The Case That Regeneron May Be Significantly Undervalued

Summary

Regeneron announced an upside surprise for sales of its lead product Eylea this week.

It has a powerful pipeline and important collaborations with Sanofi and Bayer HealthCare.

The combination of high R&D spending and elevated pre-launch expenses for its late-stage cholesterol reducer alirocumab means that P/E is the wrong metric investors should look at.

Background: In biotech, a company that begins bringing in revenues - and thus ceases to be a development-stage company - enters into a phase where it is premature to be viewed by traditional P/E and related metrics. When the company is prominent, with a high market cap, it may look bubbly to conservative investors, but appearances may be deceiving.

Regeneron Pharmaceuticals, Inc. (NASDAQ:REGN) is in my view that sort of stock. Its market cap is around $33 B now. It may be in an explosive growth phase and while it looks expensive now on traditional metrics it could, I believe, look cheap a few years hence.

This article evaluates REGN using a sum-of-the-parts type of analysis, as P/E analysis and compound growth rates are difficult to pinpoint yet.

Introduction: Regeneron is a world-class developer of biotech products, with two productive technology platforms, VelociSuite and "Trap." It develops classic biotech products that are injected; thus it is not a "biopharma" company as Gilead and Celgene (NASDAQ:CELG), which develop and market a number of oral medications.

Three REGN products are marketed, of which one, Arcalyst, is a niche product that is immaterial to investors. The other two products are Eylea (aflibercept) for retinal problems, and a chemical variant of aflibercept called Zaltrap for adjunctive treatment of advanced stage colorectal malignancies.

The company has top-tier personnel, and has received some accolades that normally would have been given to much larger and better-established firms. To wit:

Regeneron's long-time chairman of the board, Roy Vagelos M.D., was one of the greatest pharmaceutical CEOs ever. During his tenure, Merck (NYSE:MRK) was named the "most admired" company in America an astonishing seven consecutive years by Fortune 500 business leaders. Co-founder Len Schleifer, M.D., Ph.D. is CEO. George Yancopoulos is Chief Scientific Officer. Regeneron states that Dr. Yancopoulos was the 11th most highly cited scientist in the world in the 1990s; in 2004 he was elected to be a member of the National Academy of Sciences. Co-founder and current director Alfred Goodman Gilman won a Nobel Prize in 1994 for his work on G-proteins. (Some readers may recognize his unusual middle name. Dr. Gilman's father, also named Dr. Alfred Gilman, was co-author of a classic pharmacology textbook with Louis Goodman.)

Senior VP Robert Landry has served as Senior Vice President and Treasurer of Pfizer, Inc.

Directors Drs. Brown and Goldstein have won Nobel Prizes.

Other directors include Dr. Tessier-Lavigne, who was CSO and EVP at Genentech, and Arthur Ryan, former Chairman and CEO of Prudential Financial and former President and COO of Chase Manhattan Bank.

This is a highly credible and experienced management and directorial team, with broad connections to the top echelons of global business, financial and scientific communities, and extensive track records of success.

Regeneron has received several honors recently, as reported in several press releases:

1. Its pipeline product dupilumab was named "Clinical advance of the year" for 2013 by a widely-read industry journal, Scrip.

2. Scrip Intelligence also named Drs. Schleifer and Yancopoulos as "Management team of the year."

3. Regeneron was also named by Science magazine as the top employer in the global biopharmaceutical industry for the second year in a row.

This is impressive for a smallish company located in a commuting suburb of New York City.

REGN has two major partnerships. Bayer HealthCare promotes Eylea outside of the U.S., and sales are growing rapidly in foreign venues.

REGN has an extensive partnership with Sanofi (NYSE:SNY), the large French company. Sanofi supports REGN's research and gets repaid from future profits. Sanofi owns 20+% of REGN; there is a standstill agreement limiting it to 30%. A sense of the scale of SNY's support is seen in the next section, which reviews Regeneron's recently-reported second quarter.

Regeneron's Q2: A brief discussion of the quarter is important to understand the investment themes here and see some trends. From the press release:

($ in millions, except per share data)

Three months ended

June 30,

2014

2013

% Change

EYLEA U.S. net product sales

$

415

$

330

26

%

Total revenues

$

666

$

458

45

%

Non-GAAP net income

$

289

$

198

46

%

Non-GAAP net income per share - diluted

$

2.47

$

1.73

43

%

GAAP net income

$

93

$

87

7

%

GAAP net income per share - diluted

$

0.82

$

0.79

4

%

Click to enlarge

Note the large difference in non-GAAP net income and EPS vs. GAAP numbers. Interested parties may wish to look into this further; which numbers to use, or whether to use an in-between number, is a personal choice. The main focus of this article is elsewhere, however, as REGN is overvalued based on current metrics in any case.

The yoy difference in U.S. Eylea sales was 22%, not 26%, when adjusted for changes in inventories. Foreign sales grew rapidly. Analysts found Eylea sales to have been above expectations.

Revenue breakdown shows Sanofi's and Bayer's gross payments to Regeneron; note comments after this table.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands, except per share data)

Three months ended

June 30,

Six months ended

June 30,

2014

2013

2014

2013

Revenues:

Net product sales

$

418,022

$

333,893

$

780,400

$

652,633

Sanofi collaboration revenue

142,595

85,529

273,103

184,802

Bayer HealthCare collaboration revenue

97,295

31,104

222,607

46,011

Technology licensing and other revenue

7,788

7,116

15,330

13,860

665,700

457,642

1,291,440

897,306

Expenses:

Click to enlarge

The $142 MM from Sanofi is largely up-front payments to assist REGN in its R&D efforts. Product sales were not much over $500 MM.

As management's presentation in the conference call shows, payments from Bayer of $97 MM included $15 MM that was returned to Bayer for repayment of development expenses and another $15 MM was a milestone payment, which may be recurring. Regeneron's introductory remarks in the conference call are very helpful regarding the details of its cash flows and alliances with Bayer and Sanofi.

It is important to look at expenses now, to see how large the R&D effort is relative to its sales:

Expenses:

Research and development

294,501

187,463

581,880

367,762

Selling, general, and administrative

102,414

72,463

211,264

149,723

Cost of goods sold

29,945

27,283

57,418

55,304

Cost of collaboration manufacturing

16,434

12,330

32,533

13,364

443,294

299,539

883,095

586,153

Income from operations

222,406

158,103

408,345

311,153

Click to enlarge

R&D is large relative to the company's share of sales of its products (principally Eylea), and COGS is minor, which is great for investors. Thus the company desires, and receives, financial help from Sanofi (which gets repaid out of profits). Regeneron has guided to a revised $490 MM in unreimbursed R&D for all of 2014, a manageable amount that allows for substantial current profits.

Discussion of Regeneron's marketed products: These are:

1. Eylea: Its active ingredient is a recombinant protein called aflibercept, a VEGF (vascular endothelial growth factor) inhibitor. Eylea is injected into the back chamber of the eye to treat a variety of retinal conditions including macular degeneration. Its main competitors are Lucentis, a Genentech product, and (via off-label use) Avastin. Genentech is a wholly-owned subsidiary of Roche Holding AG (OTCQX:RHHBY), the Swiss giant. After the initial treatment period, Eylea has the advantage that it can be given less often than Lucentis (or its relative Avastin); Eylea has been gaining market share. Genentech has a sustained-duration version of Lucentis in its pipeline.

Introduced after Lucentis, Eylea offered discount pricing to help gain share. It may now deserve price increases toward parity with Lucentis, given that it has the same number of indications and a more convenient dosing schedule. (Lipitor followed the same curve, starting out as a budget statin but enjoying a long period as #1.)

Eylea recently received FDA approval to treat a new indication, edema (swelling) of the macula related to diabetes. This gives it the identical indications as Lucentis, and a fourth indication, for edema due to branch retinal vein occlusion, could be granted by October.

The state of the art in retinal problems is moving ahead rapidly, and Regeneron has an active R&D program to diversify/improve its product offerings. The company's ophthalmology franchise has competitive challenges, but is an important growth area.

2. Zaltrap is marketed by Sanofi as adjunctive treatment to a regimen called FOLFIRI in metastatic colorectal carcinoma. Other indications may be attained. Zaltrap is not yet profitable, and I have excluded it from specific analysis in estimating REGN's value.

3. Arcalyst is a small seller for rare conditions.

Financial modeling: I am going to look at Eylea and the ophthalmology field, and then the lead pipeline products, from the standpoint of stock market value rather than discounted cash flow. Over time, these two different valuation methods should coincide, but P/E's in biotech are different from those in most other fields, and REGN is a non-dividend-paying stock, so I prefer going straight to market values. Readers will understand that these are guesses; I hope they are well-informed guesses.

First is an analysis of Eylea as if it were two products, because it produces two different types of income streams.

Eylea #1 - foreign earnings: In Q2, growing Eylea sales internationally via Bayer HealthCare (and Santen in Japan) remitted a net $69 MM to REGN plus a potentially recurring $15 MM milestone bonus. I am not sure what happens beyond this year to the $15 MM milestone, so I will work off of about $280 MM in free cash (annualized) back to the company. This may be very conservative, because for now, REGN is paying Bayer back for its prior support at a rate of $15 MM per quarter, and as mentioned, the milestones may be recurring. Given that Eylea is just beginning to hit its stride internationally, 15X revenues strikes me as a reasonable valuation for this part of the business, or $4 B. (Given the above caveats, that may be low.)

Eylea #2 - domestic sales: Eylea should soon be annualizing at $2 B for U.S. sales, all of which accrue to REGN, which bears sales and marketing costs. Given its growth path, 8X revenues, or $16 B, may be a reasonable and conservative valuation.

Thus, Regeneron's Eylea franchise could be worth $20 B today.

Next is a discussion of the pipeline, with an extensive discussion of the product closest to commercialization.

Note that while REGN has a large number of proteins under development, some supported by Sanofi and others on its own, three late-stage drugs comprise the bulk of the stock's market value (in addition to its eye franchise).

After repaying SNY for its financial R&D support, the companies split U.S. profits equally, and SNY receives 55-65% of ex-U.S. profits based on a predetermined scale.

The three leading pipeline products are:

1. Alirocumab. This is a potential mega-blockbuster, however, analysts are apparently being cautious about it. It lowers LDL cholesterol additively to statins or without statins. From the press release:

Alirocumab, the Company's antibody targeting PCSK9 (proprotein convertase subtilisin/kexin type 9) to lower LDL-cholesterol (LDL-C), is currently being evaluated in the global Phase 3 ODYSSEY program. In July 2014, the Company and Sanofi reported positive, top-line results from nine Phase 3 ODYSSEY studies. All nine studies (ODYSSEY LONG TERM, FH I, FH II, HIGH FH, COMBO I, COMBO II, OPTIONS I, OPTIONS II and ALTERNATIVE) met their primary efficacy endpoint of a greater percent reduction from baseline in LDL-C at week 24, compared to placebo or active comparator. Alirocumab was generally well tolerated in the nine ODYSSEY trials.

REGN and SNY have not said a lot more than this about their results, but - importantly - they have indicated that a positive cardiovascular outcome benefit has been seen in at least one of the above studies.

These are massive studies, involving ultimately about 23,500 patients. Amgen's (NASDAQ:AMGN) evolocumab is the main pipeline competitor to alirocumab, with FDA approval expected shortly after alirocumab's approval. Pfizer (NYSE:PFE) and other companies trailing behind in bringing a PCSK9 inhibitor to market.

Following high-profile R&D/outcomes trials disappointments for investigational HDL-raising therapy, niacin, and Zetia, Big Pharma may see a potential gold mine here. As Regeneron explains in the conference call:

It's estimated that there are over 60 million patients in the United States and the 5 major Western European countries who are not at their target LDL-C levels despite their current standard-of-care therapies. These numbers split out fairly evenly across the regions. About 35 million of these patients are considered at high risk of a cardiovascular event, and approximately 22 million are considered at very high risk.

These are very large numbers. Add Japan, Canada, Australia and other rich countries to this and you get many more patients for whom lowering LDL cholesterol is essentially a life and death matter, and whose physicians may advise them of precisely that. That sort of news can persuade a lot of people to inject one cc of medicine under their skin once or twice a month, and I anticipate that this class of drugs is going to be used widely.

Based on projections for Regeneron's and Amgen's drugs that I have seen, I think that Wall Street may not fully grasp that these companies intend to sell tens of billions of dollars of product yearly, just as statins have done. Volumes will be less than statins at maturity, but yearly revenues per product will be much higher. (Demonstration of outcomes benefit will be required to achieve full potential.)

Regeneron/Sanofi have announced that they have purchased a voucher for $67.5 MM that will advance the FDA (potential) approval of the BLA for alirocumab to six months rather than a standard ten month consideration period. They intend to file this Biologics License Application late this year.

June therefore could be the month this product will come to market. I am hopeful that as news comes out on alirocumab and evolocumab at conferences in the months ahead, the Street will begin upgrading its expectations. (Note I am long AMGN also.)

I am apparently way above consensus for what I think that alirocumab and its related products will sell, again assuming that they prevent cardiovascular morbidity/mortality. We can simply take the 22 million high-risk patients, add 3 million (or more) for Japan, Canada and Australia, and say that early on, 10% of these known coronary (or peripheral vascular) disease patients, or similar high risk patients such as diabetics, will go on treatment. Some of these will be intolerant to statins, others will be clearly above goal. This is 2.5 million patients. At a low (for the class of injectables) price to REGN/SNY of $10,000 per patient per year, these numbers imply a market of $25 B annually.

But that could/should just be for starters, based on medical benefits.

I expect a major push by multiple interested parties to get LDL cholesterol to and below 70 mg/dl in all high-risk patients.

I actually think that this product category could be the largest ever seen in dollar terms because of the cost of the product. Statins for secondary prevention are very cost-effective. I would think that cost-benefit analyses and health benefit analyses are going to start making their way to insurance company offices and physician's journals next year to support the launch of these "-cumab" products.

A possible weakness in the alirocumab development program is that it has been given every two weeks, whereas the Amgen drug was given half as often in its trials. Regeneron/Sanofi have run some studies of alirocumab also given half as often, with results pending next year. Since alirocumab and evolucumab are antibodies (a type of protein), I would assume without specific knowledge, that their duration of effective action in the body are similar, so that the less frequent dosing schedule for alirocumab will prove effective.

The above thought process allows me to estimate (guess) that REGN's share of alirocumab could have a current discounted value of at least $40 B.

Sarilumab: This antibody to the interleukin-6 receptor is in Phase 3 trials for treatment of rheumatoid arthritis. In June, data were presented from one Phase 3 trial showing very good safety and efficacy. RA is a large market. I cannot guess at peak sales for this product, but I expect them to be large. Whether sarilumab will be tested for other autoimmune diseases is unclear.

Sarilumab might receive FDA approval in 2016, and if not then, 2017 would be the target year.

There is intense existing and upcoming competition for the large RA market. I have to believe that the details of the data that REGN and SNY are looking at, combined with their market research, that this drug can be a blockbuster. Otherwise, SNY would not bother funding it. I think that it's therefore reasonable to estimate the present value of REGN's share of future profits as being $5 B.

Dupilumab: This antibody which is active against two interleukins is in Phase 2 studies for atopic dermatitis (allergic eczema), allergic (eosinophilic) asthma and nasal polyposis (allergic rhinitis). Data that I have seen for dermatitis and asthma have been strong. I have high expectations for this product, and speculate that it could receive its first approval in 2017.

These are quite common conditions and address large, underserved markets, as many sufferers of the above problems have moderate-to-severe cases.

As was mentioned above, dupilumab received an award for clinical advance of the year last year. Great things may therefore come to pass for REGN from this molecule.

REGN/SNY are in phase 2 on dupilumab, and are behind some competitors in getting to market. Again, Sanofi is not going forward with this product for these three different indications to lose money. It expects a success with this molecule. My guess is that REGN's future share of these profits is worth at least $5 B, with a 2017 launch as my target for at least one of these indications. Given its recognition as a major clinical advance, this estimate could be far too low, however, and I believe also adds upside optionality to REGN stock.

Other products and intangibles: There is an extensive additional pipeline, all early stage. While a value cannot be put on any one product, the efficacy of Regeneron's drug development efforts to date suggest that its specific pipeline products, and its general abilities to discover drug candidates, are very valuable. More relevant to a sum-of-the-parts valuation of REGN is what the residual pipeline and all the other assets of the company would be worth to an acquirer if the rights to all the marketed products and the three pipeline drugs listed above, were sold.

This would leave the patents, the personnel, the facilities, the earlier-stage pipeline, the ophthalmology sales force, the regulatory know-how, etc. I would guesstimate that at $10 B.

Adding all the above numbers gives $80 B. This is obviously a wild guess, but I believe there is both upside optionality and downside risk to it, which may be balanced.

To think of REGN's valuation another way, perhaps one can take the marketed and pipeline products (and intangibles) without alirocumab, and make the case that REGN is close to fair value, and that adding alirocumab back in provides a wild card with the potential to add great value to the stock.

Technicals: I am positive on the chart. A multi-month consolidation may be ending, within a very strong structural uptrend:

Click to enlarge

Splits: none

About 4 million shares had been sold short (8% of the total outstanding) as of July 15.

Risks: REGN has little current sales and profits relative to its market value. There are large risks to the stock price simply from a bear market, either of the general market or in biotechs. Commercial disappointment from any or all of its pipeline products is a real possibility, and obviously none of these products is even guaranteed to receive regulatory approval. In addition, the existing Eylea franchise is likely to need refreshing as time goes by.

Thus there are both fundamental and stock market risks to REGN that are quite significant.

Concluding comments and summary: Sometimes Mr. Market gets it right. My sense is that REGN stock has soared the past few years for a good reason, not because it and biotech are in a bubble, but because it is a leader in improving human health in important and diverse ways that have great commercial benefits for the owners of this company.

REGN has enough upside potential and may have enough margin of safety to be, in my view, an attractive stock at its current price around $340 per share.

To summarize, REGN has several well-defined growth drivers that address large markets that are either stable or growing. Management and the board are superior. The company has productive alliances with two European giants, a successful niche sales force, and it has achieved profitability while advancing a diversified pipeline. Various risks exist. Growth-oriented investors may in my view wish to consider a commitment to REGN with the hope that large capital gains could accrue to patient holders who can accept potentially large volatility in the stock price and all the uncertainties of R&D-based product development.

Disclosure: The author is long REGN, AMGN. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Not investment advice. I am not an investment adviser. Facts and opinions presented represent my state of knowledge and thinking at the current time. Analyzing REGN is a complicated matter. Prospective or actual investors in REGN may wish to perform their own independent research.