Alexion Pharmaceuticals' (NASDAQ: ALXN) specialty is marketing and developing drugs that treat life-threatening conditions. Its flagship product, Soliris, is approved for treating two types of ultra-rare blood disorders: paroxysmal nocturnal hemoglobinuria and atypical hemolytic uremic syndrome. Keeping in the rare diseases niche, Alexion's pipeline includes Strensiq and Kanuma as well as other drugs in development that all seem to focus on the same types (or "complements" if you will) of diseases. This strategy has been quite successful in establishing a market stronghold and network of prescribing partners. Despite this self-made ecosystem, costs for Soliris and Alexion's other rare disease treating drugs is understandably high. This has caused investors to tread in trepidation considering recent market backlash against high priced medication. The fear is that Soliris, which costs over $400,000 annually, will have to bend to the demands of activists against drug pricing.
This fear presents a buying opportunity, and here is why:
Alexion's experience and efficacy in the rare disease arena will not be impacted by a Soliris price reduction.
The company's ability to develop rare-disease treatments will ensure there is plenty of room for growth. Alexion's pipeline of drugs focused on rare diseases will pick up any slack from a Soliris price reduction. In other words, just because Soliris loses profit, other drugs will continue to have pricing power in these niche markets, which coincidentally offer a great deal of insulation from any competition. The life-threatening ultra-rare disease business is not easy to enter for newcomers, especially not while using a low-cost model. The highest barrier of entry would be the regulatory challenges and clinical trials required to receive approval. The Soliris patents are secure until 2021 in the US, and the time needed for a competing drug to receive FDA approval would take longer than that just to receive enrollment. Not to mention the competition would then need to penetrate a strong entrenchment with patients and doctors with whom Alexion has established longstanding relationships. The Soliris demand is not going away, and in fact looks as though it will be able to receive approval for additional diseases. Therefore a price reduction would reduce EPS in the short term, but will not change my long term outlook.
First quarter 2016 saw a 15% increase in Soliris volumes which lead to$701 million in sales during the second quarter. This put them back on the annual track, but the shudder in sales effected stock prices as shareholders feared Soliris had hit critical mass. I think this should have been expected, because the explosive growth of Soliris is unsustainable in a market with only about 10,000 patients in the US and Europe. Soliris' growth rates should level out until it receives approval for new markets. Though curtailed, Soliris will continue to drive solid returns for the next several years. In the meantime, Alexion can focus on marketing the younger brothers, Strensiq and Kanuma, which both saw substantial gains over the first quarter. These two drugs are expected to add serious revenue as they mature over the next few years. During the earnings call, Management increased their guidance on them by $200-220 million.
Alexion is reducing risk by diversifying their portfolio.
Alexion's strength is its strategic focus on the ultra-rare diseases, but that narrow focus is also Alexion's biggest risk. The concern stems from the lack of diversity in their product line. While, yes they're demand is propped up with the threat of life or death, this does not mean Alexion is safe from risk. Their concentration of products is susceptible to production halts, government intervention, or generics down the road. One example would be the manufacturing speed bump they encountered when the Food and Drug Administration identified problems at their Rhode Island facility in 2012. Though not a catastrophe, it highlights the weakness of having a single product supply chain.
To address this risk the management made several acquisitions including Synageva BioPharma, Enobia Pharma, and Taligen Therapeutics. All of which I think suit the company and complement their niche strategy while widening their scope. These acquisitions show Alexion's commitment to growth by diversifying and leveraging their commercial infrastructure.
Morningstar Investment Research has Alexion listed as a Five-Star-Stock and has set a "Fair Value Estimate" of $194.
Morningstar's valuation represents a 60% upside from today's trading levels. This valuation is driven by "Alexion's profitability and cash flow generation power." They project a peak of $5 billion in global sales for Soliris based on the potential for new markets. They also see the two younger brothers, Strensiq and Kanuma, pulling in $1.5 billion between the two. They set a "Consider Sell" price of $261, more than double today's share prices.
Though all of the above makes a good case for Alexion, I'm skeptical of Morningstar's high estimates. So I set out to prove them wrong.
I found Alexion's trailing twelve month EBITDA to be $956M which resulted in an EV/EBITDA of 33.35. I thought this was high and that my apprehension of Morningstar might be valid. That is until, I ran EBITDA multiple's of 4 companies with comparable drug prices to Alexion, see below:
|Shire NASDAQ: SHPG||24.68|
|BioMarin NASDAQ: BMRN||-71|
|Sarepta NASDAQ: SRPT||-11|
|Vertex NASDAQ: VRTX||5646|
Compared to these multiples, ALXN's decent multiple looks like an anomaly. Shire PLC is the only reasonable multiple of the bunch! Obviously negative EBITDA's throw off the comparisons, but unfortunately negative EV/EBITDA multiples are common in the drug manufacturing space thanks to the high cost of R&D and cost programs. I had to search for biopharm companies with more rational multiples, so I pulled the next 4:
|Valeant NYSE: VRX||12.85|
|Allergen NYSE: AGN||35.94|
|Amgen NASDAQ: AMGN||12.12|
I threw SHPG's 24.68 back into the aggregate and found the mean to be 20.20 and the median 15.4. Using these I recalculated ALXN's EV and found the following:
|Metric||EV||MV of Equity||# shares||Est. PPS||Current PPS||Return|
This is far from proving Morningstar wrong, but it does paint a much darker picture. Considering these 5 companies are a "looser" comparable to Alexion, I understand these estimations may be too pessimistic. Morningstar may know something I do not, and the EV/EBITDA is an overly simple metric, but the reason for concern is undeniable. When something sounds too good to be true, it usually is, and in this case the high EV/EBITDA is a red flag.
Normally I'm a huge fan of Morningstar's 5 star stock picks. Their Lexicon Pharmaceuticals pick has done very well for me. My concern stems from the last time I trusted them with a pharmaceutical pick, from which I gleaned that they are not infallible.
I see today's prices around $123, despite the recent pullback, still overpriced. They may recover to $194 in the next several quarters, but I do not see above $100 as a good entry point. They need time to see the current criticism headwinds blow over, and their Strensiq and Kanuma to really blossom on their income statements.
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Disclosure: I/we 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.