Innovation Pays For Biogen Idec Inc.


The financial risks associated with getting a drug out of the lab and into the market are astronomical. It's easy to understand the tendency for the Drug Majors to play it safe and funnel their limited resources toward programs likely to win approval. Sadly, with the string of big expiring patents over the past few years, this has been happening far too often.

Consider sodium glucose co-transporter 2 (SGLT2) inhibitors for treatment of type 2 diabetes. There are at least half-a-dozen late stage programs all trying to fit in this space. During the latest annual meeting of the American Diabetes Association, Boehringer Ingelheim clinical development director, Dr. Maximilian von Eynatten, said "I think probably from a clinical perspective, there is no big difference between the SGLT2 compounds so far, at least from everything we have seen." His employer is partnered with Eli Lilly to develop these compounds, and even he admits the program isn't accomplishing anything significant.

Government and private payers are getting fed up with the lack of innovation coming out of Big Pharma. During Q3 2013, Express Scripts Holding Company implemented a far more aggressive design of its National Preferred Formulary. Government payers in the Eurozone have long been austere, but are increasingly flexing their muscles. Demanding heavy discounts for non-breakthrough therapies in return for reimbursement approvals is on the rise.

Enter the innovators
At just 35 years old, Biogen Idec (NASDAQ: BIIB  ) claims it's the world's oldest independent biotechnology firm. During the nine months ended September 30, its multiple sclerosis (MS) therapies Avonex, Tysabri, and Tecfidera comprised $3.94 billion, or about 80%, of the company's total revenue.

In April 2013, Biogen Idec acquired all rights to intravenous Tysabri from its partner Elan Corporation, plc and began recording 100% of revenue from the drug during Q2 2013. In Q3 2013, Biogen Idec recorded Tysabri sales of $401 million. Annualized, that would be about $1.6 billion. Analyst estimates compiled by the Evaluate Group predict annual sales of Tysabri will grow to about $2.5 billion, in 2018.

Tysabri figures might be higher if it weren't for competition from the company's recently launched MS oral therapy. Tecfidera exploded on the market beginning April 2013. From the launch through September 30, Tecfidera sales totaled $478 million. Analyst consensus predicts annual sales will grow to about $3.8 billion by 2018.

The competition
Perhaps the top competitor for Tecfidera comes from Novartis AG (NYSE: NVS  ) . Biogen Idec priced its Tecfidera pills at $54,900, just under Gilenya at $58,000.

Since Tecfidera's launch in the US, sales of Gilenya haven't plunged, but the rate of adoption has slowed somewhat. Studies showing the drug is linked with a reduced volume of brain loss, should go a long way to keep the competition between Novartis and Biogen Idec from becoming lopsided. Sales of Gilenya reached $1.4 billion in the first nine months of 2013, and are likely to reach about $2.5 billion by 2018.

Sanofi (NYSE: SNY  ) 's MS pill, Aubagio, is priced well below Tecfidera, but it too has a black-box warning in the US. New patients taking Aubagio are guided to receive monthly blood tests to check for liver damage, and that's not the only issue. In the UK, regulators questioned Aubagio's efficacy in terms of its cost efficiency. Sanofi offered an undisclosed discount, and the two struck a bargain in early December 2013.

Overall, Sanofi's situation is grim. Unable to cut costs, the company's per-share-earnings during the first nine months of 2013 were down 26% on year. During the same period, recently launched Aubagio sales reached about $130 million. Although this will add some much needed revenue to Sanofi's top line, Aubagio seems unlikely to be a major competitor for Tecfidera.

Cash machine
Among a group of peers that generate a heap of cash, Biogen Idec offers the most free cash flow (FCF) for your investment dollars.

Source: YCharts .

In case you're wondering why Biogen Idec's blue line just disappears, its FCF went negative during Q2 2013. During that period Biogen Idec repurchased all rights to Tysabri from Elan for $3.25 billion. As an investor, negative FCF is definitely a warning, unless the company just used a heap of cash to make a smart investment.

Not as pricey as it seems
At a glance, Biogen Idec's recent price looks like the expensive result a very optimistic market. If a company sporting a stock price up about 92% for the year and P/E Ratio near 40 doesn't set off warning bells, you've forgotten the late nineties.
Using a DCF model, it seems the market is expecting the company's sales to grow by about the same rate as they have over the past year, about 22%. Recently, I saw Credit Suisse up its target to $375, which seems even wilder, on the surface. That is until you take a look at this chart.

You can see that as sales have accelerated over the past few years, The company's operating margin has grown right along with it. That's the benefit of innovation. Over the past five years, SG&A expense has grown at a CAGR of just 5.86%. Revenue over the same period grew at a CAGR of 9.27%. That's what happens when you don't need to convince payers of your product's benefits.

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Editor's Note: A previous version of this article incorrectly stated that Novartis' Gilenya has a black box warning from the FDA. The Fool regrets the error.


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