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The Bristol-Myers Squibb Co. Overreaction Highlights The Dependence On Oncology

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After years of the big pharma industry pushing diversification as the solution to its woes, at least one major player is breaking from the pack. Bristol-Myers Squibb (NYSE: BMY  ) is prioritizing its oncology and virology assets, and the company has already staked out some attractive real estate in the immuno-oncology space. While the appeal and potential of immuno-oncology is legitimate, the valuation is already generous and the company's lead on Merck and Roche may not be as strong as the bulls hope.

A solid quarter ...
Revenue rose 6% from the year-ago period (or 7% in constant currency), about 3% ahead of the average sell-side estimate and almost 1% ahead of the high end estimate. U.S. sales rose 1%, while Europe was up about 2% in local currency and "Rest of the World" was up 12%. Oddly enough, the beat relative to expectations was pretty even across the board; Abilify was down 22%, while Sustiva was up 11% and Baraclude was up 14%. New cancer drugs like Sprycel and Yervoy were up 30% and 23% from the year-ago period. 

Margins were also strong relative to expectations. Gross margin fell almost three points from last year's level but beat the sell-side estimate by more than half a point. Operating income for the year rose by 24%, a solid beat versus expectations on lower operating expenses.

... but nobody seemed to care
Bristol-Myers' stock didn't react as you might expect with a solid earnings report. The Street was far more concerned with what the company did, and did not, have to say about its immuno-oncology portfolio.

Between the start of a new trial to evaluate nivolumab as a solo first-line therapy in lung cancer and the company's refusal to give a firm timeline for Phase III nivo+Yervoy studies, analysts and investors are now worried about the future of this combo therapy. It may in fact be the case that adding Yervoy to nivo does not meaningfully improve efficacy or may create safety concerns. If so, that would shrink the company's lead over Merck and Roche in new immuno-oncology lung cancer combo therapy.

This strikes me as an overreaction. First-to-market hasn't translated into as much of an advantage in oncology as it has in therapeutic areas like diabetes or CNS. What's more, Bristol-Myers has moved a LAG-3 immuno-oncology drug into trials that may in fact end up as a stronger combo option for PD-1 anyway.

Turning away from diversification
As noted earlier, Bristol-Myers is taking the unconventional step of willingly putting its future eggs in fewer baskets. Bristol-Myers has curtailed its early stage research efforts in areas like hepatitis C, diabetes, and neuroscience in favor of a greater focus on oncology, as well as ongoing work in HIV, hepatitis B, heart failure, and fibrotic disease. Additionally, Bristol-Myers sold its share of its diabetes JV to its partner AstraZeneca, and on very favorable terms.

Bristol-Myers still has potentially worthwhile assets in hepatitis C, but a huge amount of the company's future success now rests with its immuno-oncology franchise. Estimates for the potential of this therapeutic class keep heading higher, as analysts have moved their long-term targets from around $10 billion to over $20 billion and, in a few cases, as high as $40 billion.

Bristol-Myers is certainly going to have competition, as Merck and Roche have immuno-oncology franchises of their own that are quite promising, and AstraZeneca's position in this market is often underrated or overlooked.  What Bristol-Myers has going for it is one of the deepest and broadest collection of assets. From compounds in classes like PD-1, KIR, and LAG-3 that basically "lift off the brake" on the immune system to others like CD137 and IL-21 that hit the gas, Bristol-Myers has a rich portfolio of potential compounds that can be tested as monotherapies or combination therapies. 

The bottom line
I don't have any particular doubts or concerns that cancer immunotherapy is a legitimate "next big thing", nor that Bristol-Myers has high-quality assets for this market. I could easily see nivolumab becoming a drug worth more than $7 billion in annual sales and the star of Bristol-Myers' portfolio. The question is what that's all worth today. Unless Merck, Roche, and/or AstraZeneca encounter serious clinical setbacks (and companies like Amgen, GlaxoSmithKline, and Novartis don't get involved), Bristol-Myers is going to be sharing the market.

I am looking for Bristol-Myers to post long-term revenue growth of over 4% a year (which is actually quite strong for Big Pharma), and FCF growth of double that. Unfortunately, that's not enough to get a fair value out of the $40s.  With that, it's hard for me to get excited about the shares even if the "news" on nivo and Yervoy really wasn't as bad as the Street's reaction would suggest.

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Stephen D.

I'm an ex-Wall Street sell-side and buy-side analyst who has spent most of the last 10 years writing on a wide range of industries and investment ideas.

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