Gilead Science - Sovaldi's Pricing In A New Perspective

May. 5.14 | About: Gilead Sciences, (GILD)

Summary

Gilead’s revenues grew 98% YoY and EPS shot up by 208% YoY.

Gilead enjoys tiered pricing which it justifies on the basis of per capita income of respective countries.

The World Anti-Doping Agency’s research indicates that about 25% of the pharmaceuticals worldwide are sold on the black market.

Centers for Disease Control and Prevention (CDC) report that 3.2 million Americans are infected with Hepatitis C.

According to the World Health Organization’s (WHO) research around 130-150 million people are infected with Hepatitis C worldwide.

Gilead Sciences Inc. (NASDAQ:GILD) beat analysts' expectations yet again. The company's financial release indicates that the breakthrough Hepatitis C drug, Sovaldi, is the primary cause of the recent boost in the top and bottom lines of the company. The drug received FDA approval in the last month of FY2013 and immediately brought in $139.4 million in revenue. Now that the drug has been sold in the market for a full quarter its success is evident from the tripling of the company's bottom line. However, the pricing of the drug is still an unresolved issue. A few weeks ago, I wrote an article highlighting the efficacy of the drug in comparison to the rival drugs. At the time I wrote that article, I had a different take on the pricing of the drug. Let us discuss a few new findings.

Earnings vs. Estimates

Overall, the company's top line grew 98% YoY yielding roughly $5 billion in revenue compared to $2.53 billion in revenue in the first quarter of 2013. Aggregate revenues generated by the company beat Thomson Reuters' estimates by approximately 28%; Thomas Reuters' expectations were set at $3.92 billion. Sovaldi is the primary cause of the significant jump accounting for $2.27 billion, or more than 45%, of revenues alone while analysts anticipated that the drug would yield just $1.01 billion in the first full quarter of its sale. Minus Sovaldi's revenues, Gilead's top line increased by roughly 8%. The following graph indicates the recent increase in the company's antiviral product sales (after Sovaldi) in comparison to the past few quarters' sales.

Source: Company Presentation

It is important to point out here that the US is responsible for generating 90% of the drug's sales whereas France and Germany are major contributors to the remaining 10% of Sovaldi's sales.

With regards to the bottom line, the company yielded $2.23 billion in profits realizing an increase of almost three times the earnings in the first quarter of FY2013. The company's EPS grew astronomically by 208% and stalled at $1.48 per share compared to just $0.48 per share last year. Thomson Reuters' expectations for EPS stood at $0.89 per share while Wall Street's estimates were $0.91per share.

Sovaldi's Long Term Prospects

Even though the company showed stellar performance throughout the recently ended quarter Gilead's price in the stock market remained depressed and increased by only 2.4% post earnings release. The negative investor sentiment associated with the biotech's long term success is due to the ongoing debate over Sovaldi's pricing. Gilead charges $84,000 per treatment in the US and that is minus any supportive drugs that increase the efficacy of the HCV treatment. Deeming the pricing of the treatment unjustified lawmakers and other health providers are highly criticizing the $1000 a day pill.

Now here are a few facts related to the drug's efficacy: Sovaldi has scored a higher cure rate compared to its competitors' drugs already in the market. Where competing drugs ensure a 75% cure rate with a six-month treatment including inject-able drugs Sovaldi promises more than 90% cure rate with a 12-week oral treatment. If you conduct a cost and benefit analysis, Sovaldi wins the battle and completely justifies its pricing in the US (ignoring pricing in other countries). The drug does not involve any injectable treatment, causes fewer side effects, is much less painful, provides treatment over a shorter time period, and costs less to the afflicted patients in the long term. According to Gilead, "curing hepatitis C can avoid more costly health-care services down the line if hepatitis C is left untreated."

However, Gilead's tiered pricing, which it justifies on the basis of per capita income of respective countries, is what raises grave concerns. No matter how good the intentions of the company are in relation to helping the poorest countries with highest rates of HCV, their pricing strategy is flawed. Here is why: the World Anti-Doping Agency's research indicates that about 25% of the pharmaceuticals worldwide are sold on the black market. Sovaldi's tiered pricing will definitely give rise to this "under the table" activity and may actually promote it. Where each treatment costs $84,000 in the US, the same treatment costs roughly $55-66,000 in Europe; but in European region the company justifies it on an exchange rate basis. It gets more interesting here: poorer countries like India, Egypt, and Brazil would be required to pay just $840 per treatment that is 1% of the treatment's US cost. Burma, Kenya, Mozambique, and Iran will get each treatment for just $900.

Now I am not questioning Gilead's intentions here but their pricing strategy is quite obviously flawed. This tiered pricing opens up an opportunity to purchase medicines in the lower-priced countries and sell them in regions where the medicine is sold for a higher price. Even if these profiteers discount the price of 'black marketed medicines' compared to the prevailing market price, they would earn considerable profits. This potential threat to a growing black market is why I believe that Sovaldi's price will converge across the globe in an effort to prevent arbitrage. In my opinion, it is very plausible that the treatment cost in the US will decrease considerably thus lowering the company's revenues. Considering that 90% of Sovaldi's revenues are attributable to the US, price reduction will significantly impact the top line.

Concluding Remarks

Even with that plausible bump in the top line, the company will continue to enjoy profits as it operates in a huge market. The Centers for Disease Control and Prevention (NASDAQ:CDC) reports that 3.2 million Americans are infected with Hepatitis C. According to the World Health Organization's (WHO) research, around 130-150 million people are infected with Hepatitis C worldwide. While it is true that rival medicines with similar results and lower prices might make it to the market soon, Gilead's Sovaldi will have first mover advantage. Patients who begin the usage of Sovaldi prior to its rivals' release would rarely choose to switch medications. One analyst estimates that Gilead will secure 70-80% of the HCV market and that is in the US alone. Hence any weakness in the stock price must be considered a buying opportunity in my opinion.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.