Roche Loses A Little Luster Before Year-End

| About: Roche Holding (RHHBY)
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The Phase III MARIANNE study of Kadcyla delivered a major disappointment as this would-be successor to Herceptin failed to show superior efficacy alone or in combination with Perjeta.

Roche also announced the end of another Alzheimer's program, casting further doubt on the company's ability to develop new drugs outside of its oncology franchise.

Loss of Kadcyla upside suggests Roche is fairly valued today; a decent hold for investors looking for long-term exposure to oncology, but perhaps not as compelling for new investments.

Even good drug companies have to cope with the fact that drug development is difficult and negative outcomes are more likely than clinical successes. Roche (OTCQX:RHHBY) has had plenty of wins over the year, and the company's presentations at September's ESMO meetings included some fantastic results, but the news on Friday was decidedly more negative for Roche as it reported surprisingly disappointing data from its MARIANNE front-line breast cancer study and saw yet another clinical failure in its non-oncology pipeline.

The disappointment of the MARIANNE study is tempered by the company's robust portfolio and deep immuno-oncology pipeline. Even so, the setback to Kadcyla takes some upside out of the story and the shares appear more or less fully valued at this point in time. I believe that the quality of Roche makes holding it still a worthwhile proposition, but investors with new funds to deploy should look around the space a bit first.

MARIANNE Delivers A Surprising Setback

I don't think it is hyperbole to say that the results Roche presented from its CLEOPATRA study (Perjta plus Herceptin and chemo in metastatic breast cancer) at September's ESMO meeting represent a major leap forward. The combination was expected to be effective, but I don't believe anybody expected the 16-month improvement in median survival (to almost five years).

With the strong results of the Perjeta-Herceptin combo, expectations were high for MARIANNE, a study of Kadcyla (an antibody drug conjugate that uses the same active ingredient as Herceptin) as a monotherapy or combo therapy with Perjeta versus Herceptin (and chemo) in first-line HER2 breast cancer.

Those expectations were slammed Friday when Roche announced that none of the Kadcyla arms were superior to Herceptin and chemotherapy. Although there was a better-than-expected progression-free survival result in the Herceptin arm, it doesn't change the fact that using Kadcyla appears to offer no measurable benefit in first-line patients.

This is a setback on a variety of levels. Patients with HER2+ breast cancer (about 25% of breast cancer cases) need better treatments and Kadcyla doesn't appear to offer that. Roche also needs to offset the eventual loss of patent protection on Herceptin (the primary EU patent expired this year, the U.S. patent expires in 2019), a drug that generates close to 15% of the company's sales. With Kadcyla's price about twice that of Herceptin, positioning this drug as a first-line option was a major priority for Roche management.

What happens now? Kadcyla still holds significant potential as a second-line treatment, where it already has 50%-60% share in the U.S. and 35%-40% share in EU markets like Germany and the UK. Kadcyla did show non-inferiority to Herceptin, and that could generate some sales as a first line treatment option for patients who can't tolerate the taxanes in the Herceptin+chemo combo, and it is also already approved for "fast progressors".

My expectations for Kadcyla as a first-line treatment were lower than most sell-side analysts, who expected an average of about $2.5 billion in first-line sales in 2020, but this trial does sap upside from the model. The impressive results of CLEOPATRA offset some of the disappointment, but losing 2% to 4% of 2020 revenue is not a trivial loss and it is a major setback for Roche's partner ImmunoGen (NASDAQ:IMGN).

More Setbacks Outside Of Oncology

In addition to the bad news from MARIANNE, Roche announced on Friday that it was ending development of gantenerumab in early-stage (prodromal) Alzheimer's. This marks yet another setback for Roche (and Big Pharma in general) in its Alzheimer's program and another strike against the amyloid beta concept. If there is good news here, it's that most investors have long since learned not to assume much from Alzheimer's programs.

Specific to Alzheimer's, this was also bad news to Roche's partner MorphoSys (OTCPK:MPSYY). What it means for Lilly's (NYSE:LLY) drug solanezumab and Biogen Idec's (NASDAQ:BIIB) BIIB037 is harder to say. Unlike Roche's drug, the compounds at Lilly and Biogen target soluble amyloid beta and that may prove to be an important difference - particularly in the case of Biogen, whose drug targets oligomeric amyloid beta and reported encourage Phase Ib data in prodromal patients.

Roche also announced back in late October that the MARIGOLD study of basimglurant for depression did not meet its primary endpoint. Both this and the Alzheimer's program were considered high-risk (and potentially reward), but it won't help the narrative that Roche cannot develop drugs on its own outside of oncology.

One piece of good news in the non-oncology pipeline did come earlier in December, though. The company reported strong early-stage data on its ACE910 drug for hemophilia. ACE910 showed a 65% to 100% reduction in bleeding in patients with FVIII inhibitors and appears unlikely to cause FVIII inhibitors in other patients. With the potential for two-week dosing, this could be a viable and competitive product to hemophilia drugs from Baxter (NYSE:BAX) and Biogen.

Oncology Still Has A Lot To Offer

Outside of two compounds for asthma and multiple sclerosis, there's not a lot in Roche's non-oncology pipeline to drive a lot of excitement today. In contrast, oncology remains an area of deep breadth and depth for the company.

Immuno-oncology has rightfully emerged as a major leap forward in the treatment of many hard-to-treat cancers like melanoma and lung cancer. Roche has what appears to be a very competitive PD-1/PD-L1 drug (MPDL3280A) and the strength of results seen in cancers like lung cancer, bladder, and triple-neg breast cancer may offset the fact that Bristol-Myers (NYSE:BMY) and Merck (NYSE:MRK) are further ahead with their PD-1 programs.

Roche also boasts having 20 immuno-oncology compounds under development, including compounds targeting CSF1R, CEA IL-2, OX-40, and CD-40. As combo therapy is likely to be the norm as immuno-oncology matures, Roche's deep internal pipeline creates a wealth of combination opportunities with no need to split revenue with outside partners. Given the setback with the MARIANNE study, though, the data that Roche will report at the May/June 2015 ASCO meeting becomes all the more important.

The Bottom Line

Roche has made numerous product announcements of late from its diagnostics business, but the fact remains that Herceptin and Avastin each contribute about 60% of the revenue of the entire diagnostics business. Even granting that immuno-oncology holds the promise for further diagnostics sales (figuring out which patients can/will benefit from immuno-oncology drugs will be critical given their cost), positive developments in diagnostics are "nice to have" as opposed to thesis-changing events.

Assuming Kadcyla now has a dim future as a front-line treatment (but a strong future as a second-line treatment), I'm taking about $1.5 billion out of my revenue estimates for 2020 and beyond and also trimming my margins slightly. That lowers my fair value on Roche to about $35.

With a $35 fair value, it's hard to call Roche a compelling buy today and I would encourage investors looking to put new money to work to look around. I do still like Roche as a long-term hold, though, as I do believe its deep immuno-oncology portfolio will produce multiple blockbusters. Should the company restructure and improve its non-oncology drug development process, long-term upside outside of oncology could be attainable as well.

Disclosure: The author is long RHHBY.

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.

Additional disclosure: A member of the author's immediate family is enrolled in a clinical trial sponsored by Bristol-Myers. Bristol-Myers does not have an active role in patient selection/enrollment and does not compensate trial participants beyond supplying the drug.

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