Genzyme: Near Term Sell, Long Term Buy

For my inaugural posting, I have chosen to begin my coverage with one of the most prominent biotech names in the world, Genzyme (GENZ). Genzyme is unique in that it largely develops and markets drugs that treat rare disorders and diseases with significant unmet medical need.

In its early years, the company focused on therapies targeting the lysosomal storage disorders, including Gaucher disease, Fabry disease and Pompe disease. It has since developed or acquired products in the areas of kidney disease, orthopaedics, cancer, transplant and immune disease, and diagnostic testing. The company also has promising drugs in development for cardiovascular and neurodegenerative diseases.

Near-term trade idea - SELL:

At present, Genzyme is struggling with manufacturing issues at its Allston plant (viral contamination), which is where its blockbuster drug Cerezyme and Fabrazyme are produced. Additionally, the company has also had to overcome significant regulatory hurdles to have its potential blockbuster drug Myozyme approved through a larger manufacturing process. These setbacks have collectively resulted in the company’s 2009 revenue guidance being slashed. Adding insult to injury, the manufacturing setback at Allston will likely result in tentative FDA approval of Shire’s velaglucerase alfa to help offset the reduced supply of Cerezyme to the Gaucher disease population.

Shares of Genzyme have been hit hard by this bad news with the stock plummeting to 5-year lows; below technical and psychological support at $50.00 per share. With a lack of key clinical or regulatory catalysts on the horizon, I believe that Genzyme will be valued largely on its base business, which I value at approximately $45.00 per share (see Valuation section below for detailed analysis).

Based on this analysis, and the negative technical and psychological sentiment on Genzyme’s shares, my near-term recommendation for Genzyme is a SELL. However, I would encourage investors to buy back into Genzyme anywhere within the $40.00 to $45.00 range in advance of the November 14, 2009 PDUFA date for the company’s Pompe disease product, Lumizyme. I believe that approval of Lumizyme is highly likely and could be the beginning of a string of good news related to the company’s current product portfolio and its promising late-stage pipeline.

If investors choose to buy back into Genzyme within the $40.00 to $45.00 range, they will essentially receive any upside potential related to the company’s late-stage pipeline for free, which could be considered a bargain given the blockbuster potential of its MS drug alemtuzumab and high-risk hypercholesterolemia drug mipomersen. I note that when I include the value attributable to these two promising products, my valuation of Genzyme increases to $63.00 per share. This represents my 12-month target price, and supports my longer term view that Genzyme is a BUY after the dust has settled from the company’s Allston manufacturing issues.

Current business:

Genzyme’s current business is divided into five different groups, including 1) Genetic Diseases; 2) Cardiometabolic & Renal; 3) Biosurgery; 4) Hematologic Oncology; and 5) Other business. Products in its Genetic Diseases group comprise the majority of the company’s revenue (46.2% based on Q2/09 financial results). Within this group, the company’s flagship product, Cerezyme, is responsible for almost a quarter of the company’s entire revenue stream. The figure below provides a breakdown of Genzyme’s total revenue by group for FY08 and Q2/09.

	2008A		Q2/09A
Group sales		% of total revenue		% of total revenue
Genetic Diseases	$2,226,692	48.4%	$568,153	46.2%
Cerezyme	$1,238,977	26.9%	$298,087	24.3%
Cardiometabolic & Renal	$955,983	20.8%	$247,992	20.2%
Biosurgery	$488,455	10.6%	$138,457	11.3%
Hematologic Oncology	$102,899	2.2%	$55,078	4.5%
Other	$831,010	18.0%	$218,830	17.8%
Total Revenue (US$000s)	$4,605,039		$1,228,510

It is also important to note that approximately 50% of Genzyme’s revenue is generated outside of the US. Therefore, almost half of the company’s revenue is exposed to fluctuations in foreign currencies against the US dollar. As a result, when the US dollar strengthens against foreign currencies, Genzyme’s international product and service revenue will be negatively affected. The reverse is true when the US dollar weakens against foreign currencies. Genzyme’s domestic revenues are unaffected by a change in the strength of the US dollar as all revenues and expenses are booked in US dollars.

Overview of Genzyme’s lead products:

Cerezyme (Gaucher disease):

• 2008 sales – $1.2 billion
• Strengths: dominant therapy for Gaucher disease; strong pricing; no real competitive threat at present.
• Risks & Threats: continued regulatory struggles with Allston manufacturing facility; expected competition in 2009 from Shire’s Gaucher disease therapy velaglucerase alfa; inevitable biogeneric competition – expect US government to have regulatory pathway for biogeneric drug approval by 2010/2011; mature product.
• Opportunities: oral follow-on therapy in Phase III trials could be approved before the composition of matter patent expires in 2013. If can prove safe and effective following switch from Cerezyme, will likely be highly successful from a commercial standpoint.

Fabrazyme (Fabry disease):

• 2008 sales – $494.3 million
• Strengths: dominant therapy for Fabry disease; strong pricing; no real competitive threat at present.
• Risks & Threats: continued regulatory struggles with Allston manufacturing facility; inevitable biogeneric competition; competition ex-US from Shire’s Replagal – potential for US competition upon expiration of market exclusivity (~2010).
• Opportunities: continued penetration into the Fabry disease market is likely.

Myozyme (Pompe disease):

• 2008 sales – $296.2 million
• Strengths: only therapy for Pompe disease; marketing exclusivity in the US until 2013 and in the EU until 2016; strong pricing.
• Risks & Threats: inevitable biogeneric competition; further regulatory delay in the FDA approval of Lumizyme (PDUFA date is Nov. 14); US regulatory delay in approving drug from 4000L process (expect sBLA approval in Q1/10).
• Opportunities: manufacturing capacity expansion to meet global demand for Myozyme/Lumizyme. Potential for Myozyme/Lumizyme to reach blockbuster status.

Renegal/Renvela:

• 2008 sales – $677.7 million
• Strengths: strong sales growth with approval of Renvela; recently approved in EU. Expect continued growth through additional international expansion of Renvela and potential label expansion in the US.
• Risks & Threats: core patent estate expires in 2014. However, ANDA filed in 2009 for generic Renvela, 30-month stay of approval would push back threat of generic Renvela until late 2011/early 2012.
• Opportunities: potential for expanded use in patients with hyperphosphatemia who have not progressed to dialysis. Next-generation advanced phosphate buffer could be approved by 2011.

Synvisc/Synvisc-One:

• 2008 sales – $263.1 million
• Strengths:
• Risks & Threats: patent estate expires in 2011/2012; competition from non-viscosupplementation products.
• Opportunities: continued global launch and uptake of Synvisc-One; potential label expansion to additional joints.

Hematologic Oncology (Mozobil, Clolar, Leukine, Fludara, Campath):

• 2008 sales – $102.9 million
• Strengths: novel therapy in Mozobil; full complement of therapies to treat numerous hematologic cancers, including B-CLL, ALL, and AML.
• Risks & Threats: regulatory hurdles with Clolar as a first-line therapy in AML; strong competition and continued drug development in hematologic cancer indications.
• Opportunities: recently acquired products should complement existing therapies (Leukine with Clolar in AML, Fludara with Campath in CLL), providing a spark in these franchises.

Manufacturing and regulatory challenges viewed positively and negatively:

Genzyme’s difficulties with respect to the regulatory hurdles in getting approval of its Pompe disease product, Myozyme, highlight the challenges facing both innovative biologic drug developers, and future generic biologic drug developers. In particular, Genzyme was looking to scale up production of Myozyme in anticipation of the expected increase in demand. However, the FDA considered the product manufactured at the 2000L bioreactor to be substantially different biologically that it required a new BLA. Genzyme submitted a new BLA for this 2000L product, branded Lumizyme, which I expect will receive FDA approval in Q4/09.

Following approval of the 2000L product, Genzyme intends to submit a sBLA for its 4000L produced Lumizyme. The company expects a 4-month review, which would result in a potential approval in Q1/10. If approved, the 4000L product will be the sole source of Lumizyme. The company also plans to transition US patients from its temporary access plan using product from the 2000L scale to its 4000L scale, with data from the 4000L scale being used to support this transition.

The negative: Genzyme has been unable to fully capitalize on the commercial opportunity of its Pompe disease drug Myozyme; manufacturing and regulatory hurdles are delaying the commercial launch of Lumizyme.

The positive: if Genzyme is having this much difficulty in having the same (relatively speaking) product approved from two different manufacturing facilities, I can only imagine the clinical and regulatory hurdles that will be placed on competing biogeneric products. Furthermore, if the FDA views the products to be substantially different, one has to question how the medical community will view these competing biogenerics. As a result, I believe that we will see fewer competing biogeneric products upon genericization of a biologic. Consequently, I believe that the negative impact on sales following the genericization of a biologic will be muted when compared to the genericization of a small molecule.

Late-stage pipeline key to long-term growth for GENZ:

Genzyme has a host of promising drugs currently being tested in Phase III clinical trials. The most promising being alemtuzumab in MS and mipomersen in high-risk hypercholesterolemia. I view these drugs to be essential to Genzyme’s long-term growth strategy as both could readily achieve blockbuster status. If successful, these two drugs could arguably double Genzyme’s total revenue. As such, I believe that any significant upside in Genzyme’s stock is largely tied on the clinical and regulatory success of alemtuzumab and mipomersen. Please read below for a brief analysis of these two potentially company defining drugs.

Alemtuzumab: Genzyme recently acquired the worldwide rights to alemtuzumab in MS from Bayer for a sizeable deal valued at a potential $2.15 billion (this excludes the oncology portion of the deal that is valued at a potential $750 million in sales and milestone-related payments). Phase II results suggested that alemtuzumab could potentially halt and/or reverse the disease in people with relapsing-remitting multiple sclerosis (representing about 55% of the total MS population). These results compared favorably to market leading MS drug Avonex, which recorded sales of approximately $2.2 billion in 2008. With such highly touted efficacy, safety will be the main concern with this product as the Phase II study also revealed that ~3% of patients developed a potentially life-threatening autoimmune condition (idiopathic thrombocytopenic purpura (ITP)). Therefore, the results of the Phase III program will be highly scrutinized for its risk-benefit profile in MS. Results from the Phase III program are expected in 2011, with potential US approval in 2012. Based on the solid Phase II results, and the safety profile of the drug, I believe that alemtuzumab will be approved in the US in 2012 with a worst-case scenario being a restrictive label that includes a Risk Evaluation and Mitigation Strategies (REMS).

Mipomersen: Genzyme partnered with ISIS Pharma in early 2008 for the worldwide rights to this promising antisense therapy that has shown to drastically lower bad cholesterol levels (LDL). The total value of the partnership was valued at a whopping $1.9 billion, which included $325 in upfront fees. The drug is being developed initially in two indications, homozygous familial hypercholerolemia (HoFH) and heterozygous familial hypercholesterolemia (HeFH). The latter representing a monster commercial opportunity with the potential for a multi-billion dollar revenue stream to Genzyme. The partners recently announced positive Phase III data in patients with HeFH, in which the study met each of its primary endpoints. I was concerned over the observation of elevated liver enzymes, which resulted in one patient’s discontinuation from the trial (out of 34). Nonetheless, HoFH patients are very sick and I believe that the benefits of mipomersen in HoFH will greatly outweigh the potential safety risks. However, this may not prove to be true in the larger population of HeFH, and could result in a more restrictive label potentially including a REMS. Based on the company’s revised clinical program for mipomersen, I do not expect FDA approval of mipomersen until 2010 for HoFH and at least 2012 for HeFH.

Financial estimates:

Below are my financial estimates for Genzyme’s five main groups for FY2009 and FY2010. My FY2009 revenue estimates are in-line with the company’s guided range of $4.6 billion to $5.0 billion. I note that my estimates include the company’s ability to sell some of its remaining work-in-progress Cerezyme material following the shut-down of the Allston manufacturing facility.

	2009E	2010E
Group sales
Genetic Diseases	$1,972,618	$2,591,366
Cardiometabolic & Renal	$1,022,828	$1,195,631
Biosurgery	$562,106	$662,443
Hematologic Oncology	$370,000	$463,500
Other	$898,022	$994,084
Total Revenue (US$000s)	$4,825,574	$5,907,024
Expenses
COGS	$1,327,033	$1,594,897
SG&A	$1,351,161	$1,653,967
R&D	$868,603	$1,181,405
EPS (non-GAAP)	2.66	3.74

Valuation:

I have valued Genzyme using a couple of different methodologies. The first being a standard multiple of the company’s forward earnings combined with a risk-adjusted NPV valuation of the company’s late-stage pipeline. In this case, I have applied a 12x multiple to my estimate of the company’s 2010 non-GAAP earnings. I believe that a 12x multiple adequately reflects the current state of the economy, the uncertainties related to the looming US healthcare reform and impending biosimilars act, as well as the continued concern over common regulatory issues (i.e., manufacturing and approval). The methodology described above does not take into account any of the value attributable to the company’s late-stage pipeline. Therefore, I have also included a conservative risk-adjusted NPV of the future prospects of potential blockbuster drugs alemtuzumab in MS and mipomersen in HeFH to obtain a total valuation of $60.46.

Valuation #1
	2010E	Multiple	Value (US$)
Non-GAAP EPS (diluted)	3.74	12x	$44.86
Drug name	Launch year	Clinical & Regulatory Probability of Success	Peak sales (US$000s)	GENZ profit	NPV (US$)
Alemtuzumab	2012	60%	$1,999	63.00%	$9.82
Mipomersen	2012	59%	$2,174	35.00%	$5.78
Total risk-adjusted NPV					$15.60
			Total valuation	$60.46

The second methodology is a 10-year DCF of the current business combined with a risk-adjusted NPV valuation of the company’s late-stage pipeline (alemtuzumab in MS & mipomersen in HeFH). In this case, I have blended a potential worst-case scenario DCF (genericization of Cerezyme in 2014 and Renvela in 2012) with a potential best-case scenario DCF (follow-on oral Cerezyme therapy approved by 2012/2013 and next-generation Renvela approved in 2011). I have also included the risk-adjusted NPV of the company’s late-stage pipeline (as above). The combination of these methodologies results in a second total valuation of $65.86 per share.

Valuation #2
	NPV (US$)	Clinical, Regulatory & Commercial Probability of Success	Risk-adjusted NPV (US$)
Worst-case scenario	$43.51	53%	$22.95
Best-case scenario	$57.81	47%	$27.31
Total DCF valuation			$50.27
Drug name	Launch year	Clinical & Regulatory Probability of Success	Peak sales (US$000s)	GENZ profit	NPV (US$)
Alemtuzumab	2012	60%	$1,999	63.00%	$9.82
Mipomersen	2012	59%	$2,174	35.00%	$5.78
Total risk-adjusted NPV					$15.60
			Total valuation	$65.86

Given my view that valuing a company based on its longer-term outlook (using a DCF analysis) is the superior valuation methodology, I would suggest that Genzyme should be fairly valued at approximately $66.00 per share. However, most traders and analysts would value a company like Genzyme using a multiple of forward earnings estimates. Therefore, I have elected to blend these two methodologies equally to result in an overall 12-month valuation of $63.00 per share, supporting my long-term BUY recommendation for GENZ.

The M&A trade with Genzyme:

Although there has been significant M&A activity in pharma over the past 12 months, I do not believe that Genzyme should be viewed as a takeover target. The company is entrenched in disease areas that traditional big pharma companies do not like to tread (i.e., the majority of its products are not blockbuster material). Additionally, the company would likely command a hefty valuation premium given its current sales levels as well as its promising late-stage pipeline. Based on this analysis, and the depressed valuations within the small to mid-cap biotechnology space, I strongly believe that Genzyme will continue to be an acquirer as opposed to an acquiree in this economic environment.

Upcoming catalysts of interest:

• Q3/09 – Phase III results with Prochymal in graft vs. host disease
• October 2009 – Q3/09 financial results
• Nov. 14, 2009 – PDUFA date for 2000L scale Lumizyme
• Q1/10 – potential approval of sBLA for 4000L scale Lumizyme
• Q1/10 – results from the pivotal trial with Genzyme’s advanced phosphate binder (potential follow-on product to Renegal/Renvela)
• H1/10 – results from Phase IIb trial with ataluren in Duchenne muscular dystrophy
• H1/10 – results from Phase III trial of mipomersen in HeFH
• H2/10 – submission of a NDA application in HoFH

Disclosure: the author does not currently own any shares of Genzyme

Comments

[Doc Werlin:]

I thought the analysis of Genzyme was first rate. I wish there was more clarification on the plant problems and what steps are required to get FDA clean bill of health

Aug 06 10:32 PM

[Shailesh Ma...:]

Mark, this is a fantastic analysis. You've provided detailed analysis and reasoning than I've seen anywhere else. Thanks! Are you on Twitter?

I'm looking forward to your future articles on biotech companies - especially interested in Gilead, Celgene and Cephalon.

Thanks again for a great analysis.

Aug 07 09:31 AM

[Mark Mitchell:]

Hi Doc,

The manufacturing problems were related to a viral contamination in the source material. The company has cleaned up the bioreactors and both Cerezyme and Fabrazyme are being produced once again. Also, the FDA is still planning to inspect the facility based on previous issues (procedures to prevent microbiological contamination among others) that were found during their routine GMP inspection of Allston back in Sep/Oct 2008. The company had responded to these issues early in 2009 and is awaiting re-inspection, which I expect in coming months. Note that the FDA re-inspected the facility in May 2009, and found that not all corrective and preventative actions had been implemented as promised by Genzyme. If I were Genzyme, I wouldn't want to 'fail' another re-inspection for fear of eventual manufacturing and/or regulatory penalties.

Cheers,
Mark


On Aug 06 10:32 PM Doc Werlin wrote:

> I thought the analysis of Genzyme was first rate. I wish there was
> more clarification on the plant problems and what steps are required
> to get FDA clean bill of health

Aug 07 09:57 AM

[Mark Mitchell:]

Hi Shailesh,

I'm trying to avoid Twitter, so probably won't be posting through that venue anytime soon. Out of the 3 companies you mention below, Gilead would be of most interest to me. We'll see if I have the time to do the analysis on another large-cap like GILD!

Mark



On Aug 07 09:31 AM Shailesh Maingi wrote:

> Mark, this is a fantastic analysis. You've provided detailed analysis
> and reasoning than I've seen anywhere else. Thanks! Are you on Twitter?
>
>
> I'm looking forward to your future articles on biotech companies
> - especially interested in Gilead, Celgene and Cephalon.
>
> Thanks again for a great analysis.

Aug 07 10:01 AM

[robert99:]

Just started researching GENZ, and I'm so glad I stumbled across this fantastic article. Thanks to the author, and a job well done.

Aug 07 02:52 PM