Innoviva: On Track To Buy Back The Whole Company

| About: Innoviva, Inc. (INVA)

Summary

Innoviva posts its first profitable quarter ever.

Both Breo and Anoro are growing strongly and gaining share, with a clear path to ~25-30% within a few years.

This would produce annual cash inflows equaling half of Innoviva's market cap.

I have already reviewed the performance of GSK's (NYSE:GSK) new respiratory drugs in another article, so this one will focus on the issues specific to its development partner Innoviva (NASDAQ:INVA) (formerly called Theravance).

Innoviva ended 2015 with its first profitable quarter ever and posted EPS of 0.04. While this is less than the quarter's capital returns of about $0.32/share, it is perfectly in-line with management projections. And my own ones as well: Five quarters ago, I had forecasted royalty revenues of $50-70 million for 2015 and the final result was $67 million of gross revenues. (As Innoviva amortizes capitalized milestones paid to GSK during the development phase, revenues stated in the income statement are always a bit lower.)

Capital returns in the quarter were carried out through share repurchases. The company bought back at least 2.6 million shares in December 2015 and another ~1.3 million in January 2016, employing basically the same amount of cash that was once paid out as dividends and spreading its repurchases equally across the quarter. However, due to heavy option issuance, I expect the current diluted share count to be reduced by somewhat less than the total number of shares acquired, i.e. to ~113 million. Share repurchases will continue even during Q1 and probably for the entire year, which should reduce diluted shares outstanding by ~13%. This will obviously be possible only if Innoviva manages to purchase all these shares at the current market price. And if this lasted for three more years, GSK, Baupost and myself would probably own the entire company.

Cash and receivable royalties totaled $214 million at year end and I expect gross royalties from GSK to reach $150-180 million in 2016. Cash expenses should come in below $20 million, leaving ample flexibility for capital returns. In fact, during yesterday's conference call, analysts started to enquire about potential acquisitions, given the surprisingly (for them, not for me) good growth trajectory and the currently depressed valuations in the biotech space. However, while Innoviva has frequently stated to be looking for additional assets to acquire, from managements' answers I deduct that they don't see M&A as their first priority.

While there is some uncertainty regarding the possible launch of generic Advair in 2017 or 2018, management doesn't see any unexpected aspects to this story. The declared strategy is obviously to acquire as much market share as possible for Breo before Advair's genericization.

A reasonable expectation would be for Breo to reach 25-30% share within ~2 years, as already now its NBRx (new-to-brand scripts) share among U.S. pulmonologists is 24.4%. Usually this converts into TRx share within 1-2 years. In fact, in Q3/14 Breo's NBRx share among pulmonologists was 11.5%, which has now converted into an NRx share of 12.4% among general prescribers and a TRx share of 7%. Furthermore, during the first quarters after the launch Breo was still not indicated for asthma and Innoviva considers the drug to be even now still in the early asthma launch phase. So we should expect Breo to continue gaining share for many quarters.

As revenue growth for both drugs, Anoro and Breo, exceeded script growth during the quarter, there was evidently less couponing and better coverage in place. In this respect, however, the company expects some volatility from quarter to quarter, as launches in several countries are still ongoing and initial stocking, samples and couponing will certainly blur the picture for some more time.

All in all, if Breo really managed to reach the prospected market share of 25-30%, this would translate into gross royalty income of ~$100 million per quarter or annual net cash inflows of ~380 million from Breo alone. Three years of this would be sufficient to buy back the whole company at the current market price.

Considering that even Anoro is now growing strongly and all major competitors have a keen interest in expanding the LAMA market (Novartis (NYSE:NVS) because it has only one strong product which is a LAMA/LABA combo - and Boehringer Ingelheim needs to preserve its revenues in face of the looming genericization of Spiriva), even Innoviva's other product should deliver nice results going forward. In Q4/15, Anoro grew 42% in the U.S. QoQ and 48% in the rest of the world. It already has 25-30% NBRx market share.

So I still consider the company to be heavily undervalued and hope it will repurchase shares even more aggressively than it has done until today.

Disclosure: I am/we are long INVA.

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.