Jazz Pharmaceuticals (JAZZ -1.02%) was out of tune with the biotech investment community -- not to mention its own shareholders -- for much of last year. Indeed, its stock has lagged behind the S&P 500, with an annual return of 6.8% compared to the index's 18% gain.
On Feb. 3, the company decided to turn up the music with the announcement of a $7.2 billion acquisition of medical cannabis company GW Pharmaceuticals (GWPH). The deal consists of mostly cash, debt, and about $700 million in newly issued Jazz Pharmaceuticals stock. Considering the company only has a market cap of $8.4 billion, the acquisition is undoubtedly an ambitious endeavor. Will it be enough to turn around the ailing biotech?
The merger came right on time
Jazz Pharmaceuticals brought in approximately $1.8 billion and $565 million, respectively, from its neuroscience and oncology segments in 2020. Those are sizable increases from the $1.65 billion and $472 million in revenue the company won in 2019 in neuroscience and oncology, respectively.
But there's a catch. More than 70% of its sales come from just one drug, Xyrem, a treatment for a chronic sleep disorder known as narcolepsy. Unfortunately for Jazz, there are nine generic versions of the drug scheduled to launch by 2023 as per patent litigation settlements. After that year, Xyrem is likely to lose nearly all of its revenue and market share due to intense competition. The company produced about $700 million in operating cash flow in the first nine months of 2020, and most of it came from Xyrem.
In an effort to bolster the rest of its pipeline, Jazz Pharmaceuticals decided that it was best to take over GW Pharmaceuticals and its flagship drug, Epidiolex. This is the first and only cannabinoid drug approved by the U.S. Food and Drug Administration (FDA) to treat seizures associated with several rare diseases.
In 2020, Epidiolex generated $510 million in sales in the U.S. and E.U., which grew by a stunning 72% year over year. In 2021, the company expects to expand Epidiolex's presence to a few more European countries. Epidiolex is also being explored in clinical trials as a possible treatment for severe epilepsy, potentially increasing its addressable patient size by more than 1 million people, if successful. Unlike Xyrem, Epidiolex's patent does not expire until 2035, giving the pair more than a decade to take the drug's sales to the next level and earn new indications.
Together, the two biotechs will have 19 clinical programs in total after the merger. That count includes eight cannabinoid programs from GW Pharmaceuticals. Both companies expect their new product launches or acquired therapies will account for more than 65% of their combined revenue by 2022. At the moment, Jazz and GW Pharmaceuticals' sales totaled $2.9 billion in 2020. They also have about $2.6 billion in cash on hand.
Should I buy the stock now?
Before the deal, Jazz Pharmaceuticals was arguably very undervalued, trading at just 3.3 times revenue and 9 times earnings. After the acquisition closes, the combined entity will be slightly more expensive at 5.2 times sales. However, it expects to hold a financial leverage of 5.4 times net debt to operating income less non-cash expenses (EBITDA). Usually, anything above a ratio of four indicates a company may have trouble serving its debt obligations. Jazz Pharmaceuticals and GW Pharmaceuticals plan to get that metric down to 3.5 by 2022.
Overall, the GW Pharma takeover is not a want, but a need for Jazz Pharmaceuticals. Without GW Pharmaceuticals' help, the company would potentially lose $1.6 billion in revenue over the next decade while Xyrem fades into oblivion. Given the strong performance from Epidiolex in 2020, I expect Jazz to keep its revenue and earnings growing over the next five years. The stock should further enrich investors as the company uses its new cash flow to deleverage and pump out new clinical candidates. For biotech investors looking for value in neuroscience or oncology firms, Jazz Pharmaceuticals could be a fantastic choice -- but it might make you sweat out some growing pains before you see major returns.