Alexion: Weighing The Pros And Cons

Summary

ALXN, a rare disease specialist, has had a rocky time of it, and is functioning with an interim CEO due to "tone at the top" issues with the prior CEO.

This issue plus an overpriced acquisition at the peak of the biotech market in 2015 has knocked the stock back to 2013 price levels.

This article reviews some (not all) aspects of ALXN's investment case.

My trading conclusion is that this stock has an attractive risk-reward ratio in the low $130s, but that risks are non-negligible.

Introduction

The pioneering biotech Alexion (NASDAQ:ALXN) has released Q4 and full-year 2016 earnings and held a conference call that had both positives and negatives. This follows quite a turbulent time of it, with the Q3 10-Q having been delayed until January and the CEO and CFO being shown the door unceremoniously late last year.

The 2016 10-K has been filed, and I've read through it. The 10-K is light on certain specifics, so some of the information in the article regarding potential competition to Soliris and the next-gen life cycle management successor to it, ALXN1210, may represent a modest contribution to readers' knowledge. Please follow up via the links provided or standard Internet searches to look more deeply into some of these relevant matters, such as potential biosimilar or other types of competition to ALXN's Soliris franchise.

I'll begin with the smaller and younger product that is material right now to ALXN, then move to a discussion of the upside with mention of risks to the main Soliris franchise. Overall I think of ALXN as a trading buy with an intermediate term target of $160.

Strensiq - A success of ancillary importance

This protein, asfotase, is injected several times a week as a pioneering treatment for an ultra-orphan disease that may begin infancy or later in life. When the FDA approved it, it issued a press release that noted significant efficacy for Strensiq versus placebo:

The safety and efficacy of Strensiq were established in 99 patients with perinatal (disease occurs in utero and is evident at birth), infantile- or juvenile-onset HPP [hypophosphatasia] who received treatment for up to 6.5 years during four prospective, open-label studies. Study results showed that patients with perinatal- and infantile-onset HPP treated with Strensiq had improved overall survival and survival without the need for a ventilator (ventilator-free survival). Ninety-seven percent of treated patients were alive at one year of age compared to 42 percent of control patients selected from a natural history study group. Similarly, the ventilator-free survival rate at one year of age was 85 percent for treated patients compared to less than 50 percent for the natural history control patients.

Patients with juvenile-onset HPP treated with Strensiq showed improvements in growth and bone health compared to control patients selected from a natural history database. All treated patients had improvement in low weight or short stature or maintained normal height and weight. In comparison, approximately 20 percent of control patients had growth delays over time, with shifts in height or weight from the normal range for children their age to heights and weights well below normal for age. Juvenile-onset patients also showed improvements in bone mineralization, as measured on a scale that evaluates the severity of rickets and other HPP-related skeletal abnormalities based on x-ray images. All treated patients demonstrated substantial healing of rickets on x-rays while some natural history control patients showed increasing signs of rickets over time.

This is impressive. This drug works.

Interestingly, when this was approved in October 2015, pricing was surprising, per this headline from FierceBiotech:

UPDATED: Alexion wins FDA OK on Strensiq, but startles analysts on price

But Alexion shares slid on Monday after the company startled analysts with an annual average price of $285,000, well below the $400,000 consensus that Barclays' analyst Geoff Meacham had been tracking. A few industry observers on Twitter tied the lower-than-expected price to the current brouhaha over drug pricing that has bedeviled Valeant. But Meacham still sees a solid upside for the biotech.

Other parts of the article flesh out the bull story for Strensiq, which I expect will exceed the peak sales estimate suggested in the article:

Alexion's $1.08 billion deal to buy Enobia has paid off with an FDA approval of the "breakthrough" therapy that it gained in the blockbuster bargain...

In addition to the FDA approval, Alexion also gained a big bonus prize with the approval. The agency is handing over a rare pediatric disease priority review voucher, a ticket for a regulatory shortcut that was designed to encourage development of new drugs for the prevention and treatment of rare pediatric diseases. The last voucher on the market sold for $350 million.

The enzyme replacement therapy - which has earned peak sales estimates hovering around the $500 million mark - is injected three to six times a week.

Hypophosphatasia is a disorder brought on by a metabolic disaster. Patients with HPP can't produce an enzyme needed to maintain phosphate levels in metabolites required for normal bone formation as well as brain and muscle function. Asfotase alfa is a recombinant protein designed to address the genetic deficiency, according to Alexion, preventing or reversing the impact of dysregulated calcium and phosphate metabolism.

"We are pleased that the label includes a survival benefit in infants, substantial bone healing, and improvements in growth and mobility in patients with HPP who had symptoms prior to the age of 18 and were treated with Strensiq," noted Alexion CEO David Hallal in a statement.

The nature of these ultra-orphan, extremely expensive drugs is that it takes some time for reimbursement schemes to be negotiated country-by-country ex-US. The difficulties with this particular drug are worth looking at in detail, both for Strensiq per se and because these are representative of rare drug issues that face ALXN and its competitors in this set of niche fields. Here's a current report from Pharmafile, published Feb. 8 of this year:

NICE [an official UK drug evaluating organization] has again drawn the ire of a company over its recommendation of its drug, this time round it's Alexion with its drug Strensiq (asfotase alfa). NICE confirmed its earlier draft recommendation that the drug should only be made available to a limited pool of individuals.

The restricted recommendation covers those suffering from hypophosphatasia in people with perinatal and infantile-onset disease, which also includes a proposed discount on the cost and an annual cap on the cost per patient. However, the guidance does not include treatment for those in children and adults with juvenile-onset disease.

If you followed the FDA's points, this drug works for all ages. Yet NICE says "no" to needs patients. Why? Read on:

The decision was reached, according to NICE's release, because "the cost of asfotase alfa is very high, and there are significant uncertainties about its long-term benefits, who would benefit the most from treatment, and the number of people in this patient group who might be eligible for treatment."

Well, just to argue with NICE, of course there are "uncertainties" about long-term benefits, as the drug is new. But let's show NICE what the FDA said (not a corporate shill; emphasis added now by me):

Patients with juvenile-onset HPP treated with Strensiq showed improvements in growth and bone health compared to control patients selected from a natural history database. All treated patients had improvement in low weight or short stature or maintained normal height and weight. In comparison, approximately 20 percent of control patients had growth delays over time, with shifts in height or weight from the normal range for children their age to heights and weights well below normal for age. Juvenile-onset patients also showed improvements in bone mineralization...

How is that not enough to like a drug?

NICE also complains that there are uncertainties about patient number? So what? It's ultra-rare, as the Pharmafile article goes on to say:

In England, the estimates are that there will be one to seven people diagnosed with perinatal and infantile-onset hypophosphatasia each year.

One to seven. And NICE is upset that older patients would add to that minuscule number.

All ALXN could do was respond as summarized by Pharmafile in the same article, which reported (emphasis again added):

This [decision] riled Alexion, who released its own statement in rebuttal of the decision: "In making its decision, NICE completely disregarded the proposed consensus managed access agreement (MAA) for children, juveniles and adults with paediatric-onset disease, which was developed by physician thought-leaders, patient groups, and NHS England, with input from Alexion Medical, and that identified those patients who experience the most disabling symptoms and are expected to derive most benefit from therapy."

Anyway, it's not an easy business.

If the prevalence of HPP is about 1 in 300,000, then using a population of 850,000 for the world's richer countries, there may only be an addressable patient pool of 8,500. We will just have to see where all this goes, but in Q4, Strensiq already achieved $71 MM in revenues. I expect most of the richer countries to come on board within the next year, based on the history of other novel drugs for other rare diseases such as cystic fibrosis and the experience Vertex (NASDAQ:VRTX) has had.

In any case, if we use $500 MM as a sales figure that Strensiq can reach in the next few years and assume it will not be easy for a biosimilar to even do a registration-size clinical trial with patients of different size, I expect a long run for Strensiq.

What operating margins will this drug have at full plant utilization? It's very difficult to say, but given that this is a low volume operation to produce a complex drug (a protein), and given the complexities of marketing Strensiq, I'll assume 50% net margins. If we can simplify the product's life to 12 years at $500 MM sales per year, we get total sales of $6 B and total profits of $3 B. Whether one wants to discount that estimate for present value or assume price increases over time to keep up at least with consumer price inflation is up to the reader.

In conclusion, Strensiq may be worth $3 B of ALXN's about $30 B market cap. And ALXN paid the billion for it, plus completing clinical trials and other investments.

This section has shown that acquiring even a moderately successful drug is not usually the source of outsized profitability, though as was the case here, it can be a nice bolt-on acquisition.

The big value, almost the only perhaps, comes from the Soliris franchise as well as - maybe - the expensive Synageva acquisition of 2015, which will be discussed later.

Can Soliris and ALXN1210 prove Alexion is undervalued at $132?

Soliris is an antibody approved for two ultra-orphan diseases that involve hemolysis of blood cells in PNH and extensive small blood vessel clotting in aHUS. ALXN had some equivocal results in a pivotal study of another very rare disease, a form of myasthenia gravis. After extensive discussions with regulators, ALXN is filing for regulatory approval for a form of MG in the US and EU. Approval for this severe type of MG could boost sales, which annualized in Q4 around $3 B, nicely and perhaps rapidly, given its intended approval as salvage therapy for very severe cases.

ALXN is also working on approval of Soliris for at least two other diseases (see Pipeline).

Alexion is trying to extend the patent protection for Soliris, but pending success there, US patent protection ends in four years. This has been one of the swords of Damocles hanging over the stock.

The company has been moving along a next-generation version of Soliris, identified as ALXN1210. This is in Phase 3 for PNH, aHUS, and a switch study. It is going to be a race to see if "1210" can gain FDA approval before patent expiration, but it's not even clear when and if a biosimilar will gain approval then.

My research shows three companies disclosing work on a biosimilar for Soliris. The truly credible one is Amgen (NASDAQ:AMGN), as was discussed last year in Amgen developing Soliris biosimilar. Less credible is the effort of Epirus (OTCPK:EPRSQ), which filed Chapter 7 bankruptcy last year. Of unknown credibility is the effort of ISU Abxis, a Korean company, in biosimilars including Soliris. Omeros (NASDAQ:OMER) is planning to move OMS721 to pivotal studies in various indications, including those that could compete with Soliris.

We shall have to see about all these, and others I may not have noticed either in the 10-K or by searching the Internet. If there is only one biosimilar, and if 1210 reaches market soon after a biosimilar is launched, I'd expect good uptake if it is successful. If not, trouble.

So a lot is riding on this one drug.

What are the prospects for ALXN1210?

This could be more than a much longer-acting version of Soliris that would allow infusions to be given every eight weeks instead of every two weeks.

In a Phase 2 PNH trial, the use of 1210 every four weeks may have been associated with diminished transfusion requirements than Soliris historically has led to. If demonstrated in Phase 3, this would be a clinically and economically meaningful improvement for 1210 over Soliris and any biosimilar competitor. This is being specifically studied in a Phase 3 switch study.

The second clinically and economically relevant improvement would involve the Phase 1 tactic of converting 1210 to a version that's given subcutaneously. Both Soliris and the Phase 3 version of 1210 are given IV. ALXN would not say whether a blood level study would be sufficient to bring this version to market. If that's the case and the formulations are bioequivalent, then clinical trials could be completed with the IV version, but the SQ version would be the marketed version.

This would provide a significant real world advantage.

Since 1210 is a line extension for existing indications, I look on it as a low-risk project and give it a high likelihood of success. With patent protection already until the mid-2030s, it's possible that ALXN can keep and grow its Soliris franchise for many years. That would make Soliris/1210 (and any further improvements, which are in the preclinical stage right now at the company) the equivalent of the HIV/AIDS line at Gilead (NASDAQ:GILD) or the Botox line at Allergan (NYSE:AGN).

I think the prospects for 1210 are very good.

One of the considerations for its pricing and commercial success is that cost of goods would be less, given fewer infusions needed. So presumably ALXN could offer 1210 at a nicely lower price than Soliris and make the same gross profit per year per patient. That would pressure Soliris biosimilars, if any.

Quantifying the value of Soliris plus 1210

One of the negatives for Soliris that had kept me doing nothing more with ALXN in the 2014-5 time frame than flipping it for small gains was the history of repeated manufacturing violations for Soliris at ALXN's Rhode Island manufacturing facility. Soliris is also manufactured by a Swiss company, Lonza (OTCPK:LZAGY). Per the current 10-K, this is a continuing irritant for ALXN and therefore for me.

Assuming there is no such issue for 1210, then I look at Soliris/1210 as the gift that keeps on giving. There is no credible competitor to Soliris/1210 in late-stage trials. Hoped-for competitors include entrants from Achillion (NASDAQ:ACHN), Ra (NASDAQ:RARX), Akari (NASDAQ:AKTX) and Alnylam (NASDAQ:ALNY). I'm sure there are others. I see ALXN as having the high ground here, and think that many competitors will do well to get a drug to market that, at least initially, is indicated for patients who have failed or do not tolerate treatment with Soliris/1210.

If so, then it may be reasonable to think of an 18-year run for Soliris/1210 from here. This would be reminiscent of what GILD will be achieving in HIV/AIDS assuming that its latest bictegravir-TAF-based triplet is approved and succeeds in the marketplace.

Next, we need to make revenue and margin assumptions. ALXN is guiding Soliris sales for close to $3.1 B this year. I assume this is low, and assume $3.2 B. Whatever the number is, it will be low because there are so few individuals on Soliris, those who are not on it to be in the trials of ALXN1210 make for a meaningful cut in sales.

Assuming some success with the MG and/or other indications, and the ongoing success in identifying existing PNH/aHUS cases that benefit from Soliris/1210, as well as continued market penetration ex-US, I'm going to assume $4 B sales X 18 years, or a $72 B opportunity.

Due to assumptions of market growth due to patients living longer on Soliris/1210, new patient enrollment, new indications (i.e., AGN's credo of Botox as a pipeline in a drug), price increases where feasible, and potential sales of 1210 or a next-gen successor to it beyond 2035, I'm not going to discount this $4 B for present value.

The next question is what the after-tax margin will be. No one knows, not even ALXN. I think about it this way: 10% COGS, 10% sales, 10% other + fudge factor for estimating too low on COGS and sales. That gives 70% gross margins, after which I assume 20% taxes, which could also be too low (or maybe a little too high), giving about a 56% after-tax profit margin attributable to Soliris/1210.

Multiplying 0.56 by $72 B brings us to $40 B as an estimate of the present value of Soliris/1210. Note that this makes numerous assumptions that a conservative investor can question. Further, it assumes success in global approval of 1210 in a timely fashion, meaning around 2021. It does not, however, assume success for a major new indication or successful development of a third-generation product that might be more profitable, including either a SQ version or eventually a great oral drug for these diseases.

Adding this theoretical $40 B value plus an estimated $3 B value for Strensiq is the rest of the company. I'll cover them, some of the risks and negatives, and other matters in the next section, then wrap up.

Other positives and negatives to ALXN

A modest swing factor is the drug Kanuma. This is a complex bioengineered product obtained in the 2015 $8.4 B acquisition of Synageva. I viewed this deal as a mistake, and continue to view it as such. Right now, the deal is a big money-loser for ALXN. At least some billions of the cost came from issuing overpriced ALXN's shares for the overpriced Synageva shares, so that comes out more like a wash. ALXN did sully a pristine balance sheet in the deal, and now has some net debt. Kanuma has negligible sales, but it might have a good future. I'll completely arbitrarily give it a $2 B value. There's some risk here, however. While it's early days, this is a quote from Carsten Thiel of ALXN in the Q&A:

On Kanuma, David mentioned this before, we are not satisfied with the launch uptake so far.

We will just have to assume things go better.

However, ALXN carries $5 B in goodwill on its balance sheet, about 95% of which relates to Synageva. I consider this $5 B to be worthless. In Q4 2016, ALXN took an $85 MM write-off for a Synageva pipeline product, SBC-103.

Given ALXN's market cap at the time, an $8.4 B deal for a company with no approved products at the time was unduly aggressive. Given the time it takes - or should take - to do a deal of this size, the deal has to be placed at the feet of the prior CEO and current Chairman, Dr. Bell. It would not be fair to blame it on the now-dismissed former COO turned CEO, Mr. Hallal.

In any case, I'm giving the Synageva deal a big haircut and saying it's only worth $2 B, even though the upfront cost was $8.4 B and thus the total cost was well above that.

That brings the estimated value of ALXN to $45 B.

Are there other values? Given that rare diseases is a tough business, as shown above, and given limited proven product development capabilities beyond complement diseases, how much franchise value is there here given that $45 B is real money? We give Pfizer (NYSE:PFE) a franchise value, as it is one of the pharma world's great marketers, if not the best of the bunch. Does ALXN merit some billions of franchise value?

There's no obvious right or wrong answer here, and it's relevant to Mr. Market's changing moods. Two years ago, ALXN and other hot biotechs could do little wrong in the eyes of investors. Now, it's more of a "show me" situation. So I'll say that this is a swing factor. When investors get optimistic again that just being a force in biotech means a great future is highly likely, then it will be getting time to sell again. Right now there's a lot of realism in the air, and since I believe the future is fundamentally bright for the sector, that's when I'm more willing to buy the fundamentals and wait for the sizzle to appear.

Now, there are some negatives beyond the Synageva deal. The management review of complaints of sales practices did show unethical behavior due to "tone at the top" issues. Let us hope that with a top-flight interim CEO and top-tier permanent CFO, these matters will be relegated to the past. Also, the investigation into FCPA violations is ongoing. A fine is possible but there may have been no wrongdoing.

Certainly, any prospective investor in ALXN should consider reading the latest 10-K and its risk disclosures.

Broadly speaking, ALXN is a mostly non-diversified company. This is on the minds of some analysts. The question and the response from Mr. Brennan, interim CEO, may be revealing as to how analysts view ALXN and how the company plans to move forward (emphasis added):

Yatin Suneja - SunTrust Robinson Humphrey, Inc.

Hi, guys. Thank you for taking my question. I have a big picture question. Could you maybe talk about, as you're looking at the business, how you are thinking about diversifying it away from just Soliris or Strensiq? I mean, if you look at the complement pipeline, it seems to be still focus on or around C5, which may become competitive and we haven't seen much success in the egg white platform. So could you tell us, should we expect more pipeline to come from internal projects, acquisition, early stage, last stage?

David Richard Brennan - Alexion Pharmaceuticals, Inc.

Let me start with the view about our overall pipeline. I mean, I think we've made a very strong commitment as an organization to extend our success and expect to extend our success in the complement franchise well into the next decade. Carsten mentioned about our intellectual property protections, both are expected, some new intellectual property for Soliris along with the patents we have for ALXN1210. And so our goal is to continue to develop both ALXN1210 and Soliris for new indications. There are other complement mediated diseases that go along with some of the other complement inhibitor projects that we have in the pipeline, and Martin can comment on those in a minute.

In addition to that, I think we plan to be very active from a business development perspective to identify opportunities that we think fit with our model and with our strategy and bring them in. And so, I - and we're not committed to a particular area. I think the complement franchise, I think will continue to be a very important part of our future. We believe the metabolic franchise is positioned to grow for the next several years as well. We have samalizumab [a niche cancer drug in the pipeline] now underway, which could represent yet another diversification of the pipeline and we're very active on the business development front looking at other opportunities.

As seen with the discussion on Strensiq and then Synageva, M&A activity is a hit-or-miss proposition. For further detail on these important matters, please read on the transcript the response that followed, that of Mr. MacKay.

Summary - ALXN as a potentially timely catch-up stock

This chart and explanation below show part of the reason I went long around $131 this AM.

ALXN Chart

As you can see, ALXN in the low $130s is back where it was in late 2013. Yet, based on its 2017 guidance, sales per share will double this year versus those of 2013. Then, they were $7.88/share, and this year, $15.80 or so looks like a reasonable assumption. But, in 2013, the Soliris patent cliff looked more forbidding than it does now, for several reasons.

In an ongoing bull market, getting this sort of opportunity does not happen that often, and it's good to take advantage of it if one likes the sector. I focus on PS in biotechs due to changing amounts of R&D as well as M&A activity.

Looking at the chart again, one sees a reasonable amount of resistance on the way up and especially support at the $160-165 range.

No guarantees at all, but my sense is that the Republican Party in Congress is not going to shaft biotech companies, so given that the sector (NASDAQ:IBB) has peaked more than 1 1/2 years ago and never hit the degree of insanity of Internet stocks in 1999-2000, it's reasonable that the sector could be basing this year. And as stated, I'm long-term bullish on IBB. Yet given the Tech Wreck analogy and recovery, no one individual leading name is clearly predictable as the leader. Right now, Celgene (NASDAQ:CELG) is my pick to win the biotech stock market future, with Roche (OTCQX:RHHBY) as a safer, steadier, dividend-oriented giant; and not to forget about the US equivalent of RHHBY, namely Amgen. Beyond those, I'm valuation and price sensitive. Right now, ALXN looks poised from the above fundamental analysis and the chart to be able to attract relative value "bargain-hunters."

Normally, ALXN at 43X prospective GAAP EPS and with a focus on one product line could not plausibly be a bargain. But with the S&P 500 (NYSEARCA:SPY) trading above 24X TTM EPS, and with reality intruding that EPS can only grow at the rate of nominal GDP plus a little due to buybacks and what-nots, ALXN is trading at perhaps 2X the P/E of the SPY, but with potentially enormous upside from the Soliris/1210 complex, I can justify that premium and speculate that Mr. Market will swing around to thinking that way as well as the months roll along. No guarantees!

Beyond that, the rare diseases category is well-suited to a consolidator such as ALXN, just so it bargains better than it did for Synageva. Many things about drugs for rare diseases benefit from corporate know-how. These range from manufacturing techniques, clinical trial design and execution, regulatory expertise, price negotiating strategies, public relations, patient identification and of course marketing to physicians. This differs from more mainstream types of drug treatments.

So with management issues likely to be resolved, and with ALXN providing several ways for a new, permanent CEO to make his or her mark, I'm mentally giving ALXN some meaningful franchise value in the field of rare diseases in general and immune-related diseases in specific. Thus I'm thinking of $160 as a potential first stop if the bull thesis pans out, with higher targets possible as time goes by.

Once again, though, please be aware of the risks here. These range from management issues to Soliris biosimilars to other ways of treating PNH/aHUS to failure of ALXN1210 to come to market, among many other risks.

I do not miss checking the price of RHHBY daily, but with ALXN, I do. That's the functional difference for me between investing in a true risk asset versus a truly investment-grade stock - not that the latter is risk-free either.

Thanks for reading and sharing any comments you may have.

Disclosure: I am/we are long ALXN, AMGN, GILD, CELG, RHHBY.

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.

Additional disclosure: Not investment advice. I am not an investment adviser.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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