Recent FDA Approval of Xiaflex Drives Both Value and Takeover Interest
Auxilium Pharma (AUXL) recently announced the FDA approval of Xiaflex for the treatment of Peyronie's Disease (PD). Xiaflex is the only FDA-approved treatment for PD, a connective tissue disorder in which fibrous plaques grow in the penile soft tissue. This can lead to pain, abnormal curvature, and erectile dysfunction (ED) in between one and five percent of men.
Famous people with this condition include former President Bill Clinton, according to court documents.
As a Standalone Business, the Shares of Auxilium are Significantly Mispriced
Regardless of the strategic alternatives for Auxilium, the shares are massively mispriced under $30. The fundamental valuation of pharmaceutical companies relies almost exclusively on the sum of the projected discounted cash flows of all the future drugs that they will sell. There is no other industry where so little information is actually known about the future success of their development efforts, regulatory approvals, market acceptance, new competitive products, or unanticipated problems. These valuation problems are exacerbated for smaller development companies that lack product diversification.
Looking at the past twelve months, Auxilium had actual revenue of $445M. By way of example, BioMarin Phamaceutical (BMRN) had $534M in the same period. Both companies had operating expense to revenue that was substantially greater than their gross margin, but BMRN is valued by investors at $10.66 billion, while AUXL is valued at a mere $1.29 billion, one eighth of BMRN. AUXL is valued at 2.84x sales, while BMRN is valued at 20x sales. The difference is the investors' expectation of cash generated by products that will perform in the future.
So why do we think that AUXL is undervalued at under $30 per share? The primary reason is that since closing on the Actient Holdings acquisition last April and the FDA approval of Xiaflex for PD, the potential for future cash flow has grown far in excess of the 66% increase in market cap. The Actient acquisition added nine drugs to Auxilium's product mix from just two, and diversifies away from weaker Testim sales. The company also entered into an agreement with VIVUS, Inc. to market STENDRA, a drug to treat erectile dysfunction, in the US and Canada. While no one has the vision to project with any accuracy the impact of the different improvements, Auxilium has built a strong men's healthcare franchise. It is likely that taken together, the projected risk adjusted discounted cash flow has grown by much more than 66%.
We believe the opportunity for Xiaflex is particularly interesting and misunderstood. Peyronie's Disease (PD) is a painful and embarrassing disease that often goes unreported and untreated. Prior to the approval of Xiaflex, there was no FDA-approved non-surgical treatment for men with the disease. Estimates from AUXL and the sell side about potential market share for Xiaflex have focused on the population of men that choose to get surgery or injections, roughly four to six thousand per year. This significantly underestimates the treatment market, as most men choose not to report the issue until it becomes painful or causes an inability to have sexual intercourse.
Auxilium has good reason to temper expectations for now. The cost of Xiaflex is expensive, around $20,000. Third-party payers will likely not push back on a market of four to six thousand patients. But the number of diagnosed cases of Peyronie's disease is closer to 100,000 cases a year, and that number will likely increase with viable treatment options available. Men with this condition are heavily motivated to seek treatment, as we have seen with other forms of erectile dysfunction. Prior to existence of viable treatments for ED (such as Viagra), reported cases were much lower than they are now. Today, ED is a mainstream topic. As men see viable treatment options, they are more willing to seek medical advice for these emotional and embarrassing conditions.
For the purposes of this article, we will limit discussion to Peyronie's disease, but Auxilium is also in the midst of clinical trials to treat Cellulite and Frozen Shoulder with this drug. About 85-90% of post-pubescent females are affected by cellulite, and no-FDA approved treatment exists.
AUXL's actual gross margin was 68.9% last quarter. Its operating expense-to-sales was 82.9%. AUXL already has a urology sales force in place to capitalize on new products from the Actient acquisition as well as the launch of Xiaflex for Peyronie's, and the company has stated that it will not need to expand in order to effectively market these products. In Europe, the company has secured a lucrative licensing agreement with Swedish Orphan Biovitrum AB (Sobi). In the agreement, Sobi will bear the cost of regulatory approval and development in its region. Doubling its revenue through the same cost structure would move its operating margin from a loss of 14 percent on $445 million to a profit of 27.5% on $890 million of sales. The impact on annualized earnings would be an increase of $370 million. If AUXL remains a standalone company, at a P/E of 20, that would be a valuation of about $100 per share.
The other alternative to trying to grow the revenue is to sell the business to a larger pharmaceutical company. If the purchaser was able to put their products through their existing sales force, synergies well in excess of $100 million would be available. If the benefit of these synergies was split evenly between the buyer and the seller, it would be worth over $20 per share to the AUXL stockholders. Either solution indicates a price that is at least $35 per share, or over 30% above the current share price.
To An Acquirer, Auxilium is Worth Much More than $35
Auxilium is a valuable business on its own, but it would be worth far more to a strategic buyer. There is no good reason for small biotech companies to commercialize products such as Xiaflex with small sales forces. Larger pharmaceutical companies can wipe out essentially all of the SG&A associated with deal targets and simply have their much larger sales force sell one more product. Additionally, once AUXL is a profitable taxpayer, it would make a lot of sense to be owned by a parent company in a tax-efficient jurisdiction such as Ireland.
Auxilium and Pfizer (PFE) have had a long-standing relationship. Since 2008, the two companies had an agreement where Pfizer and AUXL developed and commercialized Xiaflex in Europe for its earlier approved treatment of Dupuytren's contracture in the hand. In April 2013, before Xiaflex was approved for Peyronie's disease, Auxilium terminated the agreement with Pfizer.
There are a lot of synergies between Pfizer and Auxilium. With Viagra, Pfizer is clearly a dominant player in the men's health arena, and it could easily add Auxilium's products to the menu of options for its men's health sales force to market. Other acquisitive buyers with interest in Auxilium's product areas include Endo (ENDP) and Shire (SHPG).
Most Importantly, Auxilium's CEO Adrian Adams is a Habitually Successful Seller
Were a highly aggressive and motivated shareholder activist to take control of AUXL and hire a new CEO with a mandate to sell the business, Adrian Adams would probably be the first name on the hiring list. He has spent three decades cleaning up and selling company after company for big premiums. Happily for AUXL shareholders, he is already the CEO.
Kos Pharma: Mr. Adams spent four years as CEO of Kos before selling it to Abbott Labs (ABT) for $78 per share, a 56% premium over the pre-deal price.
Sepracor: Mr. Adams spent three years as CEO of Sepracor before selling it to Dainippon Sumitomo Pharma for $23 per share, a 28% premium over the pre-deal price.
Inspire Pharma: Mr. Adams spent two years as CEO of Inspire before selling it to Merck (MRK) for $5 per share, a 26% premium over the pre-deal price.
So, Mr. Adams sells companies. Mr. Adams has been on the job as CEO for two years, slightly under the average time that he takes to sell a company for a substantial premium to the pre-deal price. The average premium that Mr. Adams has secured on deals in the past is 37%. It is reasonable to anticipate a premium of at least that for AUXL. The market undervalues AUXL, so he may choose to show a few quarters of Xiaflex sales numbers before finally selling. If a buyer wants to secure a deal today, it would probably take at least $40, which would be large premium over the market price.
Timing is a big question mark. We believe Mr. Adams will get a deal done this year or the very beginning of next year, before AUXL is profitable and has to pay taxes. This would allow the company to build up cash and prove some of the growth potential of Xiaflex in order to push for higher price.
In this year's BIO Buy-Side Investor Perception Survey, over 25% more investors expect biotech M&A to increase over last year than those expecting the pace to slow. The current environment has been good for acquisitions. Deals done recently have very quickly been accretive to the buyers as well as the sellers' shareholders. Both biotech specialists and investing generalists anticipate the pace of transactions to quicken. We believe one of the most promising targets could be Auxilium.
Additional disclosure: Chris DeMuth Jr. is a portfolio manager at Rangeley Capital, a partnership that invests with a margin of safety by buying securities at deep discounts to their intrinsic value and unlocking that value through corporate events. In order to maximize total returns for our partners, we reserve the right to make investment decisions regarding any security without further notification except where such notification is required by law.