Alexion Stock – The Path Ahead?
Seeking Alpha Analyst Since 2020
Summary
- Negative market sentiment continues to weigh heavily on Alexion’s share price and there have been renewed calls for a buyout.
- Alexion is a strong company primarily due to its product portfolio and financial health.
- There is an opportunity for significant upside in share price given the strong cash flows and future outlook.
Alexion’s stock performance over the past year
Impressive revenue and EPS growth? Check
Historically cheap valuation compared to its peers? Check
Financial strength indicators flashing positive? Check
Strong cash flows and promising future outlook? Check
Alexion seems to ticks all the boxes yet the stock performance versus the biotechnology sector or the broader market has been quite disappointing.
Source: Schwab Stocks Research
Over the past year, Alexion (ALXN) has meaningfully underperformed the S&P and the biotech sector by losing over 22% of its value.
So, what gives?
Letter from Elliot Advisors
Apparently, I wasn’t the only one surprised by Alexion’s stock performance.
Elliot Advisor, a significant and long-term investor in Alexion, sent a letter to the Alexion Board of Directors, urging them to explore opportunities of sale.
As they rightly point out, Alexion has been a persistent underperformer and its EV/EBITDA has reduced by over 75% since Dec ’15.[1] They argue that a buyout will only enable Alexion to meet its full potential and other options will only lead to suboptimal results for all stakeholders involved.
Source: Elliott Advisors
In this article, I will examine Alexion’s product portfolio, analyze the financials and company valuation and finally using cash flow analysis, I will be highlighting the fair value of Alexion shares both in the event of an acquisition and the in current scenario where Alexion continues to operate as a standalone entity.
Alexions’s product portfolio
To date, Alexion has four ground-breaking medicines that have been approved for the treatment of people living with six rare and destructive diseases.[2] It has seen tremendous success with its flagship drug, Soliris.
This drug, which is provided once every fortnight via injection, targets a rare blood disease called paroxysmal nocturnal hemoglobinuria (PNH).
Patients with PNH lack a kind of protein that protects their red blood cells from being targeted by their own immune systems. This leads to PNH patients having a reduced red blood cell count which may result in severe headaches, pain, fatigue and possibly more serious complications.
Soliris is additionally used to treat another rare disease called hemolytic-uremic syndrome (HUS), which is analogous to PNH except that HUS patients also suffer kidney complications. Eventually, this may result in kidney damage and other severe problems like high blood pressure, strokes, and heart problems.
Both conditions are extremely rare- estimated frequency for PNH is 1 case per 60’000[3] whereas for HUS its 2 cases per 100’000[4] annually in the United States.
Alexion's other three medicines are Strensiq, Ultomiris, and Kanuma, although they only generate a fraction of the company's total sales. However, this ‘complement franchise’ posted strong growth in the recently announced results.
Strensiq is used to treat another rare disorder called hypophosphatasia within which the body can't process calcium and phosphorus properly because of an enzyme deficiency. Kanuma is employed as a treatment for patients with lysosomal acid lipase (LAP) deficiency, in which the body can't break down fats effectively. Both conditions are quite rare. LAP is estimated to occur in 1 in 40,000 people[5], while hypophosphatasia affects every 1 in 100,000 individuals.[6]
Ultomiris is considered to be Alexion's next-generation PNH treatment. Alexion has been having continued success in patient conversions from Soliris primarily because of Ultomiris being slightly cheaper ($458k vs. $500k[7] annually) and the convenience factor as well- patients on Ultomiris require treatment once every eight weeks compared to each fortnight for those on Solaris. [8]
As they reiterated in the Q1 2020 earnings call, Alexion has continued to see a high-single digit patient volume growth which is helping them diversify their revenue stream:
Source: Q1 2020 Earnings Call Deck
The contribution of Soliris to the total revenue has declined by 14% from 84% in 1Q19 to 70% in 1Q20. However, it still seems that Alexion is over-reliant on Soliris and the management is fully aware of this. They are continuing to invest in product development to diversify their portfolio and have plans to launch 10 additional products by 2023 and beyond:
Source: Alexion 1Q2020 earnings call deck
According to John Orloff, Global Head of R&D at Alexion, even if a few of those planned indications don't materialize, ALXN still has plenty of ideas to diversify its existing product offering.
"We're going to continue to press the envelope in regards to business development," Orloff said. "If one or more of those (indications) fall off, we have other opportunities that we haven’t really talked about."[9]
As it stands today, Alexion has a highly profitable business which is protected by various patents.[10] It’s invaluable rare-disease expertise and network of patients and doctors poses high barriers to entry for other biotech companies.[11]
Having a more diversified patent-protected revenue stream in a rare-diseases segment is a key focus point for management and it will ultimately generate value for the shareholders as well.
Financial situation & sector comparison
From a financial standpoint, Alexion is doing very well. Q1 ’20 revenues came in at $1.44 billion, which is a 27% increase from Q1 ‘19. Net income for the quarter came in at $558 million, which is in line with the Q1 ’19 net income.
For FY ’20, management reduced guidance slightly, noting COVID impact to new starts and a potential shift in payor mix. As Alexion’s commercial products address high-unmet needs of a niche market, COVID impact is expected to be lower relative to other biotechs. Even if Alexion’s achieves the mid-point of its new revenue guidance range, it still reflects an increase of ~ 6% from 2019.
Alexion has a highly profitable and cash-generative business, with annual forecasted free cash flows of over $2 billion[12] based on analyst consensus estimates. It is expected to grow revenues at an 8% 5yr CAGR[13] while consistently generating EBITDA margins [14]of over 50%- impressive figures by any measure.
In terms of metrics, Alexion is a surprisingly cheap stock given its growth. It currently trades at a 4.3 price-to-sales (P/S) ratio. Most companies reporting a similar growth rate (which would be considered growth stocks by most investors) tend to trade at substantially higher premiums. The company currently trades at 9.6x earnings, as compared to 19.4x earnings for the biotech sector.
Alexion also compares favorably with its industry peers:
Source: Schwab Stocks Research
With an impressive revenue growth forecast and healthy cash flows, Alexion is a growth stock which is currently priced as a value play. If you look at other growth stocks in the biotech space (or the whole healthcare sector for that matter), you'd have considerable difficulty in finding a company trading at a P/S or a P/E ratio near Alexion's and that has been growing as fast as it has.
Crunching the numbers under a buyout scenario
Alexion has a strong portfolio rare diseases drugs and a solid pipeline along with an enviable financial position. It can be a potential target for big pharmaceutical companies that are looking to venture in or strengthen their position in the rare diseases market.
Using the company’s financial statements, I will determine the fair value of its share price using cash flow analysis under the buyout scenario.
The first step is to determine the free cash flow to the firm (FCFF) which is determined as follows:
Based on the previous four years, the average FCFF is 1.10 bn USD and let’s assume that the acquirer wants to value the firm based on this FCFF. This is significantly lower that the expected future cash flows of Alexion but this assumption ensures that the calculation is conservative.
Based on the consensus analyst expectations (5 or more) cash flows are materially higher and there is noticeable growth year-over-year:
Source: Simply Wall St.
The next step is to calculate the weighted average cost of capital (OTC:WACC) of the potential buyers of Alexion. For the WACC calculation:
- I have used all large-cap biotech and pharmaceutical companies for this analysis as they are more likely to be interested in acquiring Alexion.
- The cost of debt has been calculated using the financial statements of the respective companies.
- I have used the Capital Asset Pricing Model (CAPM) to calculate the cost of equity. It has been adjusted for the current low-interest environment by taking the average YTD 10-year treasury yield as the risk-free rate.
- The WACC is then adjusted for the market capitalization of the respective companies.
The market-cap weighted WACC of 3.89% is used for the cash flow analysis.
Lastly, I have used the very conservative rate of 1.13% which is in line with the average YTD risk-free rate as the growth rate. This is significantly lower than the growth rate evident from the consensus cash flow graph above.
The firm value is then calculated as:
From the firm value, the market value of debt is taken out. The “equity value” is divided the number of shares outstanding to arrive at the share price based on the cash flow analysis:
Under a buyout scenario, there is a significant upside potential of 66% even after considering a very conservative FCFF and growth rate.
Valuation under a “standalone” scenario
While frustration from investors (Elliot Advisors being one recent example) with ALXN’s management and board of director conservatism continues, the company has to be credited for adhering to its vision for achieving improved diversification and sustainability over time. The company recently reiterated this strategy:
Source: Alexion 1Q2020 earnings call deck
Alexion wants to do it alone with buyout not part of the plan yet. What should be the share’s fair value under a standalone scenario?
I use the 2019 FCFF and a very conservative growth rate of 2% for this analysis.
Using Alexion’s calculated WACC of 8.52%, the price per share is calculated as:
Even under this scenario with conservative metrics, there appears to be a significant upside potential of 47%.
Conclusion
Alexion is an operationally strong company with a substantial cash flow generation expected from its current and future product portfolio. In the biotech sector, it is one of the very few companies that can be classified as a growth stock but is currently priced at a bargain.
Even though the cash flow analysis is not perfect, it seems to confirm that the current valuation presents an attractive entry point in Alexion. Based on the analysis, I do agree with Elliot Advisors’ assessment of there being a significant upside in case of a buyout. The case for buyout is logical, at least on paper- Alexion has been developing life-changing drugs for patients with rare-diseases for more than 25 years and it has accumulated a wealth of experience of operating it in highly specialized field. It is currently priced very attractively for any large-cap pharma seeking to complement its existing product offering.
However, potential for substantial shareholder returns also remain if Alexion continues to operate as a standalone corporation. The current valuation underappreciates ALXN’s significant expertise in the rare-diseases segment, patent protection and orphan drug its exclusivity.[16] The risk/reward tradeoff seems quite tempting as a lot of negative news already seems to be priced in and Alexion’s strength and competitive advantage is underappreciated at the current price.
Disclaimer: I am not a registered investment, legal or tax advisor. All investment/financial opinions expressed are from personal research and experience. The ownership of any investment decision lies exclusively with the investor after he/she has analyzed all risk factors and has conducted thorough due diligence.
[1] http://www.elliottletters.com/alexion.pdf
[3] Paroxysmal nocturnal hemoglobinuria
[5] Lysosomal acid lipase deficiency
[7] Alexion's Second C5 Complement Inhibitor Requires Less Frequent Dosing, Carries New Patents
[8] FDA approves Alexion's Ultomiris for another rare blood disease
[9] Alexion to its detractors: Take a look at our Soliris switching and budding pipeline
[10] Patents Assigned to Alexion Pharmaceuticals, Inc. - Justia Patents Search
[11] Alexion's Rare-Disease Reign Not Over
[12] Based on 2021E analyst consensus estimates
[13] Revenue Forecast CAGR (5y) For Alexion Pharmaceuticals, Inc. (ALXN)
[14] EBITDA Margin For Alexion Pharmaceuticals, Inc. (ALXN)
[15] Equity Valuation Refresher Reading, Reading 28, 2020 CFA Level II
[16] Alexion's Rare-Disease Reign Not Over
[1] http://www.elliottletters.com/alexion.pdf
[3] Paroxysmal nocturnal hemoglobinuria
[5] Lysosomal acid lipase deficiency
[7] Alexion's Second C5 Complement Inhibitor Requires Less Frequent Dosing, Carries New Patents
[8] FDA approves Alexion's Ultomiris for another rare blood disease
[9] Alexion to its detractors: Take a look at our Soliris switching and budding pipeline
[10] Patents Assigned to Alexion Pharmaceuticals, Inc. - Justia Patents Search
[11] Alexion's Rare-Disease Reign Not Over
[12] Based on 2021E analyst consensus estimates
[13] Revenue Forecast CAGR (5y) For Alexion Pharmaceuticals, Inc. (ALXN)
[14] EBITDA Margin For Alexion Pharmaceuticals, Inc. (ALXN)
[15] Equity Valuation Refresher Reading, Reading 28, 2020 CFA Level II
[16] Alexion's Rare-Disease Reign Not Over
[1] http://www.elliottletters.com/alexion.pdf
[3] Paroxysmal nocturnal hemoglobinuria
[5] Lysosomal acid lipase deficiency
[7] Alexion's Second C5 Complement Inhibitor Requires Less Frequent Dosing, Carries New Patents
[8] FDA approves Alexion's Ultomiris for another rare blood disease
[9] Alexion to its detractors: Take a look at our Soliris switching and budding pipeline
[10] Patents Assigned to Alexion Pharmaceuticals, Inc. - Justia Patents Search
[11] Alexion's Rare-Disease Reign Not Over
[12] Based on 2021E analyst consensus estimates
[13] Revenue Forecast CAGR (5y) For Alexion Pharmaceuticals, Inc. (ALXN)
[14] EBITDA Margin For Alexion Pharmaceuticals, Inc. (ALXN)
[15] Equity Valuation Refresher Reading, Reading 28, 2020 CFA Level II
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.