With A New Attitude To Deals, Lilly Could Grow Stronger

| About: Eli Lilly (LLY)

In its choice of new chief executive Lilly (NYSE:LLY) has sent a strong signal that it will remain a firm advocate of heavy R&D investment. Had the company not been sitting on a handful of promising late-stage and recently launched assets, investor reaction to the appointment might not have been so forgiving.

As it stands Lilly possesses one of the most valuable R&D pipelines in big pharma, but over the past five years has spent the least on deal-making by a long way (see tables below). Its incoming chief executive, David Ricks, has already hinted at a greater openness to buying in innovation, suggesting that Lilly’s gaze could increasingly turn outwards.

Investors have only really been willing to give Lilly the benefit of the doubt for its inward-looking stance in the past few years. Arguably, the company has also benefited from the rising tide of the bull market.

This is not to discount real success stories. Jardiance looks set to become one of the most successful diabetes drugs to date and the best-in-class SGLT-2 inhibitor, while Trulicity is making strong gains in the crowded GLP-1 field. Baricitinib looks to be a strong new contender in rheumatology, as does Taltz in psoriasis. And in oncology abemaciclib and Cyramza are both projected to become blockbusters.

With memories of the painful Cymbalta and Zyprexa patent cliffs still in the memories of many investors, the breadth of this success is one of the reasons Lilly has returned to favor. The company now looks far less exposed to huge, individual products.

Risks remain, however, the most apparent being solanezumab. The Alzheimer’s antibody represents its second most-valuable pipeline asset, with a substantial $5.6bn NPV, according to EvaluatePharma.

It is clear that a big proportion of the company’s perceived value remains in its R&D pipeline, compared with others in its peer group – hence the pressure on Mr Ricks to turn this into real sales.

Big pharma outgoings and the value of their efforts

2010-15

Current

Total spend on M&A and up-front payments ($bn)

R&D spend ($bn)

NPV of R&D pipeline ($bn)

NPV of current pipeline as % of market cap

Novartis

60.31

52.13

24.5

11%

Johnson & Johnson

28.23

33.78

15.8

5%

Sanofi

26.06

36.39

21.7

20%

Pfizer

26.06

45.38

22.6

10%

Abbvie*

22.01

14.79

19.2

18%

AstraZeneca

18.46

28.31

27.2

35%

Bristol-Myers Squibb

18.06

22.41

2.3

2%

Merck & Co

17.31

44.04

18.2

11%

Roche

15.52

49.35

43.3

19%

GlaxoSmithKline

12.29

32.53

6.4

5%

Lilly

8.09

28.85

24.2

27%

*Company formed in 2013

Click to enlarge
Click to enlarge

There is evidence that Lilly’s inward strategy is working, however – only three of the company’s 10 projected biggest sellers in 2022 were derived from outside its own labs.

Baricitinib was licensed from Incyte (NASDAQ:INCY), Cyramza came with the ImClone acquisition – Lilly’s biggest M&A move at $6.5bn – while Alimta was discovered by scientists at Princeton University. And on Alimta Lilly still deserves a lot of credit – it licensed the project in the late 1980s, years before it entered clinical trials and more than a decade before being launched in 2004.

As such it is not surprising that Lilly ranks at the bottom of the table in terms of cash committed to buying in innovation. This analysis only includes the up-front payments associated with product deals and M&A – Lilly will spend on other external R&D projects through its corporate venture arm and collaborations with academic institutions, for example.

Still, product deals and M&A are the most visible and sizable contributors of external innovation, and on these measures Lilly is clearly lagging. Should a string of setbacks require this stance to change, Mr Ricks, a former business development executive, is arguably better placed to do this than the outgoing chief, John Lechleiter, who started as an organic chemist.

In fact, the experience of his replacement makes a shift in attitude towards deals almost a certainty. In various interviews in the past few days Mr Ricks has hinted that he will be more open to partnerships than his predecessor.

If Lilly can become as successful in its deal-making as it has been at internal R&D, investors should not have to rue the absence of fresh blood at the top.