Big Biotech Is Bustling With Buyouts

It's been a busy week in biotech. On Monday, Celgene (CELG) confirmed rumors it was buying Juno Therapeutics (JUNO) in a deal valued at $9 billion, and Sanofi (SNY -0.47%) surprised investors with an $11.6 billion deal to acquire Bioverativ (BIVV). Acquiring Juno Therapeutics catapults Celgene into a leadership position in gene therapy for cancer treatment, and Sanofi's acquisition makes it the fastest-growing maker of hemophilia drugs. Will these deals pay off for investors?

In this episode of the Motley Fool's Industry Focus: Healthcare, analyst Kristine Harjes and Todd Campbell discuss the reasons behind these mergers and whether they were savvy. The two also tackle Johnson & Johnson's (JNJ -0.46%) latest earnings report, diving into the details -- good and bad -- that investors ought to know.

A full transcript follows the video.

This video was recorded on Jan. 24, 2018.

Kristine Harjes: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Wednesday, Jan. 24. I'm your host, Kristine Harjes, and I'm joined via Skype by healthcare specialist Todd Campbell. Todd! Hey, how are you?

Todd Campbell: Hey, Kristine! How are you today?

Harjes: I'm doing great!

Campbell: Awesome. Well, we have a power-packed show of M&A to talk about, right?

Harjes: Yes! Monday was extremely exciting in the world of healthcare M&A, mergers and acquisitions. A rumor that we covered in detail on last Wednesday's show of a deal in the making between Celgene and Juno Therapeutics came to fruition on Monday. Celgene will buy Juno for $87 per share in cash for a total of $9 billion. And we're not going to dwell on it, because we did talk about it quite a bit on Monday, but the deal has now been approved by both boards. It's expected to close this quarter. Interestingly, there was a 91% premium to the pre-buyout rumor levels of Juno's share price. Todd, were you surprised by the price tag?

Campbell: You know, honestly, I wasn't. Gilead paid $11.9 billion for Kite, which is a Juno competitor. I thought it would come in less than that, because obviously Juno is going to be the third to market with a CAR-T for its indication in non-Hodgkin lymphoma, so I thought it'd be less than that. It was interesting to me. I had three big takeaways I wanted to share with listeners thinking about this deal and what it means. One of the takeaways was, it's actually a pretty fair price if Celgene is right about its forecast for peak sales on JCAR017, or liso-cel.

Harjes: Yeah, they're estimating $3 billion in peak sales. When you think about general buyout levels, you often see about 3 times peak sales, and that brings you right to the $9 billion total deal.

Campbell: And we've actually seen, in biotech, deals getting done at much higher levels. I've seen 5 to 7 times, and we're going to talk about one that's even bigger than that a little bit later on in the show. I think if you include the $1 billion or so upfront that Juno paid to get its 9.75% stake back in 2015, I think you're talking 3.3 times sales just on JCAR017.

And that's really interesting, because JCAR017 wasn't the only drug they got in this deal. They also get, what I think is, they insulated themselves a little bit against their bb2121 program with bluebird bio, because Juno was working on a drug for multiple myeloma that works similarly to bb2121. So, they protect the moat, as far as bb2121, with this deal. And they also now have a backbone gene therapy research program that they can leverage.

Juno is doing interesting work on TCR drugs, which is another approach to gene therapy. They're also working with Editas, which we've talked about on the show previously, working on CRISPR-Cas9 approaches to treating oncology conditions, cancer conditions. I think that's interesting as well, because theoretically that positions them, in 2025 or something, to maybe have a gene editing approach that they could roll out.

Harjes: Yeah, absolutely. There are a ton more interesting details of this story. If you missed last week's, Wednesday's, episode of Industry Focus, make sure to go back and check it out. On Monday, not only did we get confirmation about that Celgene-Juno deal, but Sanofi also announced an all-cash deal to buy Bioverativ for $11.6 billion, or $105 per share.

Campbell: Yeah. That was a little bit more of a pricey deal, as far as price divided by revenue, versus what we saw with Celgene and Juno. Bioverativ's hemophilia drugs are only bringing in, exiting the third quarter, about $1.1 billion in annualized sales.

Harjes: Yeah. Sanofi really paid up here. That was about a 64% premium on the bid. Shares of Sanofi were down a few percentage points on the news, which isn't really that surprising. You'll typically see the buyer lose a little bit of market cap when they announce a new deal. But I think I'm kind of with the market. I'm thinking this seems awfully expensive. For a little bit of background, Bioverativ was a spinoff from Biogen last year. They're a hemophilia specialist. They IPO'd in the range of $5 billion. So now, they're being bought for $11.6 billion, so if you held onto those shares, if you were a Biogen shareholder a year ago, you've done pretty well.

Campbell: Kristine, I just don't understand this deal. How come this didn't get done a year ago? Are you going to tell me that Biogen wasn't out knocking on doors saying, "Who wants to buy this company from us?"

Harjes: Yeah, really.

Campbell: So now, a year later, what's really changed in the past year that makes Sanofi so willing to pay twice what they theoretically could have bought it for pre-spinout? So I think there's reason for some question on how much they're paying for this. But for Sanofi, it's important. They need to insulate themselves against the risk of declining demand for Lantus, their multibillion-dollar diabetes drug. And one of the ways they can do that is by acquiring companies that are generating significant revenue growth.

And by all accounts, that's Bioverativ. Their sales in the third quarter of 2017 were $291 million, and that was up 27% year over year. That's pretty robust growth, especially when you consider the fact that the hemophilia market that they participate in is valued at about $10 billion annually. So that suggests a lot of running room.

Harjes: And it's a pretty competitive market, too. There's Shire in there; there's Bayer in there. But these companies and their hemophilia drugs are not growing nearly as quickly as Bioverativ and its portfolio of hemophilia drugs. I will say, though, I'm a little bit wary about the long-term potential of this because of the revolution that we could see in hemophilia due to gene therapies, like the ones that we've discussed being developed at Spark Therapeutics and BioMarin.

Campbell: Yeah. That was one of the other takeaways I had here. It seems like Sanofi has done some work and is modelling for either a longer than expected wait for those gene-editing therapies to reach the market, or a slower uptake. And I guess I could make an argument that, depending on the pricing that those gene editing therapies may command, you could see a situation where you have extremely severe cases of hemophilia A and B being treated with gene editing and less severe cases being treated with a prophylactic, such as the drugs sold by Bioverativ. So it may be one of those situations where they're looking at their model and saying, "Over the next 10 years, we may start to get bigger competition from one and done therapies, but it will take a while for those therapies to truly displace these prophylactic treatments." 

And I think you could make a good argument that Eloctate and Alprolix, the two drugs that Bioverativ markets, those are resonating with doctors and patients. They're reducing patient burden, people are having to receive transfusions of the factors that help them coagulate their blood, less frequently, and that's a big win for these patients. And one of the things that was interesting to me as I was looking through this deal, Kristine, was there's still a lot of patients in this market who aren't or haven't switched over from those old, have-to-take-them-a-lot treatments to these newer, longer-lasting treatments. That suggests that maybe you could continue to have 20% growth for the foreseeable future.

Harjes: Yeah, I can see how one would make that argument. I'll also add to that argument that you could be looking even further down the line. Bioverativ does have a pipeline outside of hemophilia. They're doing some work in sickle cell disease, they have a gene editing collaboration with Sangamo Therapeutics in beta-thalassemia. They're also entering some phase 3 trials in cold agglutinin disease, which currently has no approved options. That also potentially could be where they're seeing the long-term value come from. Due to the expensive nature of this acquisition, they do need to be thinking long-term, because it's going to be a while before they can turn a profit on this.

Campbell: Yeah. Ultimately, the long term, whether or not this is a good deal or not, they overpaid or didn't, may hinge on those other programs that you just mentioned. Each one of those programs individually could be a nine-figure revenue generator for Sanofi over time. Again, they have to figure out a way to offset headwinds tied to Lantus. And I think this is one of the ways they might be able to do it.

Harjes: Yeah, and they've been looking for a while. You'll recall that they came second in trying to acquire Actelion and Medivation. Lantus didn't just lose its patent protection. I believe the patent expired in 2015. Meanwhile, this is the first major acquisition for the company since Genzyme back in 2011. That was a $20 billion acquisition. So they've been on hunt for a while. It doesn't surprise me to see them making some M&A moves.

Campbell: The other thing that's interesting is, the hemophilia market is going to grow. As I mentioned, it's $10 billion or so right now. It's expected to grow about 7% annually from here. That's a pretty solid natural tailwind for this market.

You mentioned there's a lot of competition. There is. If you look at it Baxalta, which is now owned by Shire, they generate $900 million a quarter from their hemophilia drugs, and they still rely pretty heavily on the short-acting therapies. So it's conceivable that you could have sales go from $1.1 billion today to $2 billion to potentially $3 billion, and then as some of these other programs pay off, then maybe you're getting up toward $4 billion. So I think the devil will be in the details. You're going to have to keep an eye on things.

But it's certainly interesting. It certainly makes you say, I want to be keeping an eye on hemophilia companies, because it seems like there's a lot of interest in paying up based on how much Shire paid, and now how much Sanofi paid, to get into the space.

Harjes: Yeah, absolutely. Folks, if you listened to yesterday's episode of Market Foolery, which is one of our other Motley Fool podcasts, you already know that a handful of Fools are going to be in San Francisco in early February for a Motley Fool One event. Anyone that's in the area is welcome to come join us on Wednesday, Feb. 7, from 5 p.m. to 7 p.m. at the Golden Gate Tap Room. I'll be there. Chris Hill will be there, Mac Greer, Matt Argersinger, many, many more Fools. If you're interested but don't trust yourself to remember those details, shoot Chris an email at [email protected]. We would love to see you there!

Campbell: That sounds like fun!

Harjes: [laughs] Yeah, it should be a really good time! I feel very lucky that I've gotten to hit up the West Coast twice already in 2018.

Campbell: Fantastic. And now you've scouted all the good places to recommend to everyone.

Harjes: Oh, yeah, Golden Gate Tap Room, that was totally my choice. [laughs] 

Campbell: Fantastic.

Harjes: We have been doing intern application interviews for the past week or so here at Fool HQ, so I'm going to intro our next segment with a quick story about one of the interviews, in which the candidate asked us, "How do we avoid clickbait?" And I was like, that's a good question, because you see so much clickbait out there on the Web, people posting these outlandish headlines, and then the article totally doesn't back it up. And immediately, when I heard this question, I believe I had this interview with the candidate yesterday afternoon, I immediately thought of the headlines surrounding Johnson & Johnson's earnings, which were just reported, and they had a very shocking headline, which is that Johnson & Johnson posted a quarterly loss of $10.7 billion. This is the healthcare stalwart, Johnson & Johnson, who hasn't posted a loss in any quarter in the 21st century. So that headline right there is just absolutely fascinating, but it's not actually as scandalous as it might appear, and we're going to dig into why.

Campbell: Absolutely. We're talking about one-time items. You have GAAP reporting and non-GAAP accounting, and sometimes it makes sense to look at GAAP, and sometimes it makes sense to look at non-GAAP, and this is one of those situations where it makes sense to look at non-GAAP, to focus on the adjusted GAAP that get rid of these one-time items that aren't likely to happen again.

Harjes: Yeah. The vast majority of that loss was due to a $13.6 billion provisional charge for taxes on $66 billion of foreign earnings that are going to be brought back to the United States due to the recent tax code overhaul. If you exclude that tax charge and other one-time items, earnings were a positive $4.78 billion, or $1.74 per share. So that beat Wall Street expectations.

Campbell: Yeah, they ended up beating on the top and the bottom line -- $20.2 billion in sales versus $20.1 billion estimates, $1.74 per share versus $1.72 per share. I think, you looked at this and said, the stock is up pre-market, and then it opened up, and it finished down pretty substantially for a company of its size. I think I saw it down, at one point, close to 4%. I'm not sure exactly where it closed that day. Are you, Kristine?

Harjes: No, I'm not.

Campbell: It took a little bit on the chin, though. I think that was because people were digging into the numbers a little bit and slightly disappointed with a couple of takeaways on the performance.

Harjes: Yeah. So in order to evaluate Johnson & Johnson's performance in any given quarter, you have the three main business segments to think about: the pharmaceutical segment, which is almost always the most important one to evaluate; then there's also the consumer goods segment and the medical device segment. The pharma segment was up 17% year over year to $9.68 billion. That was mostly led by a 40% increase in sales of cancer drugs like Darzalex and Zytiga and Imbruvica.

But there are a lot of moving parts here, and there are also plenty of important drugs that lost volume in sales. Remicade, for example, that's one we've been keeping our eye on forever. It's an autoimmune blockbuster. It fell about 10% because of biosimilar competition. We knew this was coming, and management actually says that's less of a decrease than they were expecting. But it will probably accelerate in 2018. Another one, Invokana in diabetes, fell 29%. That one was pretty surprising for me, at least, due to competition from Jardiance.

Campbell: There's so much competition now in the diabetes space for Invokana. In December, yet another drug that works the same way got approved. This is a very crowded market. I think people looked at Invokana and said, oh, my God, down 29%, that's more than I was thinking it would be. They looked at the fact that Remicade sales sagged more than 10% year over year. You mentioned Imbruvica. Yes, sales grew pretty substantially, but if you actually look at what Wall Street was looking for, it actually came in below those estimates. Darzalex is probably the best bright spot among the whole bunch, with sales up 82% at $371 million. Analysts were only expecting about $347 million. 

The other thing, you mentioned the clickbait-y headline stuff, there's so much stuff to dig into when it comes to Johnson & Johnson. And part of the problem for investors looking at just the headline numbers is, you have to remember they also did a massive acquisition of Actelion. And that has inflated what they're reporting as far as growth. You look at 15% operational growth from pharmaceuticals. Well, get rid of all the benefit from Actelion and currency and stuff, and 4.2% growth overall in the quarter across all of its businesses. So, you're talking about low single digits rather than, if you just looked at the headline number, something like 11.5% growth.

Harjes: Yeah, absolutely. Speaking of low single digits, the consumer health segment was only up about 3.1%, and the medical device segment, just to round us out with the third and final segment, was up 11.5%. They also provided a 2018 outlook, and they are expecting revenue of $80.6 billion to $81.4 billion. That would be operational growth of about 4%, or organic growth of around 2.5-3.5%. 

Campbell: Yeah, and I think that was kind of disappointing to folks, too. It marks a slowdown in organic growth from where we saw in 2017. And it's really not that much better than what inflation theoretically could be. If you look at Johnson & Johnson's stock leading up into this, it was trading pretty richly compared to itself over time. If you look at, historically, the P/E range for that company, it was up at the upper band of that. So you were pricing the shares for perfection, and instead you got solid results with some question marks. And I don't think that was the perfect recipe for this thing to continue to put in new highs, at least on day one.

Harjes: One of the big question marks moving forward, and this was extremely evidenced in the Q&A section of the earnings call is, what are they going to do with this newfound cash? They have about $12 billion that's immediately accessible from the repatriation. The way that they answered this question was to reiterate that their strategy is pretty much the same. Their No. 1 priority is going to be research and development. After that, it's going to be to raise the dividend, like they've been doing for so many years. That's what makes them a Dividend Aristocrat and a very attractive stock for so many people. After that, then they'll look at M&A, but only the right company at the right price. And then, maybe, after that, some share repurchases.

But that's clearly way down the road. No. 1 for them is absolutely going to be more research and development, in particular in the United States. For a while now, they've been borrowing money to fund their R&D efforts in the U.S. because it was cheaper to do that than to pay tax on bringing the cash back. Now, they'll be able to both fund those operations better and, hopefully also pay some of that debt down.

Campbell: Yeah. If you look at their costs last quarter, they actually started to spend a little bit more than they normally do on R&D already. There is, though -- again, you look at it and say, that's exciting, that they're going to recommit that money to R&D. But as we know from being healthcare-focused on this show, R&D investment doesn't necessarily translate into growth any time soon. A lot of these drugs in R&D programs end up failing or end up missing the mark as far as what you might hope they may deliver. The thing I thought was interesting, too, is that if you go into the Q&A section of their transcript from their fourth quarter conference call, you kind of get the impression that, yeah, dividend hikes are on the table, but they also seem pretty confident a 50% return rate is pretty solid as far as the dividend goes. So maybe, the dividend increase that people were hoping for will be a little bit smaller when it finally happens. I suppose that could be maybe weighing down a little bit of enthusiasm, too.

Harjes: I think it's their job, in these answers, to temper expectations.

Campbell: Yeah, absolutely. Whenever you have a situation -- you don't want to be involved with biotech companies that pump and dump. [laughs] You want to have them underpromise and overdeliver, absolutely.

Harjes: Yeah, and that's what you get with a stalwart like Johnson & Johnson.

Campbell: I would agree with that. I think the big question marks, the things to watch in 2018 as we go forward is, what kind of things are getting closer to the market in the pipeline? What happens with drugs like Zytiga, which is their leading prostate cancer drug? Sales were up significantly last quarter, and I think they're clocking in around a $2.8 billion run rate, but there's some patent concerns there. The company addressed it on the conference call, and they said, our patent for administration use was invalidated, but we're appealing it, and if we win our appeal, that's going to protect Zytiga through 2027. But if they lose that appeal, then theoretically, Zytiga could start facing off against the competition by the end of 2018. So then you end up with Remicade already facing off against biosimilars, and Zytiga potentially facing off against generics in 2019. So, what's going to offset that, especially when you have very low-single-digit organic growth modeled?

Harjes: Well, could be an acquisition. We don't know. But, with Johnson & Johnson, there's so much going on with that company that there will always be high points and low points. It's the total opposite from a single drug clinical-stage biotech, where you know exactly the single catalyst that you're supposed to monitor. With J&J, the way that I see it is, this company has tailwinds at its back, it has a smart management team, it has ridiculous flexibility on its balance sheet, especially now that it has more access to its cash. Even with a couple of ups and downs and bumps in the road, I do see a very bright long-term future for Johnson & Johnson.

Campbell: It's hard to imagine that this company isn't going to remain a core holding for most income investors and most large-cap mutual funds for decades.

Harjes: Yeah. If you don't think you're a J&J shareholder, you probably are.

Campbell: [laughs] Yeah, absolutely.

Harjes: All right, that's all we have for you guys this week. As usual, you can hit us up on Twitter @MFIndustryFocus or in The Motley Fool podcast Facebook group, or via email at [email protected]. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Todd Campbell, I'm Kristine Harjes. Thanks for listening and Fool on!