Amgen With Onyx Pharmaceuticals: Long-Term Analysis

| About: Amgen Inc. (AMGN)
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Amgen (NASDAQ:AMGN) recently announced it would be buying Onyx Pharmaceuticals (NASDAQ:ONXX) for $125 per share, or $10.4 billion. Afterwards I disposed of my ONXX shares. Back when I made my initial biotech investments in 2007-2008, I followed Amgen closely, but decided against buying and stopped following Amgen in detail. It was the right call: my ONXX stock rose about 268% since the end of 2008. In contrast AMGN, which ended 2008 at $57.75 and closed last Friday at $108.94, was up "just" 88% during that time span.

Amgen would have been the less-risky pick in 2008 because it was a relatively fairly mature, profitable biotechnology company, while Onyx was losing money and just getting started. The past may be informative, but stock prices should be about future profit streams, which can be hard to predict. Should I invest some or all of my cash from Onyx in Amgen, or would it be likely better invested elsewhere? Since I have covered Onyx extensively, most recently in Onyx Pharmaceuticals: Profit Ramp Ahead, in this article I am going to focus on Amgen without Onyx, then indicate how I think the addition of Onyx changes the picture.

Amgen reported second quarter revenue of $4.68 billion, up 4.5% from $4.48 billion in the year-earlier quarter. Not rapid growth, especially since it included $185 million in revenue from an adjustment in reserves for Medicare rebates, offset by not repeating a one-time payment from Takeda for roughly $190 million in 2012.

GAAP net income was $1.26 billion, down 1% y/y, and even on a non-GAAP basis net income was only up 1% y/y to $1.44 billion. EPS did better, up 2% y/y to $1.65 on a GAAP basis or up 3% to $1.89 on a non-GAAP basis. The reason EPS increased while net income decreased was a substantial stock-buy-back program over the last year, but no buy-backs took place in Q2, likely in preparation for the likely Onyx acquisition.

On the surface it would look like Amgen is stalled and is acquiring Onyx to get back to a growth trajectory. However, with some caveats, it looks like Amgen was poised for faster growth even without Onyx.

A couple of newer Amgen therapies showed strong y/y growth. Prolia for osteoporosis and Xgeva for preventing skeletal degeneration in bone cancer patients (both are tradenames for Denosumab) grew revenues 57% and 39%, respectively y/y. On the other side of the equation Amgen's staple Epogen declined slightly. Amgen's leading drug by revenue, Enbrel, was up 9% y/y to $1.16 billion in the quarter. Total product sales were up 9% y/y, but that includes the $185 million reserve adjustment.

Amgen also has an impressive pipeline of new therapies, many of them in late stages of development (Phase 3). Multiple data readouts are expected in 2014, including pivotal Phase III data for AMG 145 for cholesterol control in Q1 2014. Talimogene Lasherparepvec for melanoma should have Phase III data for overall survival data in the first half of 2014. Trebananib for ovarian cancer Phase III data for overall survival should be available in the second half of 2014. In Q2 Amgen decided to advance brodalumab for psoriatic arthritis to Phase III and AMG 139 for Crohn's disease entered Phase II. But the AMG 747 for schizophrenia program was terminated because of unexpected severe skin reactions. All in all 8 of the pipeline products are expected to produce registration enabling data by 2016.

In general, companies with bright prospects of growth in profits have higher P/E (price to earnings) ratios than companies where no growth, or slower growth, are expected. Amgen's trailing P/E stood at 18.3 at the close on August 30, which would indicate analysts and investors expect only moderate growth compared to other biotech companies in the Nasdaq 100.

There are two major concerns that might account for the dim growth view reflected in the P/E. One is future competition from biosimilars. Broadly speaking a biosimilar is a substitute therapeutic agent of high molecular complexity made by or derived from a living organism using DNA techniques. In particular, it has therapeutic effects comparable to FDA-approved therapies, but is not exactly the same molecule (protein molecules often have thousands of amino units, so sometimes one or more can be changed while maintaining efficacy). For competitive purposes, biosimilars are the generic versions of complex drugs, typically a protein, commonly a monoclonal antibody. Amgen's Denosumab is a monoclonal antibody. Enbrel is a fusion protein produced by recombinant DNA. In answering a question about this issue at the conference call, Amgen reps emphasized that biosimilars are much harder to produce than generic small molecules. Amgen already competes successfully with biosimilars in Europe based on safety, efficacy and reliability of their products.

The other risk is current discussions that might reduce the reimbursement price for Epogen (also a large molecule) for dialysis patients. Epogen has a history of controversy, including a safety advisory in 2007 and accusations it was overprescribed (doses higher than necessary), but it has proven to be safe when used properly. In a typical year it is the single biggest drug expense for Medicare. In the quarter Epogen revenue was $502 million, down 4% from $525 million in Q2 2013. Clearly if the reimbursement level is reduced that would hurt Amgen revenue and profits. The CMS (Centers for Medicare and Medicaid Services) proposal is in the comment period, and of course Amgen is arguing against any price cuts. Epogen is important, but it represents just under 11% of Amgen revenue, so it is no longer as central as it was 5 years ago.

There is no way to know what the CMS will decide. There is no way to be sure what market share biosimilars may take away from Amgen, if any, in the United States in coming years. The pipeline looks robust, but of course there is no guarantee of FDA approval for any particular drug. My best guesses are that any CMS mandated price decrease will be small, that biosimilars will have difficulty gaining market share, and that much of the Amgen pipeline will be commercialized more or less on schedule.

I don't think the Amgen pipeline is fully priced into the stock. I also like management's (and the board's) attitude about dividends. The dividend is currently $0.47 per quarter, working out to 1.73% at Friday's close. The clear intent is to increase the Amgen dividend significantly over the long run. At 1.73% the dividend does not amount to much, but if it does grow (once Onyx is digested) that would be a big plus over the long haul.

Amgen has a vast amount of cash, $22.0 billion at the end of Q2, offset by $23.9 billion of debt. The acquisition of Onyx will require $9.7 billion ($10.4 billion nominal less Onyx's $0.7 billion). Amgen free cash flow in Q2 was $1.4 billion; at that rate 7 quarters, which would pay for the Onyx acquisition. In addition Onyx revenue has been ramping, and Amgen should be able to cut out a considerable portion of Onyx's operating expenses. All in all the cash required to get Onyx is a mouthful, and I would expect no dividend increase through 2014 and little or no share buy-back either.

On the whole, Amgen looks attractive to me (at $109 per share) as a long-term (minimum 2 years) investor. Risks appear to be priced in, but upsides do not. I think years of only moderate growth have dulled investor appreciation for Amgen's potential. Onyx will likely only bring in about $160 million in revenue in Q3, and there will be the usual merger expenses in Q4, but after that, perhaps as early as Q1 2014, the former Onyx component of Amgen will start kicking in some EPS as Kyprolis revenue continues to ramp. Long run, Onyx had an impressive pipeline, including good Phase 3 data for Nexavar for thyroid cancer that could commercialize as early as 2014.

However, I will again be comparing Amgen to a substantial number of other biotechnology stocks before initiating any new positions (follow me to track the process). I do not always buy the riskier stocks with higher return potential, but try to balance a mix of medium mid-to-large cap and high risk, small-cap stocks in my portfolio.

Disclosure: I 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.