Onyx Pharmaceuticals Rejected Amgen's $120 Per Share Acquiring Offer - Part 1

| About: ONYX Pharmaceuticals, (ONXX)

As we were analyzing Onyx Pharmaceuticals (NASDAQ:ONXX), news broke out late last Friday, June 28, stating that Amgen (NASDAQ:AMGN) may be interested in acquiring ONXX for a proposed $120 per share, a 38% premium to its closing price ($86.80) that day. Onyx issued a press release confirming Amgen's offer but rejecting the $120 per share proposal as significantly undervaluing the company. The news sent the stock price soaring to $109 in extended trading.

As investors digest and verify the information on Monday, we anticipate that there will be volatility associated with ONXX stock in coming weeks. In essence, our report provides a timely evaluation of the intrinsic value of the stock. It also provides information on how much Onyx might be willing to sell itself for. We wrote a three-part report to cover ONXX. This article is Part 1, an overview of Onyx's business model, its key products, and risk factors associated with the company.

In Part 2, we will review its partnership agreements with Bayer (OTCPK:BAYZF) and Proteolix and point out relevant royalty payments and liabilities Onyx will incur. Most importantly, we will present a five-year revenue projection for Onyx. In Part 3, we will analyze its financials and derive an intrinsic value for the company. Our analysis suggests that the intrinsic value for ONXX is very close to the takeover price proposed by Amgen.

Business Overview

Onyx Pharmaceuticals is a mid-cap biopharmaceutical company that develops kinase and proteasome inhibitors with broad applications for cancers and inflammatory diseases. The company currently has a market cap of ~$5.5B with a stock price of $85 and about 65 million shares outstanding. The unique aspect of this company is that it has secured corporate partners to co-develop its drug candidates. Its partnership with Bayer has developed Nexavar (a drug for liver and kidney cancers) as well as Stigarva (a drug for colon cancer). Through its acquisition of Proteolix in 2009, ONXX acquired another drug candidate, Kyprolis, which was approved by the FDA for the treatment of multiple myeloma in 2012 (as per the ONXX 10-K for 2012).

Partnership With Bayer Pharmaceuticals

The development of Nexavar (sorafenib) has been through a long-term partnership with Bayer Pharmaceuticals. The drug was approved in multiple countries for unresectable liver cancer and advanced kidney cancer during 2005 to 2007. ONXX and Bayer share equally in the profits and losses of Nexavar worldwide, except Japan. The drug has been in the market for seven years. In 2012, it reached sales of $1B for the first time (as per the ONXX 10-K for 2012). At present, Onyx and Bayer are conducting Phase III clinical trials on sorafenib for thyroid cancer and breast cancer to expand the Nexavar franchise.

A second oral multi-kinase inhibitor, Stivarga (regorafenib), co-developed with Bayer was approved in the United States for the treatment of metastatic colorectal cancer (mCRC) in 2012 and for the treatment of locally advanced, unresectable or metastatic gastrointestinal stromal tumors (GIST) in 2013. It is currently under regulatory review for mCRC in the European Union and Japan, and for GIST in Japan. Onyx receives a 20% royalty from Bayer on net sales of Stivarga in oncology indications globally. Onyx and Bayer are also conducting Phase III clinical trials on regorafenib for liver cancer and colon cancer to expand the Stivarga franchise.

Partnerships With Pfizer

Onyx initiated a partnership agreement for research and development collaboration with Warner-Lambert Company, now a subsidiary of Pfizer (NYSE:PFE), to discover and commercialize small molecule drugs that control the cell cycle in cancer cells. As a result of the collaboration, Pfizer identified palbociclib, a selective inhibitor of cyclin-dependent kinase 4/6, or CDK 4/6. The drug candidate entered Phase III trial in breast cancer in 2013. If approved, Onyx is entitled to receive 8% net sales as royalty payments.

Proteolix Acquisition in 2009

Kyprolis (a proteasome inhibitor) is Onyx's new drug, just approved by the FDA in 2012 for the treatment of multiple myeloma. ONXX obtained the Kyprolis drug candidate through its acquisition of Proteolix in 2009. Although the drug was approved as a third-line treatment for multiple myeloma, Onyx is currently conducting several Phase III clinical trials to expand the use of Kyprolis as front-line or second-line treatment for multiple myeloma.

While this drug is wholly owned and commercialized by ONXX, the company may be required to pay up to an additional $365.0 million in up to three earn-out payments upon the achievement of certain regulatory approvals for Kyprolis in the U.S. and Europe between 2013 and 2016. Onyx paid a total $396M for the Proteolix acquisition and milestone payments between 2009 and 2012. We will incorporate the potential cash outflows into our financial projection in Part 2.

Key Issues

When evaluating a company like Onyx, we need to consider several key issues (or potential risk factors) uniquely associated with the company. First and foremost, what are the future growth rates for its product revenues and product royalty revenues paid by its corporate partners? When will the company turn profitable? What is the competitive landscape for its drugs? Obviously, the company's profitability is closely tied to its drug sales. ONXX receives royalty revenues from its corporate partners on net sales of the approved drugs, but it is also liable for milestone payments to Proteolix shareholders if Kyprolis commercialization goals are met. How much will these revenue streams contribute to Onyx's bottom line? We will project revenue growth in Part 2.

A second issue is related to its expansion of clinical trials on various fronts. While the company intends to expand its drug franchises to as many indications as possible, there are significant costs associated with each clinical trial. Does the company make wise investments on this front? What is a likelihood of success for these trials? We will review its late-stage clinical programs.

A third issue is related to the company's financial strength or weakness. Due to mostly non-profitable quarters in the past, Onyx's accumulated deficit is $650M as of December 2012 (as per the ONXX 10-K for 2012). With over $1.47B additional paid-in capital, shareholder equity is $820M as of 2012. In the financial projection section, we will discuss when the company will turn to positive retained earnings.

As of December 2012, Onyx had $480M cash and cash-equivalent securities. Its long-term debt is ~$174M, representing a modest 17.4% of total invested capital. Among the debts are convertible notes with a face value of $230M due in 2016. It is highly likely that the convertible notes will be converted to equity once matured because the conversion price is around $37, much lower than the current stock price ($85). A conversion will be positive in terms of reducing the debt level (and leverage) while increasing equity to the company. The potential dilution of common stock has already been included in the calculation of diluted shares outstanding, so there is little impact on the calculation of diluted earnings per share value. We will discuss the details of this debt conversion in Part 2.

In the next sections, we will project revenue streams from its product sales as well as royalty revenues and contract revenues from these partnerships. Most importantly, we will provide a timely evaluation of the intrinsic value of the stock. We anticipate that serious negotiations will continue between Onyx's management and Amgen or other potential acquirer(s). Center to the negotiation will be how much an acquirer is willing to bid for Onyx's enterprise value and how much Onyx might be willing to sell itself for.

Disclosure: I am long ONXX, AMGN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.