Lundbeck Continues To Fight To Stand Out

| About: H. Lundbeck (HLUYY)
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Positive data on drugs like Brintellix and brexpiprazole have been overshadowed by slow marketing ramps and the departure of the CEO for an ethics violation.

2015 will be a critical year for Lundbeck in establishing the viability of Brintellix and other drugs like Northera, as well as getting brexpiprazole to market.

The loss of the CEO and significant expecting marketing spending in 2015 ups the risk, but Lundbeck shares could still return 25% to 40% if the launches gain traction.

The Danish pharmaceutical company H Lundbeck A/S (OTCPK:HLUYY) (LUN.CO) isn't going to resolve its challenges quickly. While I continue to believe there is a strong argument to be made that Lundbeck has developed a roster of differentiated CNS products that can stand apart from branded and generic competitors, the fact remains that the Street has yet to be convinced and the company is still facing significant near-term profit erosion from lost patent coverage on key drugs and significant investments to support drug launches.

Buying Lundbeck now remains a bet on the prospects that better clinical data for key products like Brintellix, Abilify Maintena, and brexpiprazole will translate into major sales and that compounds like Selincro and Northera will emerge as significant contributors in their own right. With base-case upside of around 25% and bull-case upside of more than 40%, I continue to believe it's a bet worth making for more aggressive investors.

Challenges Aren't Fading

Every company addressing a worthwhile market is going to have to deal with the slings and arrows that come with competition. Competing with Johnson & Johnson (NYSE:JNJ) and Alkermes (NASDAQ:ALKS) in long-acting antipsychotics is a known risk, as is competing with generic drugs in the depression and schizophrenia markets. Add in the near-term patent loss on Xenazine and the strong data recently reported by Auspex (NASDAQ:ASPX) in Huntington's Disease with its improved form of tetrabenazine and there is plenty already on management's plate.

One of the concerning issues with Lundbeck is that they seem to have a knack for going back to the buffet for an extra helping of challenges. The company announced the resignation in late November of CEO Ulf Wiinberg due to a violation of the company's code of conduct. Mr. Wiinberg received shares in a company (Stratified Medical) without receiving prior permission to do so and Lundbeck subsequently made a small investment in the company.

Now the company is looking for a new CEO while in the midst of a challenging launch of its key drug Brintellix, as well as the launch of Northera and the attempt to gain adoption of Abilify Maintena and Selincro. Kudos to the board for standing by its code of ethics (I suspect that many U.S. boards of directors would have looked the other way), but now the company needs to find a new CEO.

Another challenge, and one perhaps related to the now-former CEO, is how the company establishes its R&D priorities. It's not hard to label Lundbeck as a developer of me-too drugs (though I do disagree), and marketing against effective generics on the basis of moderate improvements in efficacy and/or tolerability is not an easy task.

Lundbeck has also established something of a reputation for spending significant sums on drugs with significant development risks - including spending hundreds of millions on risky Alzheimer's compounds and the very-challenged stroke drug desmoteplase. Last and not least, the company isn't always that adept at communicating its marketing and spending plans to the Street, lending a little more drama to the guidance portion of earnings releases.

Will Good Data Ultimately Carry The Day?

Against those challenges I do believe there are some meaningful factors in Lundbeck's favor.

Lundbeck recently announced the results of a study that indicate (via fMRI) that Brintellix increases neural efficiency during memory challenge exercises. Lundbeck has filed for a cognition claim in the EU for the drug and could hear back from the FDA in the first quarter of 2015 on its request to add similar cognition claims to its U.S. label - getting this change to the label would be a strong positive in the company's sales efforts. I'd also note that while Brintellix sales in the third quarter were disappointing relative to Street expectations, there was more than 50% sequential sales growth and the sales effort has yet to really start seeing traction in the general practitioner community.

Lundbeck has also announced solid data for its experimental drug brexpiprazole. The drug does appear effective in helping people with depression who have failed to respond to three prior treatments and does so with fewer side effects than established treatments for major depressive disorder. The data were are also positive in the schizophrenia studies, with good efficacy (statistically significant at 4mg for both the BEACON and VECTOR studies, significant at 2mg in BEACON, but not in VECTOR albeit with a trend of improvement) and again an improvement in side effects, including a meaningfully lower rate of discontinuations. FDA approval in mid-2015 is certainly plausible, but the Street is currently expecting less than $500 million in revenue for this drug in 2020.

Lundbeck has also presented data that should strengthen the case for Abilify Maintena. In the QUALIFY study, a head-to-head trial comparing Abilify Maintena to Invega Sustenna, Abilify Maintena showed more than double the improvement in the Heinrich-Carpenter Quality of Life Scale score relative to Invega Sustenna (a 4.4-point improvement, with a p-value of 0.031), as well as improvement in the Clinical Global Impression-Severity Scale, and a lower rate of discontinuation (10.8% v. 18.4%). Lundbeck did report sales for the third quarter consistent with 9% share for Abilify Maintena - a pretty clear sign that there's still more work to do in driving acceptance/use of their drug.

The Costs Are Real, The Benefits Are Projections

Investors have not been pleased with the recent trends from Lundbeck, including the departure of the CEO, the lack of absolute blockbuster data on brexpiprazole, the iffy Phase II data on idalopirdine in Alzheimer's, and the uncertainty over whether the company will commit additional funds to support the development of desmoteplase (a sub-group analysis suggests giving stroke patients MRIs can identify those likely to respond).

What's more, the company has made it clear that it is going to spend to support the launches of Brintellix, Northera, Selincro, and (presumably) brexpiprazole, as well as improve its efforts to sell Abilify Maintena. Combined with pressures tied to patent expirations, that all but guarantees weak earnings for 2015 and likely 2016. While it does indeed take money to make money, the fact remains that spending money is easy (and a near-certainty) but reaping the expected benefits of that spending in the form of strong sales and future profits is far from guaranteed.

All of that said, I do still believe in the potential of Brintellix, brexpiprazole, and Lundbeck's overall roster of recently-approved and late-stage drugs. With that, I expect a long-term average revenue growth rate of around 4% (meaning just under $4 billion in 2023 revenue) with free cash flow margins recovering into the high teens to low twenties. Adding some near-term expenses to the model and adjusting the discount rate for the CEO departure (an increase to the risk profile) leads me to a slightly lower target - 155 DKK or about $26 per ADR - but still enough potential to make the shares worthwhile. Should the commercial launches work out better than my base case, I believe upside to 180 DKK/$30 is credible.

The Bottom Line

Lundbeck is not going to be an easy stock to own, as the company is facing serious patent-related pressure and has to execute on multiple challenging launches. That said, Japanese pharmaceutical companies appear to be in a buying mood again and I wouldn't rule out the possibility that marketing partners Takeda or Otsuka could make a bid. Even absent that bid, I believe there are solid reasons for owning the stock, as the Street still appears to have a rather grim view of a collection of drugs that have shown clinically-relevant superiority in markets worth several billions of dollars a year.

Author's update:
After the close today (Dec. 17), Lundbeck announced that it would cease all further development of desmoteplase and take a DKK 309M charge in the fourth quarter. Management also tightened its earnings guidance range for Q4 from DKK 0.9B-1.4B to 1.1B-1.3B. These changes do not materially alter my outlook, though the abandonment of desmoteplase is a net positive relative to a very low likelihood of regulatory success.

Disclosure: The author is long the Danish shares of H Lundbeck A/S LUN.CO.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.