What's Up With Gilead

| About: Gilead Sciences, (GILD)

Summary

Gilead has had more negative news than the jury verdict in the Merck lawsuit.

Pipeline results are coming in disappointing on more than one front.

The stock's low P/E may well mitigate some or all of the pain.

This article comments on several aspects of the recent newsflow; a patient approach to the shares is reiterated.

Introduction

Gilead Sciences (NASDAQ:GILD) has had a bit of a tough time lately. Strangely, the investment world being a bit messed-up these days, this could end up with the stock trading higher for a period of time, though ultimately bad news really is bad news. This article addresses both the potential short-term effects and the more important longer-term perspective.

The first bit of news relates to GILD's pipeline.

Gilead's oncology program flounders

This actually knocked the stock last year. As I reported on December 31, GILD's marketed drug for salvage treatment of CLL and lymphoma, Zydelig, was reported to have performed poorly when used as first-line therapy for CLL. Since there was no obvious reason why the unexpectedly high incidence of side effects on naive patients would be limited to CLL and not also lymphoma patients, prospects for Zydelig dimmed a lot. I also reported that evidence was emerging that GILD's innovative (means, risky) strategy to combine two oral anti-lymphoma drugs in a repeat of its HIV and HCV strategies was also looking weak.

This view of GILD's oncology strategy has been echoed by various GILD speakers. They have been open in various comments this year that GILD's oncology strategy is not "there" yet.

The strategy is looking worse than just Zydelig's problems, disappointing though they are.

Last year, a next-generation drug entered Phase 1 with the same molecular mechanism as Zydelig. After several months, it disappeared from the Pipeline list without comment.

At this point, GILD has three drugs in Phase 3 in oncology, so it remains a major focus. One of them is Zydelig (idelalisib), which completes the company's commitment to the FDA in approving it out of Phase 2 for salvage treatment of CLL.

Momelotinib is one of the other two drugs in Phase 3, for two different types of indications. It is being tested primarily in a rare disease, myelofibrosis. The leading treatment for this is Jakafi from Incyte (NASDAQ:INCY). Jakafi has certain limitations, so even though momelotinib has significant neurotoxicity, success here following a somewhat promising phase 2 program should yield some profits.

The other Phase 3 program for momelotinib is in metastatic pancreatic cancer (one active Phase 3 study only). This should have some publicly-released data in about 2 years. I do not think we have enough information to give this program much if any value. GILD likes the drug enough, though, to be studying it for lung cancer as well. So maybe there's something here, but right now, momelotinib looks like a sidelight given GILD's mammoth profit stream.

The other Phase 3 program involves the monoclonal antibody GS-5745. This is in Phase 3 for gastric cancer, having been jumped from Phase 1 to Phase 3 based on allegedly exciting results in some preliminary study (which I cannot find on Clinicaltrials.gov).

This is a study for first-line use. Whether this single study is adequate for FDA marketing approval, even provisional approval, is unclear, but I would expect that it could be if results are strong enough.

Mostly, GS-5745 is under study for autoimmune conditions, but if it's successful in gastric cancer, my guess is that GILD will look at other cancers to see if that success could be replicated elsewhere.

Oncology was going to be GILD's 'third leg of the stool' after its hepatitis and HIV franchises. A great deal of effort has been made in assembling its assets, and now the results look mediocre at best.

There's another pipeline disappointment that may not have received adequate attention.

Simtuzumab fails again, and it may be an important failure

Several years ago, GILD brought in-house a humanized antibody now called simtuzumab. This blocks collagen fiber formation and thus is hoped to be a therapeutic anti-fibrotic agent.

When I began owning, trading and writing about GILD about 2 years ago, simtuzumab was hardly in the headlines. Quickly, it was reported to have failed in one cancer study and in the disease that involves fibrosis in the bone marrow, myelofibrosis.

Now we have an unfortunate termination of study in what is viewed as a primary fibrosing disease, primary pulmonary fibrosis:

Jan. 5, 2016-- Gilead Sciences, Inc. today announced that the company is stopping its Phase 2 clinical study of the investigational monoclonal antibody simtuzumab among patients with idiopathic pulmonary fibrosis (IPF). This decision follows an analysis of unblinded efficacy and safety data by the study's Data Monitoring Committee (DMC), which recommended that the study be terminated early due to lack of efficacy. Gilead has also reviewed the data and determined the study has not shown evidence of a treatment benefit in the group of patients randomized to receive simtuzumab.

Separately, Phase 2 studies of simtuzumab are ongoing in patients with non-alcoholic steatohepatitis (NASH) and primary sclerosing cholangitis (PSC). The DMC for these studies also met and recommended the continuation of the studies, which have a 96-week endpoint.

So there's hope for this antibody in NASH and PSC. And no safety signals were apparently seen so far. However, for the results in IPF to have been so bad that continuation of the study was futile cannot be a good sign that this antibody will help any patient in any disease.

Thus I cannot assign any value to simtuzumab for any indication. Right now it's a (modest) cost center only.

Putting the oncology programs' problems together with a series of failures with simtuzumab, which includes but now goes beyond oncology, we have a challenge to the strength of GILD's non-antiviral R&D program.

Then we have the well-publicized problem with patent infringement of another acquired drug, Sovaldi (sofosbuvir).

How should we think about the sofosbuvir patent suit that Gilead just lost in court - overview?

I am not an attorney and have not consulted one. Nothing herein constitutes a legal opinion or legal advice. These are just my thoughts at this point as an investor; though I have some familiarity with the patent process as an inventor in the pharmaceutical field.

The most obvious question is what it's going to cost GILD, and when the expenses will be borne. As the San Jose Mercury News explains, the winning issue involved these points:

Merck's (NYSE:MRK) lawyer sought to convince the jury that a Pharmasset scientist who worked on creating sofosbuvir cheated by relying on an invention that Kenilworth, New Jersey-based Merck patented in 2002.

"Gilead blatantly used Merck's own patent to make billions of dollars," attorney Bruce Genderson said in his closing argument. "That's good. We are glad they've helped get this drug to the market. But Merck should be credited for their role in the invention."

There was real economic harm to MRK from the infringement, as the article documents:

Merck's own liver disease treatments Victrelis and PegIntron last year generated $200 million in global sales, tumbling almost 63 percent in a year. The company said the fall was a contributor to Merck's 6.5 percent drop in sales in 2015. In 2012, the year before sofosbuvir hit the market, Merck's two hepatitis C drugs combined to generate about $1.2 billion in sales, according to data compiled by Bloomberg.

Most readers will be acquainted with a number of the details here.

The two patents that GILD infringed were USPTO #'s 7,105,499 and 8,481,712. The latter of the two, which is newer as shown by its higher patent number, was filed in Feb. 2007 and was granted in July 2013. Assuming that it's eligible for 20 years of patent protection from that Feb. 2007 filing date, MRK and its patent partner Ionis Pharmaceuticals (NASDAQ:IONS) (formerly Isis) have rights to that intellectual property until Feb. 2027.

However, Citi says the two patents are good until 2023 and 2030, respectively - and it should know. 2030 is beyond the expiration of GILD's sofosbuvir patent life and certainly beyond the great majority of its useful commercial life.

If MRK can be awarded after appeals its full demand for a 10% royalty on sales in the US, and if that applies to all revenues even of combos in which sofosbuvir is just one of two or three active ingredients, then we might be looking at a cumulative $100 billion in revenues subject to royalty, or a $10 billion pre-tax hit to GILD.

That might shrink to (say) $7 billion after taxes or $5/share.

Arguably something like that is already in the stock now, or something close to it. Plus, GILD has rights of appeal and the ability to at least attempt to settle the case on less costly terms.

Does this judgment have any or much bearing on the remaining suits, with MRK in several venues from the old Idenix suits or with AbbVie (NYSE:ABBV) in the US? I'd welcome any expert opinions. As of now, it's not clear that there is any relationship between infringing MRK/IONS patents and the cases and defenses that have been laid out in the controversies with Idenix and ABBV.

See pages 90-92 of GILD's latest 10-K for its presentation of its pending HCV patent cases.

So in this analysis, it's not "too bad." However...

Could MRK make things even worse for GILD?

I think this is a possibility. Any patentee who can prove infringement is entitled at the least to reasonable royalties. This is a vague term that tends to come down to industry standard royalties. (Every case is different, though, and the facts in this case are unique.)

Industry standard reasonable royalties might be 5-7% of sales (maybe less), given the importance of the MRK/IONS invention (active metabolite of sofosbuvir as I understand it) considered with the nearly 100% profit margins of Sovaldi, Harvoni, etc.

However, before this year, MRK had Victrelis generating substantial sales that largely disappeared when Sovaldi and then Harvoni came to market. So reasonable royalties are not enough.

The more important issue involves MRK bringing Zepatier to market this year. This combination product for hepatitis C, genotypes 1 and 4, is going to suffer greatly due to GILD's marketing of Sovaldi plus Harvoni and then presumably the early summer launch of SOF/VEL (sofosbuvir plus velpatasvir).

Will MRK argue that were it not for the infringing Harvoni, MRK and ABBV would be splitting very large sales for Types 1 and 4 patients in the US? If so, will it argue that GILD either needs to stop selling Harvoni for those genotypes, restrict its sale to patients who have failed Zepatier or Viekira or else continue to market Harvoni but pay MRK its estimated lost profits due to Harvoni's presence in the marketplace?

As far as sales of Sovaldi for Types 2 and 3 and the upcoming sale of SOF/VEL for those genotypes, reasonable royalties or lost profits from sales of Victrelis and interferon could be justified, whichever is greater or as applicable law calls for.

Will this verdict affect GILD ex-US?

I have been holding IONS through thick and thin. One reason is that it has been disclosing that it has been a potential beneficiary of this lawsuit between MRK and GILD. This has provided a natural hedge in that IONS was going to benefit from GILD payments to MRK. We now know from IONS that 20% the revenues, if any, to MRK from GILD will go to IONS (minus any unreimbursed MRK legal expenses). So since I have liked both GILD and IONS, roughly this has been hedged from a US standpoint.

However, if the finding that GILD has infringed MRK's patents affects GILD's patent position in China or elsewhere, then GILD can be adversely affected with no offsetting benefit to IONS. It's not clear why that should occur, as Pharmasset invented sofosbuvir, which is the chemical that allows oral administration of the active metabolite that my understanding is MRK/IONS invented. So there would appear to be a real inventive step that GILD, as successor to Pharmasset, deserves protection for.

This issue may be something to watch and obtain informed opinions on.

So, what's GILD worth at this time?

Unfortunately, there's no easy answer now. When a patent is granted by the USPTO, it has a presumption of validity from day one. When a court of law upholds that patent, then unless an outside investor has what might amount to legally-obtained "inside information" about the errors that an appeals court would point to in reversing the verdict, my experience is to assume that the case has been decided and invest accordingly. When I was a consultant to the CEO of a public company in a high-profile patent case, and our side lost in court, the CEO felt that the appeal was mostly just going through the motions - even though he really and truly believed that the decision made at trial was incorrect. So I have to assume that GILD is going to pay out significant monies to MRK and that it will start booking those on the P&L.

These charges will add to the decrement in income from Japan from the pending 31% price cuts for Sovaldi and Harvoni there. This is on top of a little weakness in scripts for these drugs here in the US as tracked by IMS. Thus I can say goodbye to my prior projection for 2016 EPS, made late last year.

Now I cannot predict EPS for 2016 and, more important for investors, I neither have a good sense for the EPS trend in 2 and 5 years; nor beyond.

With repeated pipeline disappointments and now frank disarray in the oncology division, GILD has a lot of reasons for investors to stay on the sidelines.

The best thing it has going now is a P/E that is 1/3 or less of that of the market (NYSEARCA:SPY). That's meaningful, but since I think that the market P/E is dangerously high, it does not tell me that GILD is cheap.

Thus there is no obvious "fair value" right now for GILD.

What about acquisitions?

Everyone's talking about this. Why not acquire IONS? That's almost a whole article in and of itself. I have suggested that GILD acquire its Bay area neighbor Portola (NASDAQ:PTLA). But maybe that would not move the needle enough. Or maybe GILD knows more about PTLA than I do and is avoiding the company for reasons I wish I knew about.

Among the arguments against a major product or company acquisition right now is that while junior biotechs (NYSEARCA:XBI) are off their highs, as a group they are not near bear market low valuations, and GILD historically has either been a value buyer of early-stage products or technologies or has paid up for a prime asset such as sofosbuvir.

Perhaps GILD will want to wait for a large cap stock such as Biogen (NASDAQ:BIIB) to possibly get a lot cheaper.

In addition to the above thoughts, my private guess is that GILD is actually not quite certain where it wants to go in its acquisition strategy. Double down on oncology? Does it really know how strong or weak its many oncology assets are to make that call? Or, perhaps there are more inflammation/immunology technological advances it wants to be part of.

Sometimes corporate wisdom comes from being patient, seeing how internal R&D is progressing, and then acting.

When GILD makes an important business development deal, I expect that Wall Street will cheer and send the stock up.

Concluding thoughts

Over time, low P/E, high free cash flow stocks in non-commodity fields such as healthcare have a lot of intrinsic attractiveness for buy-and-hold investors. I expect that when this year's dust settles, that will look like the case for future investors some years from now looking back at GILD today - perhaps similar to how we look at GILD on a 10-year time frame now despite its several years in which the stock went sideways.

I'm optimistic about its growing TAF-based line for HIV/AIDS. I'm also optimistic about the potential of SOF/VEL in China and many other countries, as well as to replace Sovaldi everywhere for Types 2-3 HCV.

As far as the pipeline goes, there are a lot of irons in the fire. Maybe the antibody GS-5745 will be the matrix metalloproteinase inhibitor (a graveyard of drug development historically) that breaks through and turns into a foundational blockbuster. Maybe the NASH pipeline drugs will come to the fore, and become leaders in this new, untapped and large market sector. Maybe biotech stocks will act like the techs from 2000 into 2002 and allow GILD, with its immense FCF, a choice of many depressed stocks from which to choose.

Or maybe things will not go so well, pricing pressures hit the HCV line and to some degree the HIV/AIDS products and perhaps the MRK suit will hurt more than GILD shareholders expect.

Thus, wearing the stock analyst hat I wear as a writer, I think that GILD's historically very low P/E should cover a multitude of bad news. But what the future holds is somewhat murkier than it was before in view of the changing facts, several of which have gone against the company lately.

I remain overweight GILD as a percentage of my underweighted equity position.

Disclosure: I am/we are long GILD,IONS.

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.

Additional disclosure: Not investment advice. I am not an investment adviser.