When I look at my portfolio, which contains a sizable Gilead (NASDAQ:GILD) position, I am reminded of my love-hate relationship with the stock. I first took a position in mid 2014 and exited and entered a few times around the seemingly predictable cycles of shares going below $100, then trying to climb over $110, only to inevitably crash again. For a long time, I convinced myself that this depressed price was nothing but a precursor to a eventual run-up, a consolidation phase. After this week's news, I no longer believe that and I do not expect next week's earnings to change anything.
In this article, I comment on Gilead's unlucky fate of becoming a story-stock and the general shape of biotechs that offer expensive one-time treatments.
The growth story
When the full growth trajectory of Sovaldi/Harvoni first became evident, Gilead was often portrayed as offering a free call option on its pipeline. With a 8x P/E multiple compared to its peers Celgene (NASDAQ:CELG, 49xP/E) or Amgen (NASDAQ:AMGN, 17.7x PE), the market weirdly seemed to price Gilead as if HCV revenues were already over and no further growth was in sight, so any positive news besides Harvoni's renuves should send shares up. Of course, AbbVie's (NYSE:ABBV) Viekira Pak came around by end 2014 and set the stage for what analysts expected to become a pricing war, with AbbVie taking away significant market share through aggressive discounting.
As we know in hindsight, this did not happen, both because of Gilead's superior product and because management also played ball by striking discount deals with pharmacy benefit providers. AbbVie was able to capture only a minor share (~15%) of the Hepatitis C market and Gilead could offset this through larger treatment numbers both domestically and in Japan than initially expected.
Throughout all this, share prices were mostly lingering between $95 and $110 (with a singular run-up to the mid $120 in the first half of 2015). I did not really mind this because Gilead's seemingly depressed valuation combined with huge share buybacks and what is now almost a 2% yield appeared to provide a safe haven. In fact, selling weekly or monthly $100 puts was a profitable opportunity to capitalise on this range because if they were assigned, one could just wait for the inevitable recovery. Despite Gilead's dominant position in the Hepatitis C market, many remained skeptical because Harvoni sales were such a huge proportion of total revenues and nobody could know exactly for how long Gilead would be able to capitalise on its leadership.
This week's news of Merk's (NYSE:MRK) once-a-day treatment getting FDA clearance are exactly the kind of news that always seemed lingering, yet unclear in their precise consequences. Would Gilead's ongoing improvements to their product (e.g. pan-genotype treatment) ensure continued dominance, would pricing become an issue again?
The A word
Gilead's management under John Martin (who just stepped down as CEO to become executive chairman) and John Milligan (who just went from COO to CEO) did little to dispel this lingering sentiment. They followed the generally admirable strategy of under-promising and over-delivering on guidance and revenue. This generally made for pleasant surprises on earnings, e.g. during the 2015 Q3 earnings call 2015 FY guidance was raised to $30-31 billion from $29-30. Their silence however did not nothing for share prices to reflect earnings.
The prevailing view was and is that for Gilead to break out of this range for good and get to a valuation multiple closer to its competitors, an acquisition was necessary. In fact, not just "a acqusition", but a loftily called "transformative acquisition", meaning another multi-billion dollar drug. Throughout 2015, Gilead management kept making comments along the lines of:
"We are open to suggestions" - 2015 Q1 earnings call, John Martin
"Well, we have an eye on the external world -- we have incredible cash flows and we are looking for opportunities" - Norbert Bischofsberger EVP R&D
Further, Gilead raised $10 billion in September, which caused lots of speculation about the size of a possible acquisition target. As we know, no "transformative acquisition" has happened yet. It might not anytime soon, as Gilead's management has repeatedly stated that they are waiting for the right constellation and "the stars have not aligned yet". Instead, Gilead has become a story stock I do not like that story.
The story around Gilead's story began with the infamous Waxman letter that questioned Gilead's pricing practices in early 2014. It might have even begun a little earlier, when Gilead set the price for Sovaldi at $1000 a pill and that hit the news in late 2013. In retrospect, I view the specific pricing as a grave marketing mistake. Not because I find $84,000 for a Hepatitis C cure truly outrageous, especially compared to traditional treatments.
It was a mistake, although an understandable one, because Gilead allowed itself to become the example of "predatory pricing". This is because "$1,000 a pill" is just an incredibly catchy example. It allowed Gilead to be named in the same breath with Martin Shrekli's and Valeant's shenanigans. The problem here is that Gilead really entered new territory with Sovaldi. Sure, there were highly expensive treatments for a small set of orphan diseases, but this was a generally accepted practice to offset the small patient population and it did not make a dent in public health spending.
Gilead introduced a one-off treatment for a wide-spread, deathly disease into a world of health-care systems that are designed to spread out costs for managing treatments over years, not pay lump sums to cure them. Harvoni is and will be part of an ongoing political debate that is essentially about the following: We are converging towards a world where there will be extremely effective, customized treatments available that will significantly prolong lives. I view the Hepatitis C pricing discussion as a first step of societies figuring out the ethics of how to deal with the fact that we cannot or do not want to afford these treatments to everyone. This problem will affect especially affect the Cancer-Immunotherapy market, as treatments are currently expected to be expensive to manufacture with price ranges well over $100,000 per treatment.
When a stock becomes about a story, the narrative starts to focus on a single metric. There are many examples of this. Tesla (NASDAQ:TSLA) is only judged on car deliveries. Netflix (NASDAQ:NFLX) is judged on subscriber growth. This is usually because that single metric condensates what investors believe the company is truly about. For years, Tesla and Netflix bears have argued about ridiculous multiples that in no way reflected the competitive position or cashflows of these companies. Nonetheless, both have seen extra-ordinary growth stories in the past years (which only recently ended).
I now tend to see Gilead in the same light, only unlike the above two companies, it looks good on paper but not for its shareholders. Gilead is a story stock and the story is that Hepatitis C does not matter. The story is that there is no positive end to the Hepatitis C story, so something else is needed. I wish it were different, but I have listened through too many consecutive earnings calls and have observed reactions to believe in that.
Why earnings will not matter
If Gilead reports another blow-out year, do not expect this to move the needle. The story goes "sure, 2015 was great, but that was the peak and it can only go down from here, and there was no Merck in 2015". If earnings are just in line with estimates, the argument goes the same. If earnings are below guidance, the story tells us it is all downhill from here.
John Martin and Gilead's executive team have not been willing to give into Wall Street's expectations of some mega-merger or acquisition (like Celgene has with Receptos). This is wise if they really do not see any targets, but as a shareholder I do expect companies to play the meta-game of how they are viewed and not just grind along silently, hoping the outside world will eventually change their view.
As long as the Gilead story centers around Hepatitis C, price wars and competition, I have little hopes for my shares to recover. No matter how much cashflow Gilead generates, the story will only change with a completely new product line. The problem with being a $30 billion revenue company is that a new $1 billion drug does not cut it.
If you are in the same situation as me, that is, holding Gilead shares from >$100, I recommend selling covered calls to offset losses.
Disclosure: I am/we are long GILD.
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.