprecedented until recently as the company targets those diseases that strike a very small part of the population. This, however, has given it “fast track status” on the majority of their drugs, referred to as “orphan drugs”, consequently resulting in longer patent lives than the industry average.

Genzyme began moving drugs onto the market that treated a select few with some type of rare disease, but it has gradually brought bigger and bigger drugs in front of the FDA with remarkable success. Over the last 2 years it has successfully brought 3 mini blockbuster drugs on line with several more in the pipeline in addition to some real blockbusters in the oncology arena. Unlike other mega biotech giants like Amgen (AMGN) whose main focus is in a single specialized area (oncology), Genzyme has a very diverse portfolio in terms of treatments afflicting main medical arenas. Its target market covers 6 main areas including cardiovascular disease, renal disease, diagnostics, genetic disease, bio-surgery and most recently oncology (which it has achieved enormous success in the small time spent here). The company has built up a strong capital position before entering the world of oncology as the research tends to be relatively expensive. It has done this through exploiting various niche markets as well as making contractual strategic alliances with such companies as Isis (the leader in the development in RNAi technology, which the scientific world believes is the future for cancer treatments).

Its current flagship drug (though unlikely to remain so much longer) is Cerezyme for Gauchers disease. 2008 revenue for this drug came in just above $1.2 billion. Although this accounted for 27% of its revenue, the more or less recent approval and sales growth of such drugs as Myozyme, Mozobil & Fabrazyme have the Street as well as the company projecting net income growth of 80% for FY '09. Myozyme treats a rare disease (Pompe) but is expected to be used off label for a variety of illnesses. Mozobil will be more and more widely adopted for solid organ transplant/ sensitization both in the U.S. and around the world. Myozyme is expected to grow from $300 million in 2009 to $800 million by 2013 and peak at nearly $1 billion in sales per year. Mozobil also is expected to grow 400-500% by 2012-2013, giving the company $3 billion a year by 2012 from its top 3 drugs (barring future approvals). This is great considering the entire value of the company is around $15 billion.

What caught my eye wasn’t the current wave of recent approvals but the depth and broad scope of its research pipeline, which also has potential blockbusters that should propel Genzyme to the upper echelons of the biotech world. One the best pipelines in the biotech field is even more compelling when looking at Genzyme’s past track record for drug approvals. This illustrates the innovation and excellent management team that has made Genzyme such as success. A much more sound capital position has enabled Genzyme to seek medical approval from regulators from around the world in hopes of marketing its drugs wherever possible Just last Friday, Genzyme received approval for Renvela (a drug to help control phosphate in the blood of kidney disease patients) in Europe. Not only is Genzyme attractive on a valuation basis solely based on the current products on the market, but the fact that Genzyme’s pipeline could very well be worth more than then entire company, makes it a standout in an industry that has been rather stagnant over the last couple of years.

An all inclusive valuation can be found be clicking here.

Their current pipeline has 12 drugs in stage 3 of FDA trials, nearly 22 drugs in stage 2 of FDA trials, 7 in stage 1 and 11 in pre-development. In other words, Genzyme is positioned for an extremely long period of high growth and potential catalysts year after year for the foreseeable future. This is also a unique pipeline with drugs focusing on various cancers, kidney disease, multiple sclerosis, Crohn’s disease & Parkinson’s disease among others. Even if they only live up to half the success of their past track record, the market value of this company is worth well in excess of $80/ Share. This may sound far-fetched, but 12 or so months ago, before some major approval, Genzyme was trading more than 50% higher at $79 than the current $52 dollar handle. The market, as inefficient as it tends to be, is giving a gift to those who recognize the valuation disconnect, though I doubt it will be long lived.

The company is also in the transition phase in terms of R&D spending. Like everything to due with this company, this is a unique case because they have slowly crossed over to cover both niche markets as well as those who stricken a significant portion of the population, in particular oncology. In other words, R&D spending over the last two years has been a higher percent of sales than its historic average as well as the industry average. This has masked the true free cash machine Genzyme will become, but more importantly it distorts the market's interpretation of earnings. In my opinion, I think R&D should be capitalized so it shows up in free cash flow, not real income from operations.

The average money manager likely dismisses this company for lack of understanding. It currently has operating margins around 20%, which is well below the industry average. But this is because of GAAP accounting. R&D should be a capital expenditure and show up on the statement of cash flows instead of the income statement. Genzyme had to incur these lower margins (which have been expanding) in order to develop its pipeline. But those with the wherewithal to recognize this fact or determine operating margins by capitalizing R&D expenditures would see it is right around the industry average. Another overlooked fact is that Genzyme’s entry into bigger markets via the aforementioned drugs also has larger margins, thus it is a certainty its operating margins will expand over time.

Like any other equity, I look for a large margin of safety in case the assumptions in my valuation models turn out to be wrong, thus limiting my downside. With Genzyme, the current product portfolio alone gives Genzyme an Intrinsic Value of $54-$62/share. In other words, its pipeline (which could be worth substantially more than the future cash flows generated from the current portfolio) is basically free at current prices. But realistically, I expect a fair value to be near $100/share. I think it could be worth far more depending on the outcome of the pipeline, but at the current $52 market price, there is no downside.

What to Look For The Next 2 Years

It is worth noting Alemtunuzab (for MS), Prochymal (for Graft vs. Host Disease), Clolor Combo (Adult Myeloid Leukemia), and Mipomersen (Cholesterol), just to name a few, are some potential blockbusters seeking approval over the next 6-24 months. Mipomersen has recently showed great results in clinical trials: After 24 weeks LDL was lowered 26%, which was the lowest dose, with data to support a more rapid decline at higher doses (trials ongoing). Also, the recent milestone approvals in Myozyme, Mozibil and Fabrazyme should reach peak growth in 2011-2012 as it is approved Internationally. A detailed pipeline can be found here.

Long: Genz Jan 2011 Calls

Comments

[PhillyDan:]

Great write up on GENZ. Interested to find out if Mipomersen does not have any potential liver side effects like statin medications have? If it doesn't it could really put a dent in Lipitor and other statin meds for treating Cholesterol. I will definitely do some more DD on GENZ as a long term investment opportunity.as a result of your excellent analysis.

Jul 01 01:46 PM

[437339:]

Re

Great article -However , I am concerned re the government wanting to slash health care costs . One area where this will have huge impact is on pharmaceutical firms . This is especially true with insurance firms + medicare wanting to pay ONLY for generics + VERY few brand name drugs . Your sentiment appreciated .My neighbor is a long time employee of Eli Lilly co . He states " we are just waiting for our pink slips ". His specialty area is oncology .

Jul 01 05:07 PM