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A Breach of Trust? Here's Why the FDA's Taking Aim at Novartis' AveXis

By Todd Campbell – Updated Aug 16, 2019 at 1:11PM

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What Novartis' misstep means to investors, plus how Exact Sciences is trying to lock up the genetic testing market.

The Food and Drug Administration is investigating Novartis' (NVS -0.48%) subsidiary AveXis because the latter may have manipulated data on Zolgensma, a gene therapy with a sky-high price tag and blockbuster potential. Novartis management is also on the hot seat for delaying its reporting of the gaffe to regulators until after the FDA approved Zolgensma in May. In this episode of The Motley Fool's Industry Focus: Healthcare, host Shannon Jones and Motley Fool contributor Todd Campbell discuss what happened and what may come next.

Also, they update investors on Exact Sciences' (EXAS -1.22%) latest move to dominate the emerging market for genetic testing in cancer patients. Is Exact Sciences' decision to acquire Genomic Health (GHDX) wise?

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on Aug. 14, 2019.

Shannon Jones: Welcome to Industry Focus, the show that dives into a different sector of the stock market every single day. Today is Wednesday, August the 14th, and we're talking Healthcare. I'm your host, Shannon Jones, and I am joined via Skype by healthcare Guru Todd Campbell. Todd, how's it going?

Todd Campbell: Good! I'm really excited to talk about some really high-profile, interesting stories here that I'm sure our listeners are going to be just absolutely enthralled with, right?

Jones: And it's not just these stories -- Todd, when you look back over the past week, the news across the biotech space has just been massive, so many things happening. Of course, most, I think, are snafus, more of the negative sort. But with today's show, I'm excited because we've sifted through many of the major headlines that are going on right now to the two biggest stories that I think investors need to focus on. We've got, first up, Novartis once again making the scandals headlines, unfortunately for them. Then, we'll also dive into M&A on the cancer diagnostics front.

Todd, let's just kick it off with Novartis. This is a gene therapy story we've been following really closely, especially leading up to the approval of their landmark gene therapy drug. Of course, Novartis is ticker symbol NVS. This is in relation to Novartis and AveXis and their drug that was approved back in May. First gene therapy approved for a very rare but serious genetic condition. We've learned that basically, the data supporting the approval that we saw in May was manipulated. Todd, what in the world does this mean? And, even before we get to that, let's talk about this landmark drug, just to get all of our listeners up to speed.

Campbell: Absolutely. A couple of things. When they did approve it in May, I think we did a show. so listeners can go back to May, maybe early June if they want a lot of backstory on Zolgensma and what's going on with Novartis and AveXis today. I think it's also important to say right up front, that it was only some data. We'll get to the specifics of what data was involved. But I think that one of the things that investors oftentimes overlook is the corporate governance side of investing, making sure that you've got people in the top spots at companies that are making wise, prudent decisions and not exposing you to unnecessary risks. I think with biotechnology especially that's important because so much money, Shannon, has been flowing from venture capital and other sources into the biotech industry over the last three or four years, and arguably, that's maybe led to some people who are acting faster, maybe, than they should be, and maybe aren't crossing all of the T's or dotting all the I's. Perhaps that's what we saw here with Zolgensma.

A little bit of background here. Zolgensma is a gene therapy that won approval for use in patients with something called spinal muscular atrophy, which is called SMA for short. SMA is the leading cause of infant mortality, sadly. Patients are unable to produce a protein which allows motor neurons to survive. This drug has been heralded as a major advance because it restores the ability to produce some of that missing protein by installing a working or functional copy of the gene that makes the protein. So, when it won approval, obviously a landmark, revolutionary, game-changing event that the industry covered. 

Now, fast forwarding to today, we find out that the drug Zolgensma, the company who developed it, AveXis, may have fudged some of the data relating to their production methods, or the assay used to evaluate the production methods, in animal studies, specifically in mice. The FDA has come out and said, "Yes, Novartis did indeed disclose that this data was perhaps manipulated." But the FDA also chastised Novartis strongly because Novartis is the one who bought AveXis. They paid $8.7 billion for it. They own the good and the bad. They own the fact that Zolgensma is this breakthrough drug; they also now own the fact that maybe they didn't do the due diligence they should have done to make sure all of that data early on was up to snuff.

Jones: I think this is a huge blot on Novartis' CEO. If you remember, it was around, I want to say May of last year that the CEO, Vasant Narasimhan, was apologizing for the revelation that the company paid Michael Cohen, who was lawyer to President Trump, for this $12 million year-long contract, basically to get an in with the Trump administration. That came out. He went on pretty much a worldwide apology tour, promising to change the culture within Novartis and really change the perception at the company. So, he did that, and then he also started being more aggressive in deal-making, which led to AveXis and this $8.7 billion purchase that he made. Him being the one that was behind engineering this entire deal, it's going to be really hard for him to shake that, because what you have now, even though it's just mice data that they're looking at -- and granted, the FDA is saying, "We don't plan to take this drug off of the market," what you have now is an eroded sense of trust. And it's that trust issue that, for me as an investor, for analysts, and really for doctors and patients, is central to being able to follow this company, really wanting to be excited about their prospects. If you're not doing the due diligence -- and, to your point, Todd, the corporate governance -- I tend to become much less enthusiastic, no matter how innovative the drug and no matter where it falls in terms of competition. If I can't trust the leadership, I can't trust the management, I just don't like it.

But I think this raises a number of different questions. First of which, the FDA said that executives at AveXis knew about this as early as March, but didn't tell regulators until late June. Remember, the drug was approved in May. For me, when was this disclosed to Novartis, No. 1? And, when Novartis knew about it, why did they wait? Novartis did come out and say, "We wanted to get a full scope of the entire picture," but still, when did you know about this, Novartis? [laughs] Obviously, I'm pretty sure it came after the acquisition, but I have a lot of questions in terms of when they knew about it, and do they then now become a part of the cover-up? Another question I have, the FDA has signaled there's going to be some civil, potentially even criminal penalties coming with this. Who's going to be the fall guy here to take the hit for this? And then, what will this do for patients? Will doctors really just put a question mark around the entire package? Yes, it's just the animal model data that they were looking at, but for patients and for doctors, does it raise more questions than answers? These are a lot of things that are swirling through my head right now, Todd.

Campbell: This is a very bad look for the company. This is the most expensive drug approved, $2 million. They break that price up over five years, but, $2 million for this therapy. It's a blockbuster indication, as we know from Spinraza, which is another drug that's been approved for the indication. We're talking about huge money at stake. And, yeah, the deal closed. Novartis knew. And they were conducting their interim analysis to confirm what they suspected. That's why. That's why, Shannon, they delayed it, telling the FDA, until June 28th, more than a month after the approval. [laughs] OK, yeah. Alright, we'll give them the benefit of the doubt, right? I don't know.

I think this is definitely concerning. I don't know whether or not we're out of the woods yet. I mean, you like to think that sometime, the news cycle is pretty fast, but this could stretch out because we do have political season ramping up. If you can point to a bad actor and continue to point to a bad actor, why wouldn't you? The FDA has said that this could take several months, for them to go through, look at all -- they think that there's going to need to be a BLA supplement that's going to have to get filed from them by Novartis, they're going to have to review that, maybe some changes end up being made to the label. 

They have said, as you mentioned, they're not taking this drug off the market. They don't think this has anything to do with its efficacy and safety in humans. To your point, though, it raises an important question for investors, and that is, we are only as good as the information that is publicly available to us. You look at the Novartis earnings conference call that they just had, in July -- there was no mention of this. There was no hint of this. Instead, they were just talking about how great the launch was going, and how they were going to start these other trials, and how they were going to expand into new countries, and potentially make it more available to other patients. There wasn't even a hint. And all of this, meanwhile, was going on in the background. And, granted, maybe their hands were tied a little bit on what they could say publicly. But, as investors, we are a little hamstrung. There could be things happening in the background that management's aware of that they just simply haven't disclosed to us yet. And again, like I said, all the money that's been flowing into biopharma has... maybe a lot of companies have gotten financing that wouldn't have gotten financing otherwise. It definitely is a good reminder to investors that you have to do your homework. You have to do your due diligence and you have to be willing to accept risk, because -- as we just saw -- something can come out of nowhere and derail an investment thesis very quickly.

Jones: And it's not just the small biotechs, Todd. Here, you have a company the size of Novartis who, on their best day, not only was there a data issue for the company they were acquiring, but now you have the fallout in terms of how they handled it, which really comes down to more of a management issue. The risk is there, and I think you do need to, as always, invest cautiously, especially in this space. We've talked about this on the show before Todd -- with the IPO market being so red-hot, you do have a lot of companies that are coming public that really should not be coming public, No. 1; and then, you have a lot of these companies being acquired where the due diligence just wasn't what it should have been. So, I think this is the first of many stories we'll probably hear play out over the next few years for a lot of these high-flying companies. But we will keep all of our listeners up-to-date on all of that. 

Alright, Todd, other big news happening. EXACT Sciences, ticker EXAS, making a big move to become a dominating force in the global cancer diagnostics space, all with a newly announced acquisition. Todd, what can you tell us about who they're acquiring and what the deal terms look like?

Campbell: Oh, how the times, they change. It was not that long ago, Shannon, a couple of years ago, where people were talking about EXACT Sciences as maybe being an acquisition target. Lo and behold, a few years later, they're the ones who go out and cut a multi-billion-dollar deal. They're buying Genomic Health, symbol GHDX, for $2.8 billion in a cash in stock deal. And that deal is really interesting because it should accelerate EXACT Sciences' research into liquid biopsy, which is the ability to evaluate cancer and inform cancer treatment using a simple blood draw.

Jones: What's interesting, you talked about just how much things have changed. It was 10 years ago, EXACT Sciences was pretty much puttering along, really on its last legs. I've really got to hand it to CEO Kevin Conroy, who's been able to right this ship, really help turn this company around, which of course has really been its bread and butter product Cologuard. For listeners who may not be familiar, you probably are familiar with the commercials where the little box hops on the toilet that seem to come on just about every hour on TV. [laughs] That is their product. It's basically stool samples to detect the presence of colorectal cancer, is basically what it does on the high level. This is a company who's been able to grow its presence. I have to admit, Todd, for EXACT Sciences, I've been watching the story over the past few years. I've wanted to support it. Couldn't really get past the sending a stool sample in a box in the mailbox. So, for me, I've stayed on the sidelines. I've been wondering, is this a company with a one-hit wonder? Yes, it's been doing well, but where is the next phase of growth going to come from? And for me, this deal with Genomic Health seems to answer a lot of those questions.

Campbell: This is a very heavily shorted stock. A lot of people in your camp, Shannon, thinking, why would you not go and just get the colonoscopy? Sure, it's uncomfortable, but it's the gold standard for making sure that you're free of colon cancer. The reality, however, is, I think it's up to 40% -- it's a large percentage of the people who are above age 50 who should be regularly screened for colon cancer, and they're not doing that screening. And maybe it's because of the cost. Colonoscopies can run into thousands of dollars. Maybe it's the prep regimen, which I've been told can be a little bit rough or uncomfortable. 

Jones: I can confirm, Todd. [laughs] 

Campbell: [laughs] I recently was speaking with someone, too, who had their colonoscopy, and then they ended up having some complications afterwards. They're fine now. But, I mean, there are reasons why people would rather poop in a box and mail it off to find out whether or not they're at a greater risk. And sure enough, there has been enough consumer interest in this product that sales have been rocketing higher and overcoming a lot of these objections that naysayers have had. And sure enough, that's put EXACT Sciences into a position where it's generating a significant amount of cash flow, and it's taking that cash and starting to redeploy it in research and development areas, particularly into second-generation testing, using things like liquid biopsy, which is really a fascinating advance or innovation for cancer treatment. We talk a lot about how biopharma is developing these new drugs that can attack cancer in all these incredibly new ways. But, we're also making these huge advances in being able to inform the decisions that are made by patients and oncologists. For example, you're able to take, say, Genome Health's test, and be able to say, "What does that breast cancer that this patient happens to have, what does that look like?" And, "Will they respond well to, say, chemotherapy? What is the likelihood of the recurrence of that breast cancer?" 

So, in buying Genomic Health, I think one of the things EXACT Sciences is doing is showing you why they never changed the name of their company to Cologuard. Their vision is much, much bigger than that. They want to be able to provide a soup to nuts solution for detecting and informing treatment. And now, they have this really powerful platform. They have a tremendous sales force through Cologuard, and now, they also have access to I think 90 different countries through Genomic Health. And, it's important to recognize, too, that Genomic Health is a profitable company. Not only is it bringing in additional revenue, spreading out more products to offer, but it's also helping to accelerate its pathway to overall profitability longer-term. They are saying, when this deal closes next year, they will be cash flow positive, despite all their investments.

Jones: Yeah. So, this is bringing some relief to the bottom line, as well as the top line, because really, for Genomic Health, they've just continued to grow. They generated $394 million in revenue, and $25 million in profit just in 2018. They raised their financial guidance for all of 2019, projected between $448 million and $452 million in revenue, and a profit of $56 million to $60 million. For this particular deal, it brings together their R&D teams. They do have a goal of identifying biomarkers across the top 15 deadliest cancers. You mentioned with Genomic Health, really, for them, it's been breast cancer. That's really where they've been the gold standard in terms of diagnostics. You've got EXACT Sciences with theirs in colorectal cancer. They're looking, collectively, it could be 40% of all solid tumor indications out there they may have the potential to go after. It's pretty impressive, just from a financial perspective, and just from a scientific perspective, in terms of what they can cover.

Going back to Cologuard, the company screened 415,000 patients. That was a 93% year over year increase. And this is a product that has taken off, especially as they secured recommendations from the American Cancer Society and coverage. Coverage was a big question a few years ago, as they were trying to get basically on the formularies for a lot of the public payers. They were able to secure that. And also, if you remember, in late last year, EXACT Sciences inked a partnership deal with Pfizer for marketing. You talked about their massive sales force. A lot of the numbers that we've seen even on the EXACT Sciences end has come from this partnership, where they've been able to boost up their sales force, boost up their marketing presence. That's why we see them all over the TV now. In looking at this deal, and I think they even alluded to it in the conference call, there were some questions about, "What does this deal mean, with that Pfizer partnership?" In the interim, I don't think it will change anything, but I think there are some ongoing discussions about what that Pfizer partnership could be over the long term as well.

Campbell: Yeah. I think, for investors who are trying to figure out, OK, I own Genomic Health, or I own EXACT Sciences, what does this all mean for me, should I stay around, should I go, what should I do? The combined company, they think, is going to have $1.6 billion in revenue and generate $1.2 billion in gross profit next year. That's pretty remarkable. EXACT Sciences says that the total addressable market for the products they have right now is like $20 billion. So, there's still a lot of running room. I think Cologuard itself only has 6% or 7% market share in colon cancer screening, despite where sales are today. 

I like this deal. And I like this deal for another reason, too. We talk a lot about M&A. One of the things we haven't really mentioned in this discussion is synergies. And there's a reason.

Jones: Don't you say that word, Todd Campbell!

Campbell: There really aren't that many, right? I don't have to say the word! They're only saying, "Maybe we'll save $25 million a year from some governance issues and that type of thing." This is one of those deals where truly, they're taking two successful companies, putting them together, and there's not a tremendous amount of redundancy or overlap that could be eliminated. Instead, it looks like it could be just additive. So, you've got this increasingly larger scientific knowledge base that they can tap to dominate this market. And, like I mentioned, it's a big market -- potentially $20 billion addressable market. There's competition out there. There's other companies who are in the space. I like this deal, though. And frankly, I think that EXACT Sciences -- or, if you want to backdoor play it and own Genomic Health to get the shares and the cash -- I think either one of them would be OK for investors.

Jones: Yeah, I like this deal, too. For investors that are watching what will come next, the deal has already been unanimously approved by both companies' boards, but still needs the approval of regulators and Genomic Health stockholders. Assuming all of that passes muster, the companies do expect the deal to close by the end of this year. A lot to like, a lot to look forward to. I can say I'm becoming more excited about EXACT Sciences with this deal and with the runway. We'll have to see what comes next, but I really do think it answers a lot of those lingering questions about what's next for EXACT Sciences. So, with that, I'll be keeping a very close watch on it. We'll be keeping our listeners up-to-date on all the latest. 

For us, that'll do it for this week's Industry Focus: Healthcare show! Thank you so much for tuning in! As always, people on the program may have interest in the stocks that 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. The show is being mixed by Austin Morgan. For Todd Campbell, I'm Shannon Jones. Thanks for listening and Fool on!

Shannon Jones has no position in any of the stocks mentioned. Todd Campbell owns shares of Pfizer. The Motley Fool owns shares of and recommends Genomic Health. The Motley Fool has a disclosure policy.

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Novartis AG Stock Quote
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