Introduction - INCY as a strong performer (too strong?)
The mid-cap biotech Incyte (NASDAQ:INCY) has had a volatile time of things the last few years. The three-year chart shows this:
Yet, until this year, the operating and R&D trends were basically straight up. From $50 almost straight up to above $125, then below $70, then to $150, now suddenly below $120. Clearly, this is not Pfizer (NYSE:PFE) or another takeover candidate with huge sales and revenues such as BMS (NYSE:BMY). The long-term chart of INCY is positive, to say the least:
This is impressive. With much more volatility and no dividends, INCY more or less has done as well as Starbucks (NASDAQ:SBUX) since the mid-1990s. A chart like this attracts dip-buyers. Clearly, traders have seen something here to like. But is it ahead of itself, or simply bubbly? That sort of question comprises much of the underlying theme of this article.
I've written about INCY a few times, and as I've disclosed, I bought this name at $104 on the way up several months ago and sold at $129 on the way up after the announcement that INCY was being added to the S&P 500 (NYSEARCA:SPY). The stock then soared another 20 points after I sold, and clearly, I also did not come close to buying INCY near its recent bottom, either. So, I claim no special ability to trade this stock, but maybe I can provide some organization of the facts about INCY in this article, along with some analysis and opinion, that will help you think about it.
This article will be organized in fairly brief sections that cover what appear to me to be the main issues in deciding whether to go long INCY. My bias is not to, even though the stock, around $118 as I write this Monday afternoon, is about 9% lower than where it was when I sold it in Q1. In writing this, in addition to prior research, I've relied additionally on the Q1 press release, the earnings call transcript, the slide show accompanying the earnings call, and for the partnered drug baricitinib, the Lilly (NYSE:LLY) earnings call transcript.
After a debt-for-equity swap in Q1, shares outstanding were 205 MM, per the CFO's prepared remarks. At a price of $118, the market cap is $25 B.
While this transaction increased stockholder equity, it was still only $965 MM at the end of the quarter. Of that, $409 MM were allotted to intangibles and goodwill.
$29 B market cap for a company with a little over $1 B in product sales projected for this year is quite rich.
Is the company allocating capital wisely?
For a small company with an immense pipeline and alliances with Novartis (NYSE:NVS), Merck (NYSE:MRK), and others, INCY has engaged in more deals where it acts as the big company than I would have expected. It has made a deal with ARIAD for some ex-US rights to Iclusig, and revenues have been nominal so far (though the product is young). That deal is iffy in my eyes. It also has deals with Agenus (NASDAQ:AGEN), Merus (NASDAQ:MRUS), and Calithera (NASDAQ:CALA). All these are also iffy.
Is management distracting itself with so many collaborations, as well as taking undue financial risks? Isn't it enough to pay its share of collaborative efforts with LLY, MRK, and others?
What really went wrong at FDA with baricitinib?
This is a partnered JAK inhibitor, which appeared to have a successful, Big Pharma-quality Phase 3 program for rheumatoid arthritis. This is a drug related in its mode of action to the successful, growing Pfizer drug Xeljanz. The PDUFA date was January, and FDA delayed that by three months. In the meantime, EU approval was given for the 2 mg and 4 mg doses for RA, under the brand name Olumiant. Substantial expectations were, therefore, that the FDA would be able to approve the drug, though perhaps the lead company in dealing with the FDA and the marketer, LLY, would not get the best wording in the label.
Then, the FDA failed to approve Olumiant, setting off the slide in INCY's stock price and briefly denting LLY's. INCY refuses to say much in response to questions, and LLY was pretty much tight-lipped as well in its responses to several questions from analysts on this matter in its earnings call.
All we know is that the FDA has certain safety concerns with the drug and certain questions about one dose versus another.
Because INCY paid a significant amount of the development costs for baricitinib in return for about 25% royalties and with other projects in autoimmune diseases underway and planned, the potential permanent loss of US Olumiant revenues affects my view of INCY stock in two ways. First, I have removed most royalty revenues from my modeling of its valuation. Second, questions about the quality of INCY's clinical acumen and even the quality of the drugs it develops have been raised. With so much of INCY's valuation based on the success of pipeline drugs, those are both issues that I now consider, whereas prior to the FDA's rejection of baricitinib, I gave INCY more respect in thinking of its pipeline's likely value.
Another pipeline disappointment went almost unnoticed
An oddball use of INCY's one important drug, Jakafi, could be important, namely reformulation to a topical use. That's because INCY's deal with its partner NVS gives NVS ex-US rights to all oral but not topical forms of Jakafi. That would allow INCY much greater global profits, plus (I would guess) a renewed patent protection for the topical product, if it could get a topical version approved in the US and ex-US.
I believe I mentioned in a prior INCY article that it was studying a topical version of Jakafi for a form of patchy baldness, alopecia areata, in Phase 2. PFE is apparently studying Xeljanz for this as well. In any case, at least as used on the scalp, Jakafi's active ingredient (ruxolitinib) did not show adequate efficacy as compared with placebo. Some rashes or other skin irritation was also seen. While INCY continues on investigating ruxolitinib for other dermatological conditions, previously, I gave some speculative present value to this indication or other derm indications, but I've removed that as well from my INCY valuation model.
Hints of trouble in another pipeline product
INCY has been promoting its vast, interesting pipeline. One of the secondary products it's been mentioning is essentially a second-generation version of Gilead's (NASDAQ:GILD) Zydelig, a PI3K inhibitor (another intracellular enzyme). However, apparently, while free of the liver toxicity seen with Zydelig, this compound has problems. From the conference call, part of the response from INCY to the final question:
But the PI3 kinase delta program, in a nutshell, the way we view it is it's a second generation inhibitor...
The real issue becomes long-term tolerability particularly as you get out beyond the 140, 150 days, and that's where our challenge is now. We know we have an active compound. We presented data at ASH last year across B cell malignancies a very high efficacy. What we need now is working internally and then with our investigators and ultimately with the Agency to come up with dose and the schedule modifications that help retain the efficacy, but then give you long-term tolerability. And that's in the monotherapy setting. I think in combination, we've been cautious and going slowly. We have numerous combinations ongoing in terms of safety enabling, but we have to be very focused on toxicity and appropriate prophylaxis.
I mention this because Zydelig was promising as a competitor to the mega-blockbuster anti-cancer agent Imbruvica, and a better Zydelig could have real upside. But we have learned that it may just be a class effect of inhibiting this enzyme.
Not only does this read on the potential for this particular candidate of INCY, but it's a reminder, in case one is needed, that until a drug is approved for marketing and then is successful, it's a cost center, not a proven asset.
That leads to the best-known INCY development-stage compound.
Epacadostat - is it well enough known by now?
As we have seen, there's been significant attrition or questions raised about INCY's earning power since it zoomed above $130 to all-time highs. One of the ongoing reasons for its continuing high market cap is not just the chance for Jakafi to grow steadily until it goes generic next decade. It's epacadostat, yet another of INCY's compounds with real possibilities. This is an immuno-oncology asset. It is in expanded, pivotal trials with MRK and elsewhere.
There is some competition in its class, but it is first-in-class. Now, that's a risk, as the drug may never come to market. Or, if it comes to market, an as-yet unknown side effect might limit its use. So, how do we value this drug?
Which raises the ultimate question of how we value INCY as a whole and how an acquirer would value it.
Note please, this is not a full review of INCY. Rather, it provides a sort of nested approach to weaknesses in the bull case for the stock. Yes, it's way down from its high. But on the other hand, this was a $69 stock one year ago, when Jakafi was well known and the widespread expectation was that baricitinib would be approved by the FDA in January.
So, when I look at the new market cap around $25 B, with about $0.5 B in tangible equity, I see too many question marks around this stock to want to own it yet. These questions include:
- risky deal-making with smaller entities
- does this small company have adequate clinical savvy
- questions about how superior INCY's drugs are across the board, based on safety issues on baricitinib raised by the FDA
- is the pipeline too broad and unfocused
Jakafi has patent protection until mid-2028, so it has 11 years to generate profits. There is little competition for it now and perhaps for quite some time to come. So, this is a strong company with a significant present value. Just a guess, with several disappointments to digest as I've discussed above, this stock may well have trouble gaining institutional support until it drops further, perhaps all the way to a $20 B valuation.
What would a PFE or GILD pay to own the revenue stream from Jakafi? Well, PFE's global reach is irrelevant here, as NVS owns ex-US rights. No doubt the pipeline will interest PFE, but there are issues with PFE's Xeljanz as a direct competitor of Olumiant in the EU and eventually possibly in the US. Plus, does PFE want the alliances that INCY has busily been forging? As far as GILD goes, when it hired Dr. Riva a few months ago from NVS, my first thought was that INCY was in play, and that's when I bought INCY at $104. Given GILD's historical value approach to deal-making, I wouldn't bet on a big premium being offered given clouds over Olumiant.
Of the many other possible companies that could buy INCY, the most obvious is its partner in Jakafi, namely NVS. Typically, NVS is a cautious company in this regard, though, and it could have done the deal when INCY was in the $70s. That might leave a sleeper such as Celgene (NASDAQ:CELG). This is a buyer that has not been afraid to pay a rich price if it really wants an asset. CELG knows the immuno-oncology space extremely well, but I just do not know if it wants to buy a break-even (or so) company such as INCY for at least $30 B (my guess).
So, understanding that a takeover bid could come in for INCY at any time, I'm still staying clear until either the price drops some more and/or more clarity on Olumiant and other matters appears. Also, I'm listing this as a "long" idea given that I'm looking to go long, and over time, I like this company and the stock. But, personally, I'm not buying in again - yet.
Thanks for reading and sharing any comments you wish to contribute.
Disclosure: I am/we are long CELG,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.
Additional disclosure: Not investment advice. I am not an investment adviser.