Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years? - Phillip Fisher
When you look at investors' track records over the years, there are very few who trade actively while managing to beat the market. That is, if and only if, they genuinely present their outcomes. Your proof in the pudding is that investing gurus - like Warren Buffett, Phillip Fischer, Benjamin Graham, John Templeton, and Peter Lynch, who outperformed the market - highly recommend the passive investing approach. Of note, there is nothing wrong with trading and speculating. You simply have to know when you trade and speculate versus when you truly invest. That way, you can hedge your risks properly. Simply put, don't flip in and out of your position unless you do day trading.
As a long-term investor, make sure you give the company adequate time to turn around even when the investment story changes. That being said, I'd like to revisit my investing thesis on Galapagos NV (NASDAQ:GLPG). Despite their debacle in recent years, Galapagos has been fighting hard to make a comeback. In this research, I'll feature three arguments relating to Galapagos for you to arrive at your own investment decision.
Figure 1: Galapagos chart
As usual, I'll deliver a brief corporate overview for new investors. If you're familiar with the firm, I suggest that you skip to the subsequent section. Operating out of Mechelen, Belgium, Galapagos is focused on the innovation and commercialization of new drugs to serve the unmet needs of chronic and inflammatory diseases.
As the crown jewel of this pipeline, filgotinib (Jyseleca) is a selective JAK1 inhibitor that is already launched for rheumatoid arthritis (i.e., RA) and ulcerative colitis (i.e., UC) in the European Union (i.e., EU), Great Britain and Japan. Notably, Galapagos is expanding Filgo's indication for Crohn's disease (i.e., CD). That aside, the company is brewing other novel molecules for various conditions.
Figure 2: Therapeutic pipeline
Shifting gears, let us take a deep dive into the investing story of Galapagos. As you can see, I initiated my coverage of Galapagos back in June 2018. As shown below, the crown jewel filgotinib was being expanded in a vast number of autoimmune and inflammatory conditions during that time. Given that the investment prospects of Galapagos reside in filgotinib, pertinent changes regarding this molecule are crucial. That is to say, whether Galapagos would continue to grow fundamentally (through gaining FDA approval and robust sales increase) are heavily dependent on filgotinib.
If you recall, back in July 2019, Galapagos struck a mega-deal with Gilead (GILD) for filgotinib's development and commercialization. Specifically, Galapagos received $3.95B in upfront payment and another $1.1B in equity investment from Gilead. As you know, whether a smaller company like Galapagos can fully unlock the value of their drugs is integral to having a larger and strong partner. Hence, another piece of this investing puzzle is whether Gilead would continue to advance its partnership.
Figure 3: Previous development
Fast forward to August 2020. Galapagos received a complete response letter (i.e., CRL) from the U.S. FDA regarding its filgotinib application to treat moderate to severe active rheumatoid arthritis. Accordingly, the FDA expressed concerns about filgotinib high dose (i.e., at 200mg) on sperm counts. As such, the Agency requested additional data from the MANTA and MANTA-RAy studies. Moreover, it's quite likely that the FDA also expressed concern about the overall therapeutic benefits versus the risks of Filgo 200mg.
Usually, a company would wait until it received the full data to go back to the FDA for resubmission. I've seen many companies that had better luck on their second and/or third trips to the FDA. It is interesting that Gilead and Galapagos decided to capitulate on US soils. Hence, it goes back to what I said, that there might be other safety concerns that we are unaware of.
As ramifications of the new terms, Gilead will not advance Jyseleca in the USA for RA and would not pay any additional development expenses pertaining to the U.S. market. Correspondingly, Galapagos would assume all development and commercialization expenses in the EU for both RA/UC and any other future indications. Gilead would then receive sales royalties starting in 2024. However, Gilead would still pay €160M to support developmental efforts in the EU.
Adding further injury to the insult, Galapagos encountered management concerns. Beginning in January 2022, the former CEO and Founder (Onno Van de Stolpe) would be replaced by the new CEO and co-founder (Dr. Paul Stoffels). In the press release, Galapagos stated that this is a "planned retirement." Nevertheless, it's important that you "read between the tea leaves." You can imagine that when things are going well, no CEO would want to retire.
Executives would want to add more accolades to the golden years of his career. That way, they'll have more interesting stories to tell their grandkids. If you think about it, if there are deeper troubles, it would make sense for the CEO to step away. Why not let someone else take the blame? Sure, you may disagree with me. However, you should try to see things from the executive's viewpoint. Simply put, I have never seen strong developments in a company after the CEO left. For a public company, it would usually take several years to turn around from such a departure.
In my observation, the worst situation is when a company brings in an outside CEO. That would mean the company lacks internal talent. This is not the case for Galapagos because Dr. Stoffels is a co-founder. As such, he has tremendous leadership experience and a strong background in therapeutic development from Johnson & Johnson (JNJ). Hence, it might not be as bad as you would assume.
Asides from the former CEO's departure, the Chief Scientific Officer (Dr. Piet Wigerinck) also left the company as disclosed back in June 2021. Dr. Wigerinck was the one responsible for the aggressive pipeline expansion and the development of Jyseleca. In a transition, he would be replaced by Dr. Walid Abi-Saab.
As you can see, the combo of two big hitters in a company leaving does not bode well. They were the ones who essentially groomed the company to its former glory. With them leaving, perhaps there is more to this story than what we know.
Obviously, Galapagos is in trouble. The investing story (i.e., thesis) indeed changes. The crown jewel is no longer being advanced in the most lucrative market (i.e., the USA). The mega partnership is now substantially reduced to only in Europe. The Captain, along with his top officer, has already abandoned the ship, while the other officer is taking command of the helm.
As you're now curious, the big question is can Galapagos turn around? Keep in mind that many companies will go through periods of ups and downs. Some of the greatest companies like Tesla (TSLA) hit a very low point in their life cycle that they nearly went bankrupt. Thereafter, Tesla successfully turned around to become the giant that it is today.
That being said, I will present three arguments for you to consider. If you've been following my research for a while, you know that I love to present all the data and facts for you to decide on your own.
In the first argument, Galapagos can successfully turn around to surpass its former size. In this situation, Galapagos would ramp up Jyseleca sales for the said drug to become a blockbuster. The strongest evidence supporting this argument is that the company has plenty of cash to do so. For any company wanting to make a successful comeback, you have to check its cash. After all, cash is king. With ample cash, a firm can either in-license new drugs or simply acquire another company.
Based on the latest filing, Galapagos indeed has €4.6B (i.e., roughly $4.8M) in cash. That's quite significant for a company having only €3.7B in market capitalization. Simply put, Galapagos is trading significantly below its cash position. In addition to the cash position, you have to assess their burn rate. Regarding management's latest projection, Galapagos would consume roughly €450M to €490M for Fiscal 2022.
Notably, this assumption does not factor in the ongoing research for Jyseleca and other potential business development (say, a potential acquisition). In pitting Jyseleca revenue against the cash burn rate, you can see that Galapagos has roughly eight years to turnaround. If the company can continue to ramp up Jyseleca sales to break even by 2028, Galapagos would successfully come back.
Figure 4: Galapagos financial projection
As you can see, Argument #2 is quite similar to the first one. Notably, Galapagos has the fire power to turn the company around. Moreover, the company is diligent in unlocking the value of Jyseleca as well as ramping up other pipeline molecules. But how likely is Galapagos to successfully turn around? On that note, let us take a closer look at these fundamental developments.
As you know, Jyseleca is already launched for both RA and UC in Europe and Japan. For RA, Galapagos increased Jyseleca's reimbursement in 15 countries. For UC, there are currently 5 countries reimbursing the drug. Altogether, that translated into the increasing trend in product revenue of €14.4M for 1Q2022. As shown below, Galapagos projected that Jyseleca would deliver €65M to €75M for this fiscal.
Figure 5: Jyseleca sales results
While the aforesaid €75M for Fiscal 2022 may not seem much, the longer-term revenues trend and the current cash position are highly promising. From the figure below, you can see that the management anticipated the revenue to hit over halfway toward blockbuster in the next three to five years. Ramping up drug sales is like a snowballing effect. In other words, the first few years are difficult. But once the sales traction is attained, it'd be much easier to see the sales escalates.
Figure 6: Estimated Jyseleca sales
Even with the aforementioned favorable developments, I would expect twice the growth rates in sales for Galapagos to truly come back. That aside, I want to see more significant pipeline advancement to ascertain long-term progress. At this juncture, there is a chance that Galapagos can turn around yet I believe it's not a solid chance.
From the completely opposite view, Galapagos is highly unlikely to come back for several reasons. The first one, as you know, is that the company already lost two key executives: the former CEO (Onno Van De Stolpe) and the former CSO (Dr. Piet Wigerinck). The founding CEO and long-term CSO know a company best. And if they left, the chances of the firm returning to its golden days are next to nothing. In my view, it's not where the bus is going. It's who's on the bus.
The second (and extremely important) reason is that the company has already given up on a lucrative/key market (i.e., the USA). Drugs being launched in the U.S. typically enjoy a premium reimbursement compared to elsewhere in the world. If a company either fails or chose not to market their drug here, you can see that it's a big mistake.
While I do not know the rationale for not seeing development in the USA, I noticed that the company's latest data release for MANTA and MANTA-RAy studies indicated no sperm abnormality. Specifically, Galapagos disclosed that 8.3% of patients on placebo and 6.7% of patients on Jyseleca correspondingly saw a 50% or more decline in sperm concentration at Week13 in the aforesaid trials. Therefore, this indicates that Jyseleca is unlikely to cause sperm abnormality. If this is true (and the quality of the data is great), I don't see a reason for not taking Jyseleca to the FDA. Again, it goes back to the possibility of safety concerns that we do not know about.
Regarding competition, there are many drugs for managing RA. From the figure below, you can see that they are being launched by big pharmaceutical companies. These drugs include both generics and brand names. That aside, you have the biosimilars competing in this niche. Obviously, this is an extremely competitive space. In contrast to the competition, Jyseleca is selective for a subtype of JAK1 which confers product differentiation. As such, Jyseleca would be unique from Rinvoq of AbbVie (ABBV) and Olumiant of Elli Lilly (LLY) to be competitive.
|Drug||Drug Class||Administration||Company||FDA Approved for RA|
|upadacitinib (Rinvoq)||Janus kinase (JAK) inhibitor||oral extended-release tablets once daily||AbbVie (ABBV)||16-Aug-2019|
|baricitinib (Olumiant)||Janus kinase (JAK) inhibitor||oral tablets once daily||Eli Lilly (LLY)||31-May-2018|
|sarilumab (Kevzara)||interleukin-6 (IL-6) receptor antagonist||subcutaneous injection every 2 weeks||Sanofi (SNY) and Regeneron (REGN)||22-May-2017|
|tofacitinib (Xeljanz XR)||Janus kinase (JAK) inhibitor||oral extended-release tablets once daily||Pfizer Inc. (PFE)||23-Feb-2016|
|golimumab (Simponi Aria)||tumor necrosis factor (i.e., TNF) blocker||intravenous infusion at weeks 0 and 4, then every 8 weeks||Janssen Biotech, Inc. (JNJ)||18-Jul-2013|
|tofacitinib (Xeljanz)||Janus kinase (JAK) inhibitor||oral tablets twice daily||Pfizer Inc. (PFE)||6-Nov-2012|
|tocilizumab (Actemra)||interleukin-6 (IL-6) receptor antagonist||intravenous infusion every 4 weeks subcutaneous injection every 2 weeks, then every week||Genentech, Inc. (OTCQX:RHHBY)||8-Jan-2010|
|certolizumab pegol (Cimzia)||tumor necrosis factor (TNF) blocker||subcutaneous injection at weeks 0, 2, and 4, then every 2-4 weeks||UCB, SA (OTCPK:UCBJY)||13-May-2009|
|golimumab (Simponi)||TNF blocker||subcutaneous injection once a month||Janssen Biotech, Inc. (JNJ)||24-Apr-2009|
|rituximab (Rituxan)||CD20-directed cytolytic antibody||intravenous infusion two infusions separated by 2 weeks (one course) every 24 weeks or based on clinical evaluation (not sooner than every 16 weeks)||Genentech (OTCQX:RHHBY)||28-Feb-2006|
|abatacept (Orencia)||selective T cell costimulation modulator||intravenous infusion at 0, 2 and 4 weeks, then every 4 weeks subcutaneous injection once weekly||Bristol-Myers Squibb Company (BMY)||23-Dec-2005|
|adalimumab (Humira)||tumor necrosis factor (i.e., TNF) blocker||subcutaneous injection every 2 weeks||AbbVie (ABBV)||31-Dec-2002|
|anakinra (Kineret)||interleukin-1 receptor antagonist||subcutaneous injection once daily||Swedish Orphan Biovitrum AB (OTCPK:BIOVF)||14-Nov-2001|
|infliximab (Remicade)||TNF blocker||intravenous infusion at 0, 2, and 6 weeks, then every 8 weeks||Janssen (JNJ)||10-Nov-1999|
|etanercept (Enbrel)||TNF blocker||subcutaneous injection once weekly||Immunex Corporation (AMGN)||2-Nov-1998|
|leflunomide (Arava)||pyrimidine synthesis inhibitor||oral tablets once daily||Sanofi (SNY)||10-Sep-1998|
Figure 7: Competitor landscape for Jyseleca
Just as you would get an annual physical for your well-being, it's important to check up on the financial health of your stock. For instance, your health is affected by "blood flow" as your stock's viability is dependent on the "cash flow." With that in mind, I'll analyze the 1Q2022 earnings report for the period that concluded on March 31.
As you know, Galapagos enjoyed €14.4M in product sales for Jyseleca and €136.3M in total net revenues. Of that figure, the collaboration revenues with Gilead constitute the bulk of revenues. As a whole, you can see that the product sales (which are most important for Galapagos going forward) are not as significant as I would like to see.
That aside, the research and development (i.e., R&D) registered at €99.3M compared to €130.0M for the same quarter a year prior. I generally view an R&D trend positively because the money invested today can turn into blockbuster profits tomorrow. After all, you have to plant a tree to enjoy its fruits. Additionally, there were €13.3M (€0.2 per share) net losses compared to €9.4M (€0.2 per share) declines for the same comparison. On a per-share basis, the bottom line remains essentially the same.
Figure 8: Key financial metrics
About the balance sheet, there were €4.6B in cash, equivalents, and investments. Against the estimated €450M to €490M burn rate (along with the estimated €75M in revenue), there should be adequate capital to fund operations for roughly eight years. That is assuming there are neither additional pipeline expansions nor business development. Simply put, the cash position is extremely robust for Galapagos.
While on the balance sheet, you should check to see if Galapagos is a "serial diluter." A company that is serially diluted will render your investment essentially worthless. Given that the shares outstanding increased only from 65.5M to 65.6M, Galapagos easily cleared my 30% cut-off for a profitable investment.
It's important that you appraise Galapagos to determine how much your shares are truly worth. Before running our figure, we'd like to share with you the following:
Wall Street analysts typically employ a valuation method coined Discount Cash Flows (i.e., DCF). This valuation model follows a simple plug-and-chug approach. That aside, there are other valuation techniques such as price/sales and price/earnings. Now, there is no such thing as a right or wrong approach. The most important thing is to make sure you use the right technique for the appropriate type of stocks.
Given that developmental-stage biotech has yet to generate any revenues, we steer away from using DCF because it is most applicable for blue-chip equities. For developmental biotech, we leverage the combinations of both qualitative and quantitative variables. That is to say, we take into account the quality of the drug, comparative market analysis, chances of clinical trial success, and potential market penetration. For a medical diagnostic device, we focus on market penetration and sales. Qualitatively, we rely heavily on my intuition and forecasting experience over the decades.
Molecules and franchises
Market potential and penetration
Net earnings based on a 25% margin
PT based on 65.6M shares outstanding and 10 P/E
"PT of the part" after appropriate discount
Filgotinib for RA, UC, CD
$2B (estimated from the $125B inflammatory disease market)
$72.40 (5% discount because Cabo is already approved and generating increasing sales)
Younger assets for various conditions
|Will wait for more development to assign value||N/A||N/A||N/A|
The Sum of The Parts
Figure 9: Valuation Analysis
Since investment research is an imperfect science, there are always risks associated with your stock regardless of its fundamental strengths. More importantly, the risks are "growth-cycle dependent." At this point in its life cycle, the main concern for Galapagos is whether the company can continue to ramp up Jyseleca sales in the rest of the world (i.e., Ex-USA).
Despite the sales traction that you saw, it's extremely difficult for Galapagos to successfully "go at it alone" in commercialization. Moreover, there is a great risk of not unlocking Jyseleca's potential without launching the drug in the USA. Furthermore, the two senior management departures may indicate deeper problems beneath the surface.
In all, I changed my recommendation on Galapagos from a buy to a sell with a 3.8/5 stars rating. The current valuation of this stock is a $72.40 price target which is still higher than its current share price of $58.40. Galapagos is an investing story of high promises and low delivery. Sometimes, it's the management's fault. Other times, despite their best efforts, the company just can't get through the FDA. As I often mentioned, investment research is an "imperfect science." As such, there are chances and probability working against and for you. When the fundamentals start to deteriorate, I typically like to give the company at least a year to turn around. However, when the ship is nowhere near the Promised Land, it's best to cut your losses and move on to other investments. As you can see, the investing lessons on Galapagos reinforced my emphasis on diversification. Moreover, it demonstrated that you shouldn't buy a stock simply because it is cheap. It's important to size up the future prospect and the direction where the company is going.
As usual, the choice to buy, sell, or hold is always yours to make. In my view, you should reflect on the three arguments that I presented in this paper. If you believe the company can successfully come back, you should correspondingly average down. If you think the company would turn around but the chances aren't high, you should hold your shares "as is."
If you strongly believe against its turnaround prospects like me, you should dispose of all of your shares to move on to other stocks. As the final note, if Galapagos managed to come back, it'll still take many years to do so. Hence, you are better off taking the proceeds to average down on the 20 stocks that I recently recommended.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.
Additional disclosure: As a medical doctor/market expert, I'm not a registered investment advisor. Despite that I strive to provide the most accurate information, I neither guarantee the accuracy nor timeliness. Past performance does NOT guarantee future results. I reserve the right to make any investment decision for myself and my affiliates pertaining to any security without notification except where it is required by law. I'm also NOT responsible for the action of my affiliates. The thesis that I presented may change anytime due to the changing nature of information itself. Investing in stocks and options can result in a loss of capital. The information presented should NOT be construed as recommendations to buy or sell any form of security. My articles are best utilized as educational and informational materials to assist investors in your own due diligence process. That said, you are expected to perform your own due diligence and take responsibility for your action. You should also consult with your own financial advisor for specific guidance, as financial circumstances are individualized. That aside, I'm not giving you professional medical advice. Before embarking on any health-changing behavior, make sure you consult with your own doctor.