Regeneron: Pipeline Not As Undervalued As You Might Think


Regeneron continues to underperform relative to some of its peers in the biotech sector.

While many consider the stock's decline to be more of a sympathetic sell-off due to sector headwinds, we feel the skepticism is not misplaced.

We peg the enterprise value of the company's blockbuster EYLEA at $29 billion, which implies a pipeline valuation of $11 billion at today's prices.

Given the limited potential for Praluent and Sarilumab, coupled with the potential addressable market for Dupilumab, we feel the current pipeline valuations are appropriately priced.

After what many considered to be a sympathetic sell-off, Regeneron (NASDAQ:REGN) continues to lag many of its biotech peers (Figure 1). A lot of claims have been made about how wildly undervalued the stock is. A couple of our favorites are that the company has far and wide the best pipeline in the business right now, and that the value of Regeneron's WMD blockbuster, EYLEA, alone nearly matches or exceeds the company's market capitalization.

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Figure 1 - YTD performance for REGN compared to IBB and selected top holdings

It is true that Regeneron is a solidly managed company with an innovative discovery approach, solid foundation, etc. For these reasons, along with our bullish view on the sector as a whole, it's hard to be pessimistic about Regeneron. Yet, at this point in time, we do not see an abundance of reasons for optimism.

Nearly all of the company's revenue comes from its blockbuster WMD drug, EYLEA. A nice way to analyze Regeneron's risk/reward profile is to first come up with a fair value for the EYLEA franchise. In theory, the amount by which Regeneron's market cap exceed the enterprise value of the EYLEA franchise is essentially the market's valuation of the company's pipeline. Table 1 below shows our projections for cash flow generated by EYLEA sales through the next five years.

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Table 1 - Projected EYLEA sales growth

Of course, EYLEA sales won't see these levels of growth indefinitely. Some other blockbusters like Enbrel (NASDAQ:AMGN) and Humira (NYSE:ABBV) have seen consistent top line growth north of 5-6% even past twelve years post approval. However, at this time, EYLEA does not appear to have the same potential for robust expansion to different disease state indications as the aforementioned pair. Sales growth has already fallen short of expectations more than once, and less-than-expected EYLEA revenue growth has been a big reason for Regeneron's negative alpha this year. Once patent protection expires in 2023, EYLEA will likely lose some market share to biosimilars, whose manufacturers commonly shoot for a 40-50% profit margin, which might also cut into Regeneron's margins on EYLEA. For these reasons, we estimate an appropriate cash flow perpetuity rate of -2.5% for the EYLEA franchise. Using the FCF terminal value of $5.4 billion from Table 1, along with an 8% discount rate and a -2.5% cash flow perpetuity rate, we believe the NPV of Regeneron's future EYLEA-only cash flows is just shy of $29 billion. At today's share price, the company's market cap is right around $40 billion, which implies a pipeline valuation of $11 billion.

Regeneron's pipeline has been discussed ad nauseam as of late, so we will keep our points brief. Sarilumab, the company's competitor for market-leading Humira, enters an increasingly crowded rheumatoid arthritis product space. It is expected to receive approval in the next year or so, which will provide a modest boost to Regeneron's top line growth, but we (along with most) are not expecting to see any booming growth here.

The biggest disappointment, though, has been Praluent, Regeneron's PCSK9 inhibitor for hypercholesterolemia. Clinical results for PCSK9 inhibitors in general have shown impressive reductions in LDL levels, but at such high costs, insurers are not paying for them without proof of reduced CVD events down the line that would provide any real benefit over the current standard of care. CVD outcomes studies are underway (for Praluent and competitors), with results expected by the end of 2017. We consulted a panel of physicians (at Johns Hopkins Hospital), and there seems to be a consensus that results from CVD outcomes studies for PCSK9 inhibitors would have to be very impressive to spur more widespread adoption. For reference, the current SOC (statins) have already been shown to prevent ~25-50% of CVD events in five-year trials. It has been suggested in the medical literature that we may have reached the limit of what we can do by lowering LDL (see here for review). For instance, under current guidelines, most physicians do not treat hypercholesterolemia until the fifth-sixth decades. Yet, early warning signs (fatty streak lesions, even raised lesions in many cases) are often prevalent by the third decade. Thus, it is entirely possible that no drug, no matter how effective at lowering LDL levels (namely PCSK9 inhibitors), will be able to effectively prevent CVD events down the line when prescribed under current guidelines. For these reasons, we are inclined to believe that (barring any new clinical developments) outcomes studies will not have much of an impact on Praluent sales. Factor in Amgen's Praluent patent infringement victory over Regeneron and Praluent's contribution to Regeneron's pipeline valuation would appear to be negligible.

Regeneron's best chance for a new blockbuster to spur growth is dupilumab, which we believe accounts for most of the company's pipeline valuation. The therapeutic focus of dupilumab is diseases with a large allergic component. The farthest along is the atopic dermatitis program. While topical steroids are often prescribed for mild cases, the current SOC for atopic dermatitis offers very few treatments for more advanced cases. Recent phase III data for dupilumab was very strong, so it could in fact end up being a sleeper success. After all, atopic dermatitis is very common and affects an estimated 9-30% of people in the United States, with over 3 million new cases per year. If ~15% of the patients in the US and Europe have AD, then perhaps 1-2% are candidates for biologic therapy, which would come to around 10 million candidates. If 10% of them went on dupilumab, then assuming pricing at least equal to that of the small molecule Otezla (NASDAQ:CELG) for psoriasis, that could be ~$20 billion in revenues annually for this indication, which is no joke. Assuming metrics similar to the above mentioned, along with ten years to reach that level of market share, the NPV of these future cash flows would come to around $75 billion.

Given our pipeline valuation of $11 billion, it would appear that the market has priced in roughly a 15% probability that Regeneron will knock the ball out of the park with dupilumab. We believe this is more or less a fair estimate, but recognize that future developments involving dupilumab could significantly move Regeneron's share price. For now, though, we're staying on the sidelines.

Disclosure: I/we 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.