About a month ago, fellow SA author Bret Jensen and I agreed to friendly wager on Relypsa (NASDAQ:RLYP) being acquired in the next 12 months for $40 or more per share. I outlined the bear argument in The Relypsa Rumble, Part 1: The Bear Case and Bret provided the bull argument in Occam's Razor And The Bull Case On Relypsa. On July 21st, Relypsa was acquired by the Swiss firm Galenica (OTC:GNHAY) for $1.5 Billion or $32 a share.
Many were a bit surprised by the low acquisition price in context to the $2.7 Billion that AstraZeneca (NYSE:AZN) paid for ZS Pharma last year to acquire their competing hyperkalemia drug ZS-9. In this article, I will undertake a sum of parts valuation of the acquisition to Galenica.
So where did I go wrong?
I believe that I didn't do enough due diligence and failed to understand the potential value to a strategic acquirer like Galenica.
Who is Galenica?
Galenica is a diversified healthcare company with two divisions: Galenica Sante, which operates the largest pharmacy network in Switzerland and Vifor Pharma that develops, manufactures and markets pharmaceuticals.
With its iron replacement products Ferinject®/Injectafer®, Venofer® and Maltofer®, Vifor Pharma is a leader in the treatment of iron deficiency, a widespread ailment around the world. The product portfolio is completed by Velphoro®, a new drug developed by Vifor Pharma, to effectively control phosphorus levels in the blood for patients with chronic kidney disease on dialysis. To gain rapid and direct access to the various international markets, Vifor Pharma works through its own sales affiliates as well as with partners.
What's the rationale for Galenica to acquire Relypsa?
In acquiring Relypsa, Galenica is not only obtaining Veltassa but also a number of other strategic and financial assets that I've outlined and attempted to assign a rough "back of the envelope" sum of parts valuation.
US Commercial Infrastructure:
To date, Vifor has relied on strategic partnerships to market its products in the US. Strategic partners include the leading dialysis care business Fresenius Medical Care and the specialty pharmaceutical company Luitpold. There is value in being able to buy an existing operational infrastructure of sales, marketing, med affairs, etc. compared to having to build it out from scratch.
Given nephrologists' use of iron and phosphate binders like hyperkalemia agents, this appears to be a good fit to cross sell multiple products to a single audience. Let's assume that to build from scratch would take the equivalent of one year's time and operational expenses that I'll estimate the value of at $300 Million. Note this is probably conservative since it doesn't assign any value to the potential leverage that will likely be achieved by "loading" multiple products into a single commercial organization.
Financial Benefits from Eliminating ExUS Milestone and Royalty Payments:
Vifor Pharma in their JV with Fresenius already licensed rights to Veltassa outside the US excluding Japan. Based on this agreement, Relypsa was due to be paid $125 Million in regulatory and sales milestones plus a double-digit royalty. Let's assume the future milestones are currently worth $100 Million and assume $300 Million in sales and 20% royalty.
The present value of a $60 Million annual royalty payment over 15 years at a 10% discount rate is worth $450 Million today. Combining milestones and royalties, the present value under modest assumptions is about $550 Million. Based on Galenica's 55% ownership in the Fresenius joint venture their portion should be about $300 Million. In the acquisition, Galenica is essentially pre-paying upfront for a stream of future payments that I estimate at a current value of $300 Million.
Existing Net Operating Losses:
As of the end of 2015, Relypsa had $163 Million of unused Net Operating Losses. With an expected loss of $300 Million in 2016 and assuming a 34% Federal Tax rate this should increase by close to another $100 Million by the time of deal closing at the end of 2016. Assuming minimal future discounting of NOLs, I estimate the value at $250 Million.
As of the end of Q1 2016, pro-forma cash was $336 Million after a $150 Million debt offering. Assuming $50 Million a quarter in projected cash burn by closing in Q4 2016 cash should be near $200 Million, so I assume that net cash less debt should be worth about $50 Million at closing.
So how much did Galenica pay for Veltassa?
Based on my rough estimate of the value to Galenica of a US commercial infrastructure, future payments on ExUS development, Net Operating Losses and Net Cash are worth a combined $900 Million. From this based on a buyout price of $1.5 Billion, you can estimate "value" assigned to Veltassa in the US and Japan was only about $600 Million. Based on my estimates, Galenica didn't appear to assign much value to Veltassa especially in context of the potential market and what AstraZeneca paid for ZS-9.
Overall, this appears to be a reasonably attractive $600 Million "call option" for Galenica. If Veltassa can ultimately realize its "blockbuster" potential, this will be a steal and Relypsa shareholders will regret a buyout at such a low price. On the other hand, if Veltassa is a much more modest product (as I believe), they will still get a reasonable deal.
Congrats to Bret and the Relypsa longs on a takeout.
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.
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