You've probably heard about "black swan" events. The concept was popularized by Nassim Nicholas Taleb's best-selling book, The Black Swan. Taleb defined a black swan as a highly improbable event that's unpredictable, has a huge impact, and is rationalized in hindsight.
But what about "gray swan" events? A gray swan is similar to a black swan in that it's very improbable and makes a massive impact. The primary difference is that, unlike black swans, gray swans can be predicted. People often use the term black swan to refer to an unlikely occurrence, when gray swan is more appropriate. There are more gray swans in the business world than black swans.
A significant gray swan for Celgene (CELG) right now is the possibility of losing a legal challenge to key patents for Revlimid. Such a loss isn't likely and would certainly have a major impact on Celgene, but it's not totally unpredictable.
However, there's also a black swan swimming in the waters around the big biotech. And it could potentially sink Celgene.
The black swan scenario
The black swan for Celgene includes several components. First, and most important, is a loss of the aforementioned patent challenge to Revlimid.
Celgene's U.S. exclusivity for key-use patents for the drug expire in 2027, while European patents expire in 2024. However, other companies are challenging these patents. The most significant of these threats comes from Dr. Reddy's Laboratories, which is battling Celgene in the U.S. District Court for the District of New Jersey.
The next part of Celgene's black swan scenario is for regulators to turn down approval for ozanimod in treating multiple sclerosis (MS). Celgene confirmed in its Q3 earnings conference call that it plans to submit the drug for approval in the U.S. and in Europe in the first quarter of 2019.
Finally, there's a pick-two-out-of-four component. Celgene anticipates launching four other drugs with blockbuster sales potential by 2020: fedratinib, luspatercept, liso-cel, and bb2121. If a couple of these top pipeline candidates fail to win regulatory approval in addition to a thumbs-down for ozanimod and a major patent loss for Revlimid, the biggest black swan to ever hit the biotech industry will have arrived.
Some might argue that such a nightmare scenario for Celgene is a gray swan rather than a black swan because it can be predicted. But the combination of these blows for the biotech would be, to use Taleb's description of a black swan event, "an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility."
A devastating impact
There could be some quibbling about how dark the feathers are on the swan. But no one would argue that the scenario described above wouldn't devastate Celgene.
Revlimid generates more than 63% of Celgene's total revenue. Just as crucial, the hematology drug accounted for 60% of the biotech's overall sales growth in its latest quarterly results. Because of Celgene's dependence on Revlimid, success for the company's pipeline products is paramount.
The biotech is counting on ozanimod to rake in peak annual sales between $4 billion and $6 billion. This estimate includes the MS indication plus indications for the drug in treating Crohn's disease and ulcerative colitis. But if ozanimod is turned down by the Food and Drug Administration (FDA) and European regulators for treating MS because of safety concerns, you can probably throw all the indications out the window.
What would the effects of setbacks for other top pipeline candidates likely be? Failure to win regulatory approval for cancer cell therapy liso-cel would probably hurt the worst. Celgene spent $9 billion to acquire Juno in early 2018 to obtain full rights to the drug, betting that liso-cel would pull in close to $3 billion annually.
However, estimates for cell therapy bb2121 and blood disorder drug luspatercept aren't too far behind. Both drugs could each generate peak annual sales of more than $2 billion if approved. Fedratinib trails the other candidates, but could still bring in around $1 billion annually in peak sales.
The bottom line is that this black swan scenario could drastically reduce Celgene's sales from top-selling Revlimid and simultaneously wipe out most of the revenue from pipeline candidates that the biotech was counting on to offset future sales declines for its flagship drug.
Just how unlikely?
Remember that a key criterion for black swan events is that they're highly improbable. But how unlikely would it be for Celgene to lose its patent challenge for Revlimid, fail to secure regulatory approval for ozanimod, and be turned down for two other drugs?
The patents for Revlimid have been challenged before, resulting in a settlement with Natco Pharma in a deal that was generally favorable to Celgene. Under the terms of this settlement, Natco will launch a generic version of Revlimid in March 2022 but can only sell it at limited volumes initially.
It's possible that Dr. Reddy's Laboratories or another challenger could prevail over Celgene in patent litigation. But to do so would require proving that key patents for Revlimid are invalid. Celgene remains confident in its intellectual property rights for Revlimid.
Probably the most likely outcome from the latest challenge is a settlement along the lines of the one with Natco. Such a deal could result in lower sales for Revlimid sooner than Celgene hopes, but it probably wouldn't hurt the company too much. The likelihood of a major loss for Celgene seems very low -- my guess would be under 5%.
As for ozanimod, Celgene has already received a refusal-to-file letter from the FDA earlier this year. However, that was a blunder related to the drug's approval submission and not a sign of problems with ozanimod's safety or efficacy.
Historically, 86% of autoimmune-disease drugs submitted for approval have received a green light from the FDA, according to the Biotechnology Innovation Organization (BIO). I suspect that the odds of ozanimod winning approval are even greater based on the phase 3 clinical study results for the drug -- perhaps close to 95%.
But there could still be a big uphill climb to approval for Celgene's other top pipeline candidates. Only one-third of cancer drugs in late-stage clinical studies go on to obtain FDA approval. Hematology drugs have better odds, with 63% of candidates in late-stage testing ultimately gaining approval.
So what's the probability of Celgene's black swan scenario unfolding using all of these numbers? It's around 3,000 to 1 against the black swan happening.
Black swan strategies
What are the alternatives for investors with Celgene? There are three basic choices:
- Bet against Celgene stock.
- Avoid buying Celgene stock.
- Buy Celgene stock.
Placing a bet on an unlikely scenario unfolding is usually a way to lose money quickly. Granted, Celgene's share price would be hurt by any setback. It wouldn't require the full-blown black swan to happen. However, there's already a lot of negativity priced into the stock, with shares trading at a super-low price-to-earnings-to-growth (PEG) ratio of 0.39. I'm not surprised that the short interest in Celgene is very low -- the stock is simply too cheap to bet against.
Perhaps the easiest path is to avoid buying Celgene stock and look elsewhere. And that's what most investors will choose to do.
I think, though, that buying Celgene is the best alternative. When a stock is too cheap to bet against, that makes it an intriguing choice to bet on. Another favorable settlement for Revlimid and a handful of regulatory wins for very promising drugs with solid clinical results could easily make Celgene one of the hottest biotech stocks around.
Yes, a black swan could sink Celgene. I wouldn't recommend putting too much of your portfolio at risk with this stock -- or any other stock, for that matter. But, as in nature, there are a lot more white swans than black swans. I think Celgene's chances of sailing are much better than its prospects of sinking.