Nearly 20 years ago on Dec. 15, 2000, medical device and pharmaceutical maker Abbott Laboratories (NYSE:ABT) announced its $6.9 billion acquisition of Knoll Pharmaceuticals, a subsidiary of chemical giant BASF. At that time, no one knew that Knoll housed a drug, still in clinical development, that would one day become the world's largest selling drug.
Then in 2013, Abbott Labs split its company in two. The medical device side retained the name Abbott Labs and the pharmaceutical business was spun-off to shareholders and the new company was named AbbVie (NYSE:ABBV). The aforementioned drug was called D2E7 by Knoll, and generically known as adalimumab, but better know as Humira, generated $19.9 billion in global sales last year and was the world's best-selling drug. Humira is a subcutaneous injection used to treat a variety of diseases including rheumatoid arthritis, psoriatic arthritis, plaque psoriasis, Crohn's disease, ulcerative colitis, and ankylosing spondylitis among others. Humira's sales accounted for 60% of AbbVie's revenue in 2018.
Humira's days of market exclusivity are numbered
Humira was approved in the U.S. in 2002. Last year, U.S. sales of Humira were $13.7 billion, or roughly 42% of AbbVie's total global sales. Humira is set to lose U.S. patent protection in 2023, which will likely precipitate a significant drop in profits. Another $6.3 billion of Humira sales (19% of total sales) was generated outside the U.S. Late last year, biosimilars of Humira (generic biologics) were approved in Europe. The impact of these generics entering the market can be seen in AbbVie's third-quarter earnings release which showed international sales of Humira declining by 32%. AbbVie realized it would have a significant problem in 2023 when U.S. Humira biosimilars are scheduled to launch.
Will an $86 billion diversification strategy work?
AbbVie's solution to this impending patent cliff was to acquire Allergan (NYSE:AGN) for $86 billion including the assumption of Allergan's debt. Allergan will bring over $15 billion in revenues to AbbVie and in the process reduce overall Humira exposure to less than 40% of total sales, still significant, but better. Further, over the next few years international competition from generics should cause international sales of Humira to continue declining. In fact, at the current rate of decline, international sales of Humira will likely be less than $1 billion by 2023.
With Allergan, AbbVie now has two main components of its business, Humira and a diversified $30 billion pharmaceutical business it forecasts to grow at a high-single-digit rate for the next decade. The problem is domestic Humira should post similar growth rates. Thus, even if AbbVie's long-range forecast is correct, by 2023 Humira could still account for roughly 35% of sales.
The Allergan acquisition should lift the trough earnings of AbbVie in 2024.
According to AbbVie CEO Rick Gonzalez:
You can take this $15 billion set of assets that are durable and growing and highly profitable (referring to Allergan), and the cash flows from HUMIRA prior to or shortly into the LOE (loss of exclusivity) in 2023 will have paid down the incremental debt that was necessary to be able to buy these assets. So, essentially, HUMIRA is buying the assets that replace it over the long-term.
So in other words, AbbVie is viewing Allergan as a similar-sized asset that will replace the lost sales from Humira; and Humira will pay for it.
The approaching 2023 patent cliff looms for investors
While investors wait for more clarity surrounding AbbVie's earnings power post the Humira 2023 loss of exclusivity, a dividend yield of 5.5%, which was increased by 10% on Nov. 1, should help reduce investors' concerns.
When asked about the recent dividend increase Gonzalez said,
We certainly would not have increased our dividend double-digits now if we had any concerns about that going forward. So, I can tell you we are committed to a strong and growing dividend and we are committed to paying down debt and we have the ability to be able to do both. And I think the dividend increase that we are announcing today is a reflection of our confidence in that cash flow generation.
One way to think about AbbVie today is that it is over-earning, or that AbbVie's normalized earnings power is less than what it is reporting today. After all, the substantial bulk of Humira's profits are going away in the not-so-distant future.
But investors aren't paying much today for Humira's profits. AbbVie trades at less than 10x forward earnings. Further, Allergan will be highly accretive to AbbVie's earnings with over 20% accretion at peak. And AbbVie's other assets could also provide upside, such as its successors to Humira called Skyrizi and Rinvoq, both of which have shown superiority to Humira in head-to-head clinical trials for several indications. Given the low valuation, accretive acquisition, robust pipeline, and strong new drug launches, AbbVie is well-positioned for its impending patent cliff. While earnings will no doubt take a dip in 2023 and 2024, investors should expect dividend growth to continue.