Regeneron Generates Negative Alpha: Buy, Sell Or Hold?

Summary

REGN, my stock of the year for this year, has been very weak.

Some of the reasons, such as the commercial failure of Praluent, are self-inflicted.

Other reasons may represent more fear than is justified by publicly known facts.

This article discusses current thinking and some newer insights on the company provided by its senior executive leadership.

Longer-term I remain bullish and may add some shares; shorter-term there may be few catalysts for upside action, though.

Background - from hero to goat

They loved it at $400 going to $500 on its way to $600, then they started disliking it at $500 on its way to $400. Now that it's $354, are the traders recoiling in horror as they push Regeneron (NASDAQ:REGN) to $300 and thence even lower, to multi-year lows?

I can't answer that, but herein I review REGN and conclude it is a proven company, with proven core technologies, that has numerous ways to justify a much higher share price. Thus I remain bullish over the long haul. This bullish view was reinforced by a lengthy "deep dive" interview that REGN's CSO Dr. Yancopoulos gave a few weeks ago at a Leerink conference. The questioner, Geoffrey Porges, a medical doctor, was quite good. This in turn elicited thoughtful, informative answers from Dr. Yancopoulos. This interview, comments from the CEO Dr. Schleifer at the annual meeting, as well as the stock's sharp drop motivate this article.

What makes REGN special

The company maintains a History web page which is a good starting point in understanding it. Among the key takeaways that a careful reading of this history shows are the very long timelines involved. First, the company had to develop its gene cloning and general protein manufacturing capabilities. Then it had to have the insights to develop its current technologies, namely its "trap" technology that is used in its first three marketed products, including its mega-blockbuster Eylea.

After that, it had to make decisions about what the best molecular targets were, settle on it or them, then allocate limited resources to picking a small number of molecules to take into the clinic.

Some specific examples show the immense difficulties that this company has faced.

One example involves its sarilumab product, which has a pending BLA for rheumatoid arthritis. This was the company's first fully-human antibody, created using its VelociSuite technologies. It entered the clinic in 2006, which means that the pre-clinical work was going on for some years before then. Its targets were in the field of inflammatory disease. Only recently has it completed Phase 3 successfully, with rheumatoid arthritis emerging as the major indication. Despite showing some advantages in one of its Phase 3 studies versus the industry leader in RA, Humira, as well as some advantages over the RA antibody from Genentech (Actemra) that works by the same mechanism, expectations for sarilumab restrained by the heavy competition in the RA market. So, here's an innovative and top-notch product that basically won't begin bringing in noticeable revenues until 2017, maybe as much as 15 years in the making. Given investments in launch activities, the product will not turn profitable until much later. And at some point it will get old, then fall prey to biosimilars. The ROIC it will generate will not be so hot; that seems very likely.

And this is a very good, successful molecule.

In other words, this is a tough business, given that most molecules never come close to making it to market.

That's the good news, bad news part of this topic.

The more favorable analysis is that like Apple (NASDAQ:AAPL), REGN has shown the ability to emerge from the pack with more than one first-in-class/best-in-class drug. This includes Eylea (best-in-class; one of the most successful biotech drugs ever) and dupilumab (first-in-class). Part of my bullish thesis is that acceptable risk-reward exists in thinking of REGN as a hit-driven expanding ecosystem. My bullish thesis is that as with AAPL on its long way up after Steve Jobs began Act II with the company, the stock always looks expensive, and setbacks do occur, but that the platform technology, untapped need for better products, and quality of the company's leadership end up making the stock an outperformer.

There's a different analogy regarding REGN's valuation: Amazon.com (NASDAQ:AMZN). AMZN has a market cap nearly 10X that of REGN despite still largely being a "show me" story regarding profits. The AMZN bulls say that it just keeps reinvesting its operating profits into growth opportunities. This is really my thesis for REGN, namely that its ambition is to be there for decades to come, and that short-term profits are unimportant now.

Unlike a junior biotech with a platform technology such as Ionis (NASDAQ:IONS), Alnylam (NASDAQ:ALNY) or Acceleron (NASDAQ:XLRN) with no revenues from product sales (and therefore commercially unproven technology), REGN now has 4 marketed products generating sales, with 2 seemingly nearly certain to gain FDA approval within about the next 12 months. So it has proven a lot, and what investors are looking for is sustained, rapid growth of profitable sales. If the company is worth investing in now, then I think it's so young that we should want almost all its free cash flowing going into growth.

With that extended and generally bullish introduction, a sense of balance leads me to begin this mid-year point-by-point review with the most negative aspect of the company I can find.

REGN gets Praluent very wrong

As recently as this June's annual meeting, REGN has been complaining about the treatment insurance companies have been giving its drug Praluent as well as Amgen's (NASDAQ:AMGN) similar drug Repatha. Dr. Schleifer commented to shareholders that the company and its marketing and financial partner Sanofi (NYSE:SNY) put in nearly $2 B into this product's development, yet insurers are being overly tight in approving the drug.

Sorry - I disagree with REGN on this one.

I think the better approach would have been to have done a "physician, heal thyself" sort of introspection. In this day and age, it's no secret that healthcare budgets stretch to treat actual diseases, not "merely" a risk factor for a disease; in this case, high cholesterol with REGN's and AMGN's brand new approach to the condition.

The asking price of $14,000+ for both Praluent and Repatha in the US fit no cost-benefit model I can find or think of. So of course the insurers are going to restrict access.

Pfizer (NYSE:PFE), which is in Phase 3 with its own PCSK9 inhibitor, has made the (self-serving) comment that it was a mistake for AMGN and REGN/SNY to have come to market with a PCSK9i without proof that CV outcomes have been favorably affected.

I would think there's a middle ground. The companies should have come to market but been extremely sensitive to the views of the insurers until positive outcomes were proven. I think the optimal strategy may have been to get doctors and patients using an injectable therapy to modify a risk factor; to learn about the safety of the drug; to hone the general marketing techniques; and simultaneously engage in cost-benefit pricing discussions with the insurers based on certain scenarios of outcomes studies. Then, when the results were in and the FDA was reviewing the supplemental applications to expand the label, the companies would be in tip-top shape to grow the market cooperatively with the insurers. This approach would have also prominently involved the cardiology societies as well as public health authorities and Medicare/Medicaid officials faced with paying for these drugs.

None of this was done.

In his talk at the annual meeting, Dr. Schleifer took pride in saying that since Eylea came to market in November 2011, REGN has taken no price increase on it.

Wouldst he had been as sensitive about pricing concerns on Praluent.

REGN comments on the RNA-based PCSK9i drug

One of the many ways that investors sometimes do not hop on a moving freight train is their reasonable fear that a better product is coming on down the tracks. This can be exactly the correct attitude, as it was for Vertex (NASDAQ:VRTX) investors regarding its blockbuster drug for hepatitis C. This drug's moment in the sun was all too brief, blown away first by Gilead (NASDAQ:GILD) and then by AbbVie (NYSE:ABBV).

For the antibody-based PCSK9is of all the above-named companies, the worry has been the RNA-based inhibitor from Alnylam, now in Phase 2. The Medicines Company (NASDAQ:MDCO) has licensed this product from ALNY and has the substantial economic interest in it.

Dr. Yancopoulos was asked about the threat from this ALNY/MDCO drug and others like it. He was relatively dismissive, though not completely so. His argument was that the safety issues with RNA-based drugs were significant, and that they should be used where antibodies could not. His point is that antibodies have been proven to be so safe that they should be favored. Implicitly he appeared to be saying that fewer injections, as ALNY has been promoting as a benefit of its drug, are not very important to the FDA or prescribers.

He did not address the question of whether a positive outcomes study for Praluent would be appropriately applied to an RNA-based drug that also lowers PCSK9 activity.

Overall, my view remains that with positive outcomes data in hand one of these years, which multiple threads of evidence suggest is likely, the PCSK9 class should be a commercially important one - but I still don't see a $14,000 per year list price. I would like to see the companies being realistic on pricing: treating a risk factor for a disease is a different matter than treating a condition from which a person is suffering pain or other problems in the here and now.

What's up with the AMGN lawsuit?

REGN continues to insist that the jury verdict from earlier this year was legally incorrect and that its Praluent did not infringe any valid AMGN patent claim.

As I imperfectly understand the argument, REGN/SNY assert that AMGN's patents were overly broad and should not cover the REGN molecule, alirocumab. Whether this argument can succeed on appeal is over my head.

The immediate issue is that the judge has now heard the opposing sides present their arguments about AMGN's request that Praluent be banned from sale in the US. Chardan reported on AMGN's arguments, picked up by Barron's blog. Again, I mention this just to report on it, but not to express a particular view.

There are ex-US Praluent sales, though.

So far, I'm unaware of any legal action by AMGN against Praluent ex-US. Assuming that holds true, then a worst-case scenario would be that Praluent gets marketed internationally, presumably by SNY and not REGN. I'm not 100% certain of the details, but I think that in that situation, SNY would owe royalties to REGN only after it recoups the funds forwarded for the product's development. This ex-US opportunity could, over time, still be a meaningful profit driver for REGN. And if it occurs, REGN would have a significant short term cost savings on its sales force.

I'd like to have more insights here, but I've just been letting Mr. Market weigh in here without having an opinion of my own on how this legal action will come out.

The risks of poor product launches and patent issues provide plenty of reason to view REGN as a risky stock. Praluent may not be the only disappointment.

At best, I expect no dividends to be paid for years to come, and I'd doubt there will be any significant share buybacks either for a number of years. Thus I look at the stock as a true growth vehicle. But it's biotech, thus risky.

Moving on...

REGN explains its views on Eylea combinations

Much has been made this year of threats to Eylea. One such involves changes in compensation to eye doctors injecting Avastin, Lucentis or Eylea. Another one that reared its head late last week was addressed in some detail by Dr. Yancopoulos. Here is Barron's blog on the concern:

More Fovista Risk For Regeneron Than Investors Realize: Canaccord

...We believe investors are underestimating the risk of positive Phase 3 data for Ophthotech's (NASDAQ:OPHT) Fovista by YE16, which could meaningfully pressure EYLEA revenues if positive. We recognize that suspicion remains regarding lower-than-expected control arm performance in the Fovista Phase 2. Nonetheless, we caution investors ahead of the Phase 3 data.

Fovista is an aptamer (nucleic acid chain) that inhibits the action of the platelet-derived growth factor. If approved, it will need to be injected separately from the VEGF inhibitor, meaning an unappealing two-injection visit to the eye doctor. It's being studied with Eylea, but Lucentis is receiving more attention than Eylea in Phase 3. OPHT has partnered with Novartis (NYSE:NVS) and Roche (OTCQX:RHHBY) on Fovista; Roche is the sole owner of Genentech, which markets Avastin and Lucentis.

REGN has a combination of Eylea plus an antibody to the PDGF receptor in Phase 2; the name REGN has given this combo is REGN2176-3. Dr. Yancopoulos expressed a surprising amount of skepticism about this combination and by implication about Fovista. I had thought that we were going to hear Phase 2 data on this combination, but it appears that this is going to be a year-end report on the top line. More details, which Dr. Yancopoulos indicated might be more relevant than top-line data, are expected to be released next year. Whether this apparent delay in receiving results is a bad sign has crossed my mind, but I can't say for sure.

Dr. Yancopoulos emphasized that after very careful study of the topic, REGN is hopeful about the PDGFR inhibition plus Eylea, but that's all (not optimistic). He went on to say that REGN's other Phase 2 combo involving Eylea plus an antibody to Ang2 was more promising theoretically.

Both Eylea combos are now partnered with Bayer (OTCPK:BAYRY), the lead marketer for Eylea ex-US.

My operational thinking on this important subject is to trust the team that challenged Genentech with a superior product, Eylea, and simply see what unfolds. This is another situation where I do not think I can "beat" Mr. Market.

Dupilumab may begin, or even represent, a broader franchise in allergy

The company is quite proud of this molecule. In atopic dermatitis (eczema), it proved just as efficacious in Phase 3 as it looked in Phase 2, a sometimes onerous accomplishment. Dr. Schleifer estimated there are 1.6 million adult Americans with moderate-to-severe AD. I'd like to see further estimates of the realistic addressable market, but clearly the worldwide market in developed countries is large. For safety reasons, the company began clinicals with adults; but AD is common in children, and the worst cases may be candidates for biologic therapy. A pediatric approval should follow one of these years.

The asthma program for dupi has completed one registrational Phase 2/3 study, with two more underway. I am targeting about a Q2 2017 US intro for dupilumab for AD and a H1 2019 intro for asthma. Assuming that the earlier results that dupi treats all forms of asthma, including the "low eo" forms, I expect it fairly quickly to be the dominant antibody for asthma in almost every major market it enters.

More broadly, in addition to the two other Phase 2 programs for dupi that are known, Dr. Yancopoulos alluded to the possibility of additional indications in allergy for this drug. This could be very interesting medically and commercially. Could dupi be another Humira, with multiple indications, and just grow and then grow some more?

Beyond that, a surprising amount of discussion occurred about REGN1908-1909, an antibody to the main cat allergen, Fel d1 (written variously as Feld1, Fel d 1, etc.). The company believes this could be a simpler way to deal with cat allergies than a prolonged desensitization campaign. What the specific follow-up plans are for this drug, which is unpartnered with SNY at this point, are not known outside of REGN. I'd expect some news on it sooner rather than later, perhaps with Q2 results.

It's important to remember that dupi is a SNY-sponsored program. I expect SNY to earn more than half the global profits, if any, from this drug. My base case is that with limited competition from this first-in-class molecule, similar upside to expectations as occurred with Eylea could occur with dupi. I believe that Street expectations have been trending up for dupi, and I think that its commercial prospects are bright for years to come.

The company explains the case for its RSV preventive drug

One of REGN's more obscure Phase 3 projects is REGN2222. This is another antibody that is not partnered with SNY, though SNY would get royalties on it as with the cat allergy antibody and the PDGFR and Ang2 antibodies.

I've had little to say about this in prior REGN articles because it was unclear to me why the company was challenging the incumbent antibody, Synagis.

Dr. Yancopoulos answered this question. The main proposed advantage of 2222 is longer duration of protection, as seen in the protocol for the study that is now underway. REGN is testing one dose protection versus two doses for preemies at risk for RSV infection. Potential completion date may be spring 2017; but, I'll wait for the company to confirm that it's on track before counting on that date. If the study is successful and 2222 has a labeled advantage over Synagis, I wonder if it will take over most of its market share and perhaps enlarge the market, as well.

So this just might be a nice billion dollar annual sales drug that REGN controls all of aside from what I think would be smallish royalties to SNY.

One never knows what analysts are thinking, but I wonder if they have been paying attention to the chance of success here.

Immuno-oncology a big question mark

Last year, SNY and REGN announced that SNY would be kicking in a substantial sum of money to help fund REGN's new immuno-oncology program. Dr. Porges had a cogent question about this. He pointed out that to date, REGN has gone straight after first-/best-in-class drugs. Here, it is challenging Big Pharma in areas it knows best and where it has a significant head start. These include Merck (NYSE:MRK) with Keytruda and BMS (NYSE:BMY) with Opdivo. These and other companies have broad programs in IO. How, Dr. Porges asked, can REGN and SNY succeed against this competition as latecomers?

The answer: the field is young, so certain diseases responsive to PD1s have not been studied yet. REGN has disclosed in its Q1 10-Q that a potentially pivotal Phase 2 study of REGN2810 was initiated in advanced cutaneous squamous cell carcinoma. Presumably REGN and SNY have identified what they think are other under-investigated diseases.

Another point in his answer was that clinical response rates to the PD1s have been running around 20%. Thus there is, at least in theory, lots of headroom to find new combinations of agents to work with PD1s to achieve higher response rates.

Right now I'm not thinking of IO as a profit center for REGN, but I think there's a lot of upside potential with limited downside for REGN shareholders.

Now I'd like to begin the wrap-up by asking what vision for the future beyond the specific products in the pipeline does REGN have. This is where AMZN shines and where AAPL and GILD are now being questioned.

Dr. Yancopoulos and Dr. Schleifer as well addressed this point, which I'd like to close the body of the article with, as I see it as important in providing investors with an expansive vision of REGN's future.

REGN, large-scale population genetic analysis, and CRISPR

REGN has begun sounding even more enthusiastic than before about the Regeneron Genetics Center. Thus I'm going to emphasize it more than previously.

The company in part describes RGC's goals as follows:

Our objective is to elucidate, on a large scale, genetic factors that cause or influence a range of human diseases. We believe that the knowledge we and our collaborators create can advance basic science around the world, provide clinically-valuable insights to physicians and patients, and identify novel targets for drug development.

Specific activities being scaled up will include gene sequencing projects, functional biology and mouse genetics for disease modeling, and translational research integrating genetics discovery research with the growing Regeneron pipeline. Program goals include target discovery, indication discovery, and patient-disease stratification through the use of human genetics and related genomic sciences.

A related REGN web page shows that it has several other collaborations that are researching genetic targets. Basically, this is cutting-edge stuff that has unknown but very large growth potential for decades to come.

There have now been 100,000 exomes analyzed via RGC's collaboration with the Pennsylvania-based Geisinger Health Systems. Dr. Yancopoulos reports that the company is ahead of schedule in developing actionable leads toward new products addressing orphan or relatively rare but non-orphan diseases. He sounded realistically optimistic here, and I do not think he was just pretending.

There is other, related progress:

In April, REGN and the now-public Intellia Therapeutics, Inc. (NASDAQ:NTLA) signed an agreement for the companies to cooperate on new drug technology development. REGN purchased shares of NTLA and gained rights to up to 10 targets using NTLA's CRISPR/Cas gene-editing technology.

Many specific deals such as this one will not work out. So far, there's been no obvious pay-off from the deal REGN made with Avalanche (AAVL).

In the next and near-final section, I'll try to put the REGN picture together as I interpret it.

The evolving picture REGN is painting

My view is that from a top-down perspective, REGN is a top-tier company that made the correct decision in the Y2K period. Then, the human genome project and related technologies were absorbing lots of energy from lots of pharma companies. REGN, with limited resources, decided (correctly!) that the time was not ripe to get into generalized genetic sequencing, and instead focused on the (successful) development of its VelociSuite technologies.

These have powered what looks like the FDA approval of one important antibody a year: Praluent in 2015, sarilumab this fall and dupilumab next year.

Beyond the pipeline as discussed above, though not comprehensively, the company has been moving in a measured but impressive pace into the gene sequencing story looking for product leads now that the technology to do so at reasonable expense and in large quantity is readily available.

All this has been unusually well thought-out and executed, with few major glitches.

So I see the company as well-positioned in one of the most dynamic growth areas of the US and global economy.

There are warts. The company's share of losses in Q1 in connection with commercialization of antibodies with SNY was $99 million. The majority of this would be from Praluent; some would be from preparations to launch sarilumab and dupilumab, though. The Praluent launch is especially embarrassing given that no company could have greater expertise in lipids on its board of directors than REGN. The board boasts two Nobelists in cholesterol research, and the chairman is Roy Vagelos, who was "Dr. Statin" at Merck, where he launched the first and third statin blockbusters, Mevacor and Zocor. So, this failure is sad and unexpected, and the whining from the very top of REGN about allegedly stingy insurers rubs me the wrong way.

Also a noticeable wart was the loss to AMGN in the PCSK9 litigation. It's certainly possible that the jury misapplied the law, but this is not REGN's first adverse legal patent decision or settlement.

There are not a lot of warts, though; none of us, and no company, is perfect.

REGN is profitable under GAAP even though it is spending heavily on all sorts of things, ranging from plant and equipment expansion in New York State and Ireland; pipeline expansion; and building out a sales force. The company is routinely ranked #1 or #2 by a trade journal as the best biotech and pharma employer globally. The inherent profitability of innovative, successful drugs means that for now, the non-finance background of Dr. Schleifer and Dr. Yancopoulos is a secondary issue. Some day, if the company reaches a stage of maturity with the success level I hope for, then it may be that the optimal CEO should not be an M.D., Ph.D. - but given the prolonged timelines in this industry, that level of maturity should be a long way off.

How, after all this, should REGN be valued?

I tend to think of price:sales for younger biotech companies. For that, I ignore the significant payments from SNY to REGN. I'm modeling about $4 B from product sales this year, which pretty much only includes US Eylea sales plus REGN's share of ex-US sales. For next year, I'm tentatively penciling in $5 B, which is almost exclusively comprised of Eylea sales and royalties from BAYRY. There could be upside (or downside) to that, as sarilumab, Praluent and dupilumab kick in. With its current market cap below $40 B, REGN has downside risk if we think about a share price at the 8X sales that I recall Genentech trading at in the 90s. However, my base projections for growth end up suggesting something like mid-teens share price growth looking out to the 2020 time frame, perhaps higher if either dupi or Praluent catches fire or if some other part of the business excites investors. In other words, I expect growth up and down the line given that all products are either just ramping (Praluent), are not launched yet, or are growing so fast that their peak sales date cannot be established yet (Eylea).

After 2017, the next 5 or so years could also show rapid, sustained sales growth. All the above products could be growing, with one or more Eylea combination products kicking in if the clinical trials are successful. Plus, one or more large new indications for Eylea could add materially to growth.

After that point, the names of the growth drivers may or may not fade. Dupilumab and the Eylea franchise may not be mature even by 2022; only time can tell that.

Moving away from the specific names of individual products or product lines, what attracts me to REGN for the long haul is that I can be hopeful that unlike GILD right now, REGN has an expanding, wholly-owned product discovery platform in an expanding field. So I would think and hope that it's reasonable to expect that if I'm more or less on target, the stock can trade as a growth stock 5 years from now as a much larger company.

With REGN having so many product launches and legal matters pending, along with the uncertainties of certain material Phase 2 and Phase 3 clinical trials, I wish I could delve even more deeply into price targets, sales growth levels, etc. But I think it's premature to do so. So while the chart is weak, anxieties are high about political harm being done to the biotech industry, and few catalysts are visible for the stock, I'm looking past the Praluent fiasco(s) for future product launches to look more like the Eylea launch. Of course, SNY was not involved in Eylea, and this is perhaps my least favorite Big Pharma company. If the sarilumab launch is no good, then the finger can be pointed at SNY. But not yet.

In conclusion, I trust that REGN along with SNY and AMGN have learned some humility given their joint mistakes launching their PCSK9is. Beyond that, I see REGN as a company that could grow sustainably and rapidly for many years and more than grow into its current valuation and overcome the inevitable bumps in the road and challenges all companies face.

As previously discussed at different times in 2015, I pared my holdings of all my favorite biotechs beginning in late 2014, but I have sold no REGN into this year's sell-offs and have begun to slightly scale deeper into the stock. I believe that REGN may end up treating patient investors as AAPL, AMZN and other big long-term winners have treated their loyal long-time investors, and that the risk-reward ratio here is tilted toward the 'reward' side of the equation.

Thanks for reading; I look forward to any comments you'd care to share.

Disclosure: I am/we are long REGN,GILD,AMGN,AAPL,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. Note that the list of stocks mentioned in this article is quite long, and I may trade in any of them at any time.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.