Diversifying Royalties at a Hefty Cost

What do a multiple sclerosis drug from Biogen Idec (NASDAQ: BIIB  ) and several lung drugs from GlaxoSmithKline (NYSE: GSK  ) have in common? Basically nothing other than the fact they generate royalties for the biotechs that helped develop them.

That's apparently the point of Elan's (UNKNOWN: ELN.DL2  ) new deal. The biotech is diversifying its royalty stream, moving beyond collecting royalties from Biogen's Tysabri to sign an agreement with Theravance (NASDAQ: THRX  ) to collect a portion of the royalties Thervance is due on Glaxo's lung drugs.

I'm not convinced it's necessarily the best use of cash -- returning it all to shareholders might be better -- but at least it's better than Elan in-licensing a bunch of compounds and reinventing its pipeline wheel.

In exchange for a $1 billion payment, Elan is entitled to 21% of royalties that Theravance receives on the four respiratory programs it helped develop: Breo, Anoro, GSK961081, and vilanterol, which is one of the components of Breo and Anoro.

Thervance gets royalties of 15% on the first $3 billion of combined annual sales of Breo and vilanterol monotherapy and 5% on sales above $3 billion. For Anoro, Glaxo pays royalties that range from mid-single digits to 10%. GSK961081 is a little more lucrative for Thervance, with royalties between 10% and 20% of the first $3.5 billion of annual sales, and 7.5% of sales above that.

Breo was approved by the Food and Drug Administration last week, so at least we know for certain that drug will generate sales. The other three are still up in the air.

At 21% of 15% of Breo sales, Elan will take home 3.15% of Breo sales. If Breo could hit $3 billion in sales, that's $94.5 million annually, not too shabby a return on its $1 billion investment. Of course, it'll take years to reach that level. The return in the initial few years is going to be paltry, and Elan really needs the other drugs to get approved to justify the investment.

When I read the headline for the deal, I kind of figured this was an alternative to Theravance splitting its royalty assets on Glaxo-partnered compounds -- dubbed Royalty Management -- from its pipeline drugs, but it appears the royalty deal is in addition to the split rather than because of it. Take the money and run. Good for you, Theravance.

There go the acquisition targets
Before the deal, Elan and Theravance's Royalty Management spinout both appeared to be good takeout candidates. Now they both look less appealing.

Elan was being perused by Royalty Pharma in a deal that Elan wasn't willing to accept. Beyond the Tysabri royalty, its cash was a big component in the valuation of Elan. Maybe Royalty Pharma will see the move as a good use of Elan's cash, but the new deal changes the dynamic, and I wouldn't be surprised to see Royalty Pharma walk away.

Thervance's Royalty Management spinoff looked like a perfect acquisition target for Glaxo if the drugs were extremely successful. The large pharma could buy the spinoff, paying itself back with royalties it wouldn't have to pay. Now it'll still have to pay Elan royalties. It doesn't mean Glaxo might not pull the trigger down the line, but it changes the valuation it's willing to pay.

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