Large Cap Biotech: Conclusion

Indeed on a valuation basis, Amgen is the cheapest of the three companies. However with a questionable corporate culture and a dodging of recent scientific data Amgen’s future is uncertain. Epogen is ancient, and has been on the market sine 1989. Its sister product Aranesp was patented in 2001. Amgen’s largest revenue driver Neulasta was approved January 2002. These three combined account for $10 billion in revenues. Amgen is struggling to find its next blockbuster drug. The fear with investing in them is that either Amgen may never find this next drug, or it will take too long. While Genentech and Amgen both have large oncology based therapies, their approaches are distinct. Genentech’s two biggest drugs Avastin and Rituxin both attempt to slow cancer down by attacking cancer cells or their supply of nutrients directly. Meanwhile, Amgen’s oncology drugs don’t have any affect on the cancer directly. Rather, they assist the body as it is weakened during chemotherapy.

Genentech has a huge pipeline. But in regards to biotech stocks, Wall Street is very short sighted. Most biotechs are valued like other companies on Wall Street, based on financial models. The thing is, a potential drug in the pipeline cannot enter a financial model until it is somewhat nearing approval. Otherwise, the volatility and variability in the models would be outrageous. In the near term, Genentech doesn’t have a clear cut driver of growth. Thus, I do not expect profit models to be revising upwards in the near future.

Genentech and Genzyme attack different fronts of the therapeutics market. Genzyme tries to focus its research for rarer genetic diseases, while Genentech is seen along with Amgen as the kings of oncology. While this inherently limits the size of Genzyme’s market, it also inherently limits the number of Genzyme’s competitors. While Genentech faces a constant stream of new competition for its products, Genzyme is seen as the market leader in its largest product segments. Even if Genentech were to presently have a successful drug, the duration for which it has an advantage over other drugs is very uncertain. In constrast, Myozyme is seen as the clear cut choice in treating Pompe’s disease. Most patients have no other choice. They either begin treatment with Myozyme or die within months. With no competitors in sight, other than from Genzyme itself possibly developing a true cure for Pompe’s, the cash flows from the product should be steady and growing. I came across a statistic from “Wikinvest” that I was unable to find the source for. In reference to the currently limited number of people inflicted with Pompe’s (~10,000):

“Most babies born with this disease die withing a year, but the growth of diagnostic testing in utero and through the first three months, the potential number of patients could expand to 20-60,000 patients worldwide.”

If this is a realistic number, the profit potential is outstanding.
Another problem that Genentech faces due to the competitiveness of their market is through enrolling of participants for clinical trials. Enrolling participants is essential to complete a clinical trial and accounts for the majority of the clinical trials budget. In the recent conference call over Q1 2008 numbers this was said regarding the matter:

“The company's president of product development, Dr. Susan Desmond-Hellmann, said she's less worried about dealing with the Food and Drug Administration than she is about ‘enrollment rates in a highly competitive clinical trials era.’ “

http://seekingalpha.com/article/72036-genentech-earnings-great-formatting-but-not-so-great-sales

It is very interesting to see a company as large as Genentech have trouble enrolling patients, especially as many big pharma companies take their clinical trials overseas. Either Genentech is trying to cement their reputation as a righteous company (by doing all their clinical trials in the US) or something else is going on here. This is in stark contrast to Genzyme’s trials of Myozyme. Patients are practically begging to stay in the trials in order to receive the free treatment. All this despite a much smaller patient pool. So we realize another benefit of Genzyme’s niche market. The people that Genzyme targets need Genzyme just as badly as Genzyme needs them. A wonderful harmony indeed.

One common rationale for investing in biotech stocks or healthcare in general is that with the aging of the US population, healthcare should have a bull market for at least a couple of decades. Investing in Genzyme will not allow one to partake in this trend because the genetic diseases that power 50% of Genzyme’s revenues exist from birth. Genentech which focuses greatly on oncology, will face the trend of aging society head on. While presently, it is recommended to stick with Genzyme, with a more attractive valuation Genentech represents quality exposure to that area of the economy. Genentech’s pipeline is bursting at the seams and in a year, while the valuation retracts, Genentech’s pipeline should move further along the development process. Assuming a couple of the treatments make it through clinical trials, momentum can start picking up and analysts will be ready to update their models.

Ultimately, investing in biotechnology companies in the long run means placing faith in the company to react to an ever changing competitive landscape. Pfizer is currently the largest pharmaceuticals company based on sales. Yet, its stock is suffering due to the fear that it will not be able to produce products that can fill the void of expired patents. Investing in a biotech company such as Genzyme or Genentech, means believing that they will be able to continually hire the best researchers, who will continually be able to produce quality innovations. All three of these companies represent intriguing investments, Genzyme due to its unique niche market, Amgen due to its valuation and Genentech due to its bursting pipeline. In the next year or so, Genzyme is believed to be the best and least risky investment. However, Genentech and Amgen should be on kept on the radar because Wall Street truly is short sighted. These companies are not start-ups. They are all flush with cash to invest in R&D. And if R&D seems slow, they are at a very powerful position as many very promising startups may seek partnerships or buyouts in order to sustain such expensive research. This debate should be revisited in 6 months – 1 year. It is believed that Amgen’s stock needs time to stabilize and Genentech is currently too highly priced.

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Genentech: the future

Although, Genentech and Genzyme are projecting very similar growth rates, Genentech is presently much more richly valued despite being so much larger (size leading to worries of economies of scale). Genentech has a trailing price/earnings ratio of 30.75 and a trailing price/sales ratio of 7.25. Genzyme has a trailing p/e of 43.24 and p/s of 5.3. Although, Genzyme has a much higher p/e ratio, it is not due its inability to generate revenue. Over the past year Genzyme has been an active purchaser of small biotechs and had to spend extra money in SG&A to integrate the companies. Without a potential major contributor to the top line, I don’t see how Genentech can be valued more highly than Genzyme. The pressure to continually produce new therapies is huge for Genentech because it has to grow 11 billion by 20%, which amounts to 2.2 billion in order to maintain this type of valuation. In contrast, Genzyme only needs to add $600 million in revenues. It is assumed that the bulk of Genentech’s growth will come from more applications for its existing drugs Avastin, and Rituxin.

Avastin did receive accelerated approval for treatment for breast cancer. Accelerated approval is used to allow drugs for life-threatening diseases to enter the market as long as there is initially positive data. The FDA did that after an FDA advisory committee voted 5-4 to not approve it. The close vote by the FDA advisory committee hints at Avastin not being as effective as people may think. If the studies currently being conducted with Avastin fail, Avastin will have advanced approval revoked and be pulled out of the breast cancer market.

Let’s assume that Avastin actually does get approval to stay on the market. How much money can we expect it to bring in? Again, the fact that an FDA advisory panel had trouble deciding whether or not to recommend approval makes me concerned about the drug’s efficacy. And anytime you introduce a new competitor to a market, it better have a significant “competitive edge” to steal market share. This is competitive edge is questionable. Although I do believe that it will “take a piece of the pie”. The pie needs to be large enough to support $2.2 billion more revenue in the next year.

Another thing to note that I’m not sure many people are aware of is that Avastin is already prescribed “off-label” for breast cancer treatment to 9,500 patients. Prescribing a drug off label is a completely legal practice when physicians use their judgment to prescribe a drug for treatment not described on the label (aka not approved by the FDA). This means that of the $2.5 billion or so of revenue that Avastin brought in in 2007, an estimated $900 million (9,500 patients * a reported cost of $92,400/year - http://blog.wired.com/wiredscience/2008/02/fda-approves-ca.html - http://www.msnbc.msn.com/id/23298776/ ) may have been due to off-label use. I say may because of the 9500 patients receiving the drug off-label, it is uncertain as to when they began treatment. Nonetheless, this is a significant number. The main increase in revenue due to advanced approval will come from patients who wanted the treatment but were not able to afford it before. Those who can currently afford it, are already able to attain it. Insurance companies will not cover off-label treatments. Thus even with sustained approval for metastatic breast cancer, the growth potential in that market is limited.

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Amgen : the Future

Amgen currently concerns me because of the possible competitor to Epogen, which is a large portion of their revenue. Though this uncertainty may be “priced into the stock” the fact that the decision is uncertain means there are negative and positive outcomes priced in. I for one, would not want to partake in this volatility, as it resembles nothing more than a random gamble. If Amgen is truly desired, I would suggest allowing the outcome of the patent case to surface first. Then I would wait a couple weeks for investors’ reaction and the stock price to cut back on volatility. If the judge rules that Roche is allowed to release Micera then I would expect an initial overreaction by shareholders. Then, a slight rebound, followed by another overreaction to analysts revisions of estimates. Only after the stock price is able to contain the new earnings estimates would I consider purchasing the stock at what should be a significantly lower price. If the judge rules that Roche is not allowed to release Micera then I would expect an initial overreaction to the “good” news and subsequent consolidation of the stock price. Again, I would not consider purchasing the stock until after this consolidation.

Also, after reading through several articles it appears as though there is a relatively negative perception of Amgen’s corporate culture. In two separate articles authors have contrasted Amgen’s corporate spoiling to Genentech’s and Genzyme’s corporate responsibility. Where Amgen’s executives are described as wastefully spending money on corporate jets, Genentech’s are revealed to fly commercial.(http://www.biotechstocksblog.com/2008/03/28/drugs-penny-wise-but-a-pound-foolish/) (http://seekingalpha.com/article/71166-a-bone-of-contention-with-amgen-s-bone-drug-data) Furthermore, Amgen is coming under fire for its marketing practices.

“John Dingell (Democrat), chairman of the Committee, said that ‘millions of dollars have been poured into aggressive marketing campaigns, despite mounting evidence that these therapies pose serious risks.’ ”

http://www.pharmatimes.com/WorldNews/article.aspx?id=13206

In March the FDA advisory panel recommended further restrictions on the anemia drugs Epogen and Aranesp. They are recommending that these treatments only be used for terminally ill cancer patients. For the most part, the FDA adheres to the advisory panels recommendations, but this cannot be guaranteed. Not only are Epogen’s revenues potentially reduced from competition of Roche, but also on new restrictions on its usage.

Epogen and Aranesp are blockbuster drugs used for cancer patients to counteract the anemia (loss of red blood cells) that results from chemotherapy. However, there have recently been 8 clinical trials supporting the case that these drugs actually increase the proliferation of the cancer. There are a couple speculations over the mechanism of such action:

1) the drug which provokes the growth of red blood cells may spur the growth of blood vessels which will provide nutrients to the cancer cells allowing them to proliferate

2) cancer cells themselves have a receptor for the drug, and react to it in a similar manner as red blood cells

http://www.nytimes.com/2008/03/12/business/12anemia.html?ref=business

A quote from the article:

“Dr. Arthur J. Sytkowski, an associate professor of medicine at Harvard who has studied Epo for 30 years, said scientists assumed Epo did nothing except spur red blood cell formation. ‘Nobody’s to blame for this,’ he said.”

I do agree with him in that no one is to blame. But language like that makes it seem like he is speaking after the fact, and that Epo indeed negatively effects cancer patients. The defense that Amgen gives is that:

“Amgen says there is no convincing evidence that Epo does anything in the body besides spur red blood cell production. The company thinks the excess deaths in the trials among Epo users might stem from blood clots. The clinical trials in question all used the anemia drugs to raise patients’ red blood cell levels more than what is recommended in the drugs’ labels. At those levels, blood clots are a known side effect.”

The fact that Amgen denies any potential negative effects of Epo in light of the release of several studies directly contradicting that stance portrays Amgen as defensive and desperate. But, in all honesty, we cannot expect anything more out of a company that relies on Epogen (and the related Aranesp) to bring in $6 billion/year. Though Amgen portrays itself as very defensive, as a business it must maintain the quoted stance. And it is allowed to maintain this stance because the FDA has decided to still allow the usage of Epogen and Aranesp. They just have to be used with the lowest possible dosage.

One of the studies related to Epo found that keeping Epo away from cancer cells may actually be a possible treatment to destroy them! This study was conducted by Matthew Hardee and Yiting Cao and is titled “Erythropoietin Blockade Inhibits the Induction of Tumor Angiogenesis and Progression.”

“An important finding of our studies is that EPO blockade in window chambers disrupted tumor neovascularization and growth, particularly in the window chambers implanted with R3230-GFP cells secreting the R103A-EPO antagonist which was associated with virtual disappearance of tumor-associated blood vessels, and eventually, the implanted tumor cells”

“Our findings suggest that further investigation is warranted to employ erythropoietin blockade for the therapeutic modulation of tumor angiogenesis.”

http://www.pubmedcentral.nih.gov/articlerender.fcgi?artid=1891087

Sytkowski is right in that there is “no one to blame.” Amgen is not at fault because up until recently there was no knowledge of Epo’s relationship to cancer growth. And if further studies further ascertain Hardee’s findings, who could blame Amgen for being scared. The notion that a drug marketed to assist cancer therapy actually progresses cancer growth has is sadly ironic. And if this were to leak out to the general public, I’m certain many patients will note the irony and let out a couple of awkward chuckles as they ponder the possibility of paying thousands for chemo, then paying thousands for Epogen to grow back the cancer cells that were lost in chemo.

(Food for thought: Of Amgen’s 2007 revenues, approximately 6.1 out of 14.7 billion came from dialysis drugs based on EPO.)

Other than revenue concerns over the dialysis drugs, Amgen’s near term future outlook (1-3 years) seems dominated by the prospects of its osteoporosis drug in development called Denosumab. There are a lot of hopes pinned on this drug mainly because the osteoporosis market is so large. Sales for Denosumab are projected to potentially reach $2 billion (at the high end) of the current $7 billion market. Currently, Merck dominates the market with its drug Fosamax ($3 billion in sales/year); however Merck’s patent expired on Feb 5, 2008. (http://money.cnn.com/2005/04/21/news/fortune500/fosamax/)

The belief is that Denosumab has the potential to replace Fosamax. In its most recent Phase III results Denosumab was shown to be better than Fosamax at improving bone-mineral density. However, there was also a higher incidence of bacterial infections that required hospitalization. Amgen claimed that these infections were easily treated with antibiotics. Regardless, the high infection rate will ultimately affect Denosumab’s marketability. The fact that the patent for Fosamax has expired means there is potential for a generic and much cheaper competitor to Denosumab. Though Denosumab may improve bone density better, the degree is uncertain. Assuming Denosumab even gets FDA approval, patients will have to weigh the costs versus the efficacy of each drug.

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Genzyme : the Future

It appears as though Genzyme’s strong earnings estimates and technical stock picture are the result of its newly released drug Myozyme. It is being hailed as a miracle drug for those with Pompe’s disease, a particularly rare disorder in which glycogen is not able to break down properly resulting in muscle degeneration and death. It is believed to affect 10,000 people worldwide. The cost for the drug is approximately $300,000 per year. There were approximately 1,000 people involved in the clinical trials. If only these 1,000 people merely continue their treatment, that is $150 million immediately added to the top line. Looking at the International Pompe Association website (http://www.worldpompe.org/) I came across updates on the supply of Myozyme. There is actually a short supply of the drug and Genzyme is having to ration the drug to younger patients who are more likely to have significant improvements in their quality of life. Myozyme is a must-have drug. Governments of developed countries are even seeking ways to provide the funding for its citizens to pay for the massive yearly bill. It is a disheartening situation for patients who are worried about how they can afford to essentially survive.

The current bottleneck on Myozyme’s revenues is a supply side issue. In my opinion, a supply side concern is much easier to overcome than a demand side one, especially with drugs. For this reason, I have full confidence that eventually Myozyme will reach its full revenue potential. Genzyme is currently in the process of seeking FDA approval of a large-scale manufacturing facility for Myozyme in Massachusetts. Although the approval is technically “uncertain” I believe that both Genzyme and the FDA eagerly want the approval to go through, as this is a vital drug to thousands. The drug is not only the sole viable option for those with Pompe’s disease, it is truly a great one. Patient’s are expected to add years to their lives so long as they have uninterrupted treatment. This fact that patients need continual uninterrupted treatment of Myozyme is key. It’s like having a lifetime cell phone subscriber. Imagine a cell or cable company that doesn’t have to worry about subscriber losses. When Genzyme recruits new patients they are not simply booking $300,000. They are taking in an annuity of $300,000 year. In reality, this will only last until a better treatment for Pompe’s comes along. But in the meantime, that figure is outstanding.

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Large Cap Biotech

We're going to do a short series comparing three large cap biotechs: Genzyme, Genentech,and Amgen. Celgene was in the mix at first, but due to an extremely high p/e (relatively) celgene is more of a momentum stock right now. This analysis is for you investors looking for a good company with good, but not out of this world, growth. If you want out of this world, check out Potash. Since it was recommmended here at 122 in January it has proceeded to run to 197. That should more than make up for the 12% loss in Apple!

Generally, during recessions we see large revisions of forward earnings estimates. Consequently, stocks that seem “cheap” based on forward growth are in reality far from it. However, I believe biotechnology companies, such as these, who already have established cash flows to be relatively “recession-proof.” Perhaps, smaller biotech companies who have yet to create profit and need large influxes of capital may see tougher times ahead as the credit markets tighten significantly. But, these three companies can afford to pay for their R&D with their own cash. For this reason, I am not too concerned about overstated forward estimates. This leads me to relatively trust the forward PEG rates of each company, which are all essentially 1.

It is interesting to note the disparity in pipeline treatments. Genentech has a significantly larger portfolio of drugs awaiting approval, especially in Phase 3 Trials. Yet we notice that the pipeline size is directly proportional to the market capitalization of the company. In order for Genzyme to sustain a 20% growth rate with its $80 billion market cap, Genentech needs to have a significantly larger pipeline than Genzyme, which needs 20% growth rate of only a $20 billion market cap. So can Genzyme sustain this growth rate?

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