Plenty of big pharmaceutical companies started 2018 with piles of cash burning holes in their pockets. The pace of acquisitions and large licensing deals cooled off after hitting a crescendo in late April, but plenty of the industry's well-heeled members are still eager to invest.
GlaxoSmithKline plc (NYSE:GSK) recently agreed to pay $5.1 billion for part of a cancer drug that has some tough competition. On the same day, Johnson & Johnson (NYSE:JNJ) agreed to give a European biotech $500 million upfront for rights to an experimental blood cancer therapy that's still in early-stage clinical trials. Did these two heavy hitters make the right decision for their shareholders, or should investors be nervous?
What they bought
GlaxoSmithKline is so eager to bolster its presence in the oncology arena that it recently agreed to acquire Tesaro, Inc. (NASDAQ:TSRO) for $5.1 billion. Tesaro's lead drug, Zejula, is a poly ribose polymerase (PARP) inhibitor that makes it hard for some kinds of tumor cells to repair their own DNA.
Zejula earned its first FDA approval in early 2017, so GlaxoSmithKline will begin booking significant revenue as soon as the deal is complete. Johnson & Johnson's recent deal was much smaller than Glaxo's, but we still don't know if it will bear any fruit. Johnson & Johnson agreed to give argenx (NASDAQ: ARGX) $300 million upfront and bought 4.7% of the clinical-stage biotech's outstanding shares for $200 million.
Now, Johnson & Johnson owns a small slice of Argenx and the global rights to develop and commercialize cusatuzumab, an experimental cancer therapy formerly known as ARGX-110. If cusatuzumab earns approvals, J&J will also pay Argenx a tiered double-digit royalty percentage and up to $1.3 billion in milestone payments. The clinical-stage Belgian biotech has an option to co-promote the drug in the U.S. for an even share of the profits.
Why they bought
Johnson & Johnson has had tremendous luck with early-stage cancer drug deals in the past. In 2011, the big pharma invested $150 million upfront for the rights to Imbruvica when it was in early-stage clinical trials. Now it's a leading leukemia treatment, and it contributed $1.9 billion in sales to Johnson & Johnson's top line during the first nine months of 2018.
Imbruvica sales are still growing for J&J, and early-stage clinical trial data suggests cusatuzumab has what it takes to deliver blockbuster sales down the road as well. Celgene's Vidaza earned approval by producing overall response rates lower than 20% for patients with acute myeloid leukemia (AML) and related malignancies. Johnson & Johnson scrambled to cut a deal with Argenx because adding cusatuzumab to Vidaza helped 10 out of 12 AML patients treated to achieve complete responses. It's early, but more results like these could make cusatuzumab a blockbuster drug.
Back in 2015, GlaxoSmithKline sold off its oncology assets to Novartis, but Glaxo's new CEO wants to jump back in with a big splash. Zejula sales reached just $63 million during the third quarter, but independent cancer drug launches frequently disappoint. GlaxoSmithKline's sales team has a lot more resources to work with, and it can probably make Zejula a blockbuster drug in the years ahead.
Reasons to be nervous
Competition with PARP-inhibitors from AstraZeneca, Clovis Oncology, and Pfizer will make it difficult to squeeze $5.1 billion out of Zejula in the years ahead. Also, Tesaro originally licensed Zejula from Merck, which puts Glaxo on the hook for a tiered royalty percentage in the low teens based on worldwide Zejula sales.
Cusatuzumab put up some impressive early data, but 12 patients really isn't a large enough population to draw big conclusions about a potential first-in-class drug. The candidate targets CD70, which should work in theory, but we probably shouldn't get too excited until we're sure cusatuzumab plus Vidaza can outperform Vidaza on its own. First-in-class treatments that look great in early single-arm combination studies have a tendency to disappoint once tested against a control group.
Who should worry?
If anyone needs to be concerned that their company cut a bad deal, it's GlaxoSmithKline shareholders. Johnson & Johnson's deal with Argenx was generous, but the smattering of results we've seen so far are strong enough to suggest that cusatuzumab rights are worth $500 million upfront. Moreover, Johnson & Johnson can afford to swing for the fences and miss on this one. The company generated $18.5 billion in free cash flow over the past year and used just 51% of that cash to make payments for a dividend that hasn't gone an entire year without increasing since JFK was in office.
GlaxoSmithKline's dividend is anything but dependable, and investors should probably brace for more downs than ups in the years ahead. Glaxo's operations generated just $6.9 billion of free cash flow over the past year, and dividend payments ate up 75% of those profits. That means Glaxo doesn't have any room for error when it pulls off a big acquisition, which means its shareholders should probably be more than a little concerned right now.