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By David Lerman & Jodie Warner
Between October of 2010 and February of 2011, the United States Food and Drug Administration (FDA) rejected three potentially ground-breaking obesity drugs after major phase III clinical trials. Despite the fact that over 33 percent of Americans were obese at the time, there were no significant drug therapies for obesity. Along with the weight issue comes diabetes, cardiovascular issues, and a host of other collateral damage to the body.
The first company to face the FDA guillotine was San Diego based Arena Pharmaceuticals (ARNA). They conducted huge phase I, II, and III trials, involving 8,963 patients at a cost of more than $400 million. The FDA was concerned about its obesity drug, Lorqess, because it caused cancer in rats although there were no such indications in the large clinical trials in humans. In February of 2011, Lorqess was rejected by the FDA. Arena’s stock price dropped 80 percent.
Other obesity drugs such as Orexigen Therapeutics, Inc.'s (OREX) Contrave and Vivus, Inc.'s (VVUS) Qnexa met similar fates, although for different reasons. It had been over a decade since the regulatory body approved any weight loss drug. Despite having enrolled 18,000 patients at a cost nearing a billion dollars, the three companies had no drug to show for all the years of effort and money invested.
Fortunately, Congress became involved in the FDA’s draconian rejection record and began to pressure the administration in an attempt to moderate the massive failure rate of drug approval. These drugs were approved within a few years after the FDA reconsidered new data.
One extreme example of the costs of drug development involves the costs of clinical trials for Johnson & Johnson's (JNJ) Xarelto and Bristol-Myers Squibb's (BMY) (and Pfizer’s (PFE)) Eliquis. Costs exceeded $6 billion and the companies enrolled a mind-boggling 130,000 patients for the stage III trials for the factor Xa Inhibitor that is used to treat cardiovascular diseases such as Atrial Fibrillation and Venous Thrombosis. (See figure 1 below to see just how much more the Biopharmaceutical sector spends than other sectors of the economy.)
Figure 1: R&D Expenditures per Employee by Manufacturing Subsector/Industry 2000—2010
The cost of drug development in the United States has continually escalated and stands in the billions depending on whose research you read. A good deal of the cost is locked up in navigating the various clinical trials required by the United States Food and Drug Administration (FDA)—especially the phase III trials which, on average, are about 90-95 percent of the total costs of the three phases. Approval can mean large profits for the successful company; rejection spells a huge loss of money and adverse consequences for any publicly traded company. Just ask Eli Lilly and Company (LLY). After announcing in November the failure of their promising Alzheimer’s drug, Solanezumab, in stage III trials, the stock price fell off the cliff. Despite Lilly’s financial strength and a long successful operating history, Lilly’s shares dropped over 10% on the news.
In view of these examples and the vast need for newer drugs and therapies to combat an aging society, pharmaceutical companies must respond to the escalating complexity and costs involved in drug development.
Clinical trials take years, require huge investment costs, and their increasing complexity makes it difficult for even the strongest companies to move forward. Xarelto had over 60,000 patients enrolled in their stage III trial. Imagine the massive record keeping and data generated by 60,000 patients over the life of a clinical trial… all the blood tests… all the physician/nursing reports… as well as the other exams and procedures. The trend over the years makes these trials even more complex and capital intensive, as the average length of a trial has increased from 500 days to nearly 800, and the number and types of routine blood tests, x-rays and other exams has grown significantly. Understandably, pharmaceutical companies, more than ever, are outsourcing some of their complex clinical trials to Contract Research Organizations (CROs) as they seek more efficient clinical trials and ways to increase their odds of success at recouping their investment and subsequently making a profit. To achieve these goals, the biopharmaceutical industry will often partner with CROs. Here we investigate one the best in the business—Quintiles IMS Holdings (Q).
New therapies are needed to treat not only common conditions such as cardiovascular disease, cancer and Alzheimer’s disease, but also diseases that we either thought were cured, like drug-resistant bacterial infections or tuberculosis; diseases we did not previously recognize, such as the potential link between in utero Zika infection and microcephaly; or curiosities from medical textbooks, such as Ebola and dengue fever.”
—Tom Pike, CEO, Quintiles (2015 letter to shareholders)
Quintiles IMS Holdings is really two unique companies in one. In fact, Quintiles Transnational and IMS Health merged in 2016 to form the combined entity. The merger was completed in October of 2016. We have long been a fan of IMS Health before it was folded into Quintiles. For the purposes of this issue, we will cover their basic businesses separately, but we will present the financials and investment thesis as one consolidated entity. Quintiles IMS indeed has a strange name. They haven't invented any miracle drugs to cure or treat disease such as Vertex Pharmaceuticals' (VRTX) Kalydeco or other biopharma blockbusters, but you can be sure that odds are good, most of the drugs we are familiar with went through a clinical trial that Quintiles IMS had a hand in organizing. Their products and services are a vital prerequisite for the pharmaceutical industry as it takes a drug from the research lab, to FDA approval, to the shelves of a pharmacy. They also have a huge arm (the former IMS division) that possesses critical data on the prescribing habits of doctors, as well as a massive database on prescription drugs filled at major pharmacies like CVS (CVS) and Walgreens (WBA). Even if the drug fails in late stage trials, Quintiles IMS still gets paid. Could it be the biopharma equivalent of a picks-and-shovels company?
Quintiles IMS is, in a strange sort of way, a picks-and-shovels company. For every blockbuster like Humira or Lipitor, drug companies will suffer many failures in their search for the next breakthrough medicine. Q helps drug companies plan and orchestrate the all-important, late-stage clinical trials. Since the 1940s when antibiotics were used to combat Tuberculosis, clinical trials have been crucial in demonstrating the safety and effectiveness of the drugs used in modern medicine.
Contract Research Organizations (CROs), of which Quintiles IMS is the largest, advise and consult with clients about every aspect of these important FDA trials. They plan and organize the trials, as well as dealing with the submission for regulatory approval. If you want an up-close and personal look at an FDA new drug application, check out the book The Antidote by Barry Werth. Werth wrote about Vertex Pharmaceuticals and was given unlimited access to the company’s senior management and scientists. He had a CEO’s view into Vertex’s New Drug Application (NDA) submission for Teleprevir, the Hep-C drug it brought to market after a 15-year effort. Over a million pages were submitted as part of the regulatory approval process. Quintiles IMS’s expertise, infrastructure and massive database on clinical trials make them the go-to company for nearly every major pharmaceutical firm in the United States (See figure 2 below).
Where Q really can add value is in achieving efficiencies that speed clinical trials along at a faster rate. As an illustration, let’s examine the immuno-oncology drug Keytruda, Merck & Co.'s (MRK) blockbuster PD-1 inhibitor that is gaining wide acceptance in multiple cancer indications. What if, due to efficient design, the stage III trials were accelerated to completion 3 months ahead of schedule, and FDA approval was gained a quarter or two early? Given that Keytruda will be a multibillion-dollar blockbuster, the revenues gained to Merck, from the earlier approval, can be substantial and into the tens of millions. Now, we’re not saying Keytruda’s trials were completed early, or even that Quintiles IMS had a hand in Keytruda’s trials; we are merely trying to illustrate the benefits that Q might add to trial outcomes. It should come as no surprise that clinical trial sponsors (drug companies) are willing to pay a premium for this service since it would pay for itself.
The IMS part of Quintiles IMS is also an attractive business, one we came close to purchasing many years ago but couldn’t because the company was taken private by TPG and Canada Pension Plan Investment Board (the largest pension plan in Canada).
Today, most people would agree that information is a valuable commodity. Simply survey the success of Google (GOOG, [[GOOGL]]) and Facebook (FB) at monetizing the information they have – both firms make tens of billions in advertising because they have access to vast storehouses of information and attract billions of users to the search firm and the social networking giant. While IMS Health (as it was known before their merger with Quintiles) isn’t quite the same business model as a Google or Facebook, they have a compelling story:
- IMS’ database contains over 15 petabytes of information. To give this scale, 1 petabyte is equal to 20,000,000 four-drawer filing cabinets, filled with text; 1.5 petabytes = the size of 10 billion photos on Facebook; 50 petabytes = the entire written works of mankind since the beginning of history in all languages. Clearly, IMS has a very big database.
- IMS processes over 45 billion healthcare transactions per year (that’s 6 for every man, woman and child on the planet).
- IMS collects data from 780,000 streams of data and organizes them into comprehensive databases.
- IMS has 500 million longitudinal studies and anonymous patient records. (Longitudinal studies are those done on the same patients over a long period of time.) The famous Framingham Heart Study is an example of a longitudinal study. Patients were studied regularly over decades and had thorough evaluations to determine cardiovascular health. The results of the study laid the groundwork for determining who is at greater risk for a cardiovascular incident (heart attacks…etc.). The result was major advances in treating heart disease and greater survival for those who suffered heart attacks. IMS has half a billion of these types of studies (although likely not as large and encompassing as the Framingham Study).
Imagine if you had access to information regarding a substantial percentage of the prescription drug sales in the United States. What if you knew the pharmacy, the doctor prescribing the medicine, and you had reams of data about the patient as well, with the exception that all the data was “anonymized” (i.e. names removed from the database so that patients’ confidentiality is preserved.) Furthermore, what if you had the information on medical records…blood tests…procedures…diagnosis…etc.…on millions of “anonymized” individuals? IMS Health has substantial amounts of this data.
So how is this data useful to big pharma? Let’s consider a doctor, a group of doctors, or even a hospital prescribing Prozac (made by Eli Lilly), more often than Zoloft (made by Pfizer). Pfizer would be a likely subscriber to IMS’ database and would know who in the country is prescribing the competitor drug, Prozac, over its Zoloft drug. With this information, Pfizer could allocate teams of pharma reps to that area or more specifically the doctors. The hope would be, to convince some of these professionals to switch to the Pfizer product.
Clearly, the expertise and databases that both entities possess are valuable. When the two companies merged late in 2016, a juggernaut of healthcare information and IT was formed. Quintiles IMS has thousands of large customers in the pharmaceutical business and in the healthcare space. The firm boasts a client retention rate of nearly 100 percent among its largest customers—unheard of in most businesses. Another key attribute to this firm: The average length of Quintiles IMS’ relationship with their top customers is on the order of 25 years. How many firms in the ultra-competitive business world stick with a service provider for that length of time? It speaks volumes to the quality of their work and the reputation of the company, if not also to the lifecycle of Pharma’s R&D pipeline and ongoing drug trials.
Investment Thesis—Quintiles IMS
Q doesn’t easily lend itself to the typical analysis at this point, because of the recent merger. Debt levels have soared in order to finance acquisitions. In time, the numbers will consolidate, the debt will be reduced, and shareholder equity will rebuild. Still, the metrics we can see are solid. The P/E ratio is reasonable at about 20. It's relative P/E ratio is slightly above 1 and stands at 1.05. Not too expensive…but not cheap either (see figure 3 above)
- Return on invested capital is a solid 17.5%. Return on Equities is not applicable because equity is temporarily in deficit. Remember, this is a company that has massive databases and expertise. It doesn’t have significant tangible assets like real estate, buildings or a portfolio of investments.
- Earnings and revenue forecasts are solid and well into double digits. Valuation metrics such as Price to sales and Price to free cash flow are also reasonable like the P/E ratio.
- One of Quintiles IMS’ biggest strengths rests with a very large and growing backlog of orders. The book to bill ratio (business booked / actual revenues) is a healthy 1.23.
- We like that officers and directors (company insiders) own over 10 percent of the shares outstanding. They have skin in the game and we always like to see shareholder and management goals aligned.
Figure 3: Quintilies IMS Metrics
|Market Capitalization||$19.5 billion|
|Long term debt||$2.4 billion|
|Price Earnings Ratio current||19.4x|
|Relative P/E Ratio current||1.05|
|Dividend yield||0.0 %|
|Operating Margin (2017 est)||23.0|
|Return on Invested Capital||17.5%|
|Est 5-year Earnings growth||12.0%|
|Past 5-year Earnings growth||17.8%|
|Price to Free Cash Flow||18.2x|
|Price to Sales||1.6x|
|Price to Earnings growth||1.3x|
|1-year Total Return||12.7%|
|3-year Total Return||70.9%|
|Does business in||Over 100 countries|
|Insiders own:||10.9% of shares|
|Order backlog 2011||$7.9 billion|
|Order backlog 2015||$12.1 billion|
|Book to Bill Ratio||1.23 (new business/revenues)|
Risks to the Business
The entire CRO business is vulnerable to changes in spending for drug development and R&D. While trends look positive for companies to outsource their clinical trials, any reduction in capital spending or budgets for R&D could have an adverse impact on revenues on Quintiles IMS and their competitors.
- With its large size, if they were to lose a clinical trial client, they would survive. No one client makes up more than 10% of revenues; the impact would be minimal.
- Although IMS’ vast archive of data and medical records are “anonymized” for privacy concerns, there is a growing concern that patients will demand increased privacy going forward. In fact, several court cases have been tried against the IMS entity, but all have lost. However, should the courts prove friendlier to privacy concerns, additional litigation could be brought, and that poses a risk to IMS's massive data-gathering potential in the future. Should patients be allowed to opt out of having data collected, this will cause headaches for Quintiles IMS.
This is a solid company that rides the coattails of drug development and commercialization. As biopharmaceutical companies shuttle potential drugs from initial concept to placement on pharmacy shelves, there are hundreds of questions that must be answered. Quintiles IMS helps the pharmaceutical industry arrive at solutions. Their massive scale and reputation in the industry is second to none. While Q does have several competitors, they are in a solid position and should be able to grow their business substantially. The stock has traded as high as $81.4 a share. In 2013, they traded at $40 a share. They have had a nice ride higher. The merger does present investors with some questions: Will Q be able to realize those all-important merger related synergies in the months/years ahead? Will the merger proceed smoothly and will these two newly-weds grow their marriage? Personally, we have liked IMS Health for years. We find Quintiles IMS an attractive company and a play on the biotechnology/pharmaceutical sector.
Disclosure: I am/we are long Q.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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