Gilead Sciences (NASDAQ:GILD) has a well-deserved reputation as an excellent business purchaser. Its $11 billion Pharmasset acquisition in 2012 enabled Gilead to seize 90% market share in Hepatitis C, to the tune of more than $10 billion in Hepatitis C revenue in 2014 -- and more than $14 billion in Hep C revenue in just the first nine months of 2015. Its acquisition of Triangle Therapeutics has also paid off handsomely for Gilead's HIV franchise.
That's why its recent deal with the Belgian biotech Galapagos NV (NASDAQ:GLPG) for the autoimmune disease drug filgotinib raised my eyebrows. The deal wasn't in Gilead's usual style, because it involved Gilead taking an equity stake in Galapagos. Usually (and this was true in the case of both Triangle and Pharmasset), Gilead doesn't bother with equity and either licenses the precise drug it wants or just buys the whole company. The "we like you and are interested enough that we want to stay close, but not enough to buy you right now" strategy of buying up equity in a company is more what you'd expect out of Celgene (NASDAQ:CELG).
Does this signal a change in Gilead's methods? And perhaps more importantly, which style of growth is better for shareholders?
Breaking it down
The Galapagos deal works like this: Gilead is paying Galapagos $725 million upfront to license filgotinib -- including a $425 million equity investment in Galapagos, which means Gilead will own around 15% of the company. Galapagos can earn another $1.35 billion in milestone payments, as well as tiered royalties starting at 20% of eventual sales.
The companies will share the cost of phase 3 trials in rheumatoid arthritis, and Galapagos is responsible for 20% of global development activities' costs. Gilead is responsible for the remainder, as well as marketing, sales, and manufacturing expenses. Galapagos gets an option to co-market filgotinib -- assuming it makes it to market -- in certain European countries.
All well and good -- and, for the record, I've argued that the $725 million is a very good price for what Gilead's getting (to summarize the linked article: The drug could be worth as much as $2 billion in annual peak sales, and because Gilead will also own 15% of Galapagos, that means additional possible upside for Gilead because of Galapagos' other growth opportunities). It's just not typical of what you'd expect Gilead to do. Gilead usually aims to either license a drug or suite of drugs, or buy the company outright. An equity investment in a smaller competitor just isn't really Gilead's style.
Well, sort of...
That's not to say that it hasn't happened. I spent some time last weekend looking through every press release on Gilead's corporate website dating back to 1996 (weekends are a rockin' good time at the Douglass household), and there are a few instances of Gilead purchasing stock or warrants in competitors as part of a license agreement.
In April 2006, Gilead invested $25 million in Corus Pharma to gain access to its cystic fibrosis treatment Cayston -- and then bought the rest of the company that July. In November 2004, Gilead made a $5 million equity investment in Hepatitis C competitor Achillion Pharmaceuticals as part of a broader Hepatitis C collaboration. Gilead also structured a pair of deals in 2001 to gain equity or warrants in a pair of other companies -- OSI Pharmaceuticals and Archemix -- as it out-licensed or offloaded assets to improve its focus on core areas of expertise.
But really, it's mostly a Celgene thing -- and it's great for Celgene
Celgene is much better known for making these kinds of deals. I'll let Celgene CFO Peter Kellogg explain the company's modus operandi. The following is from his remarks at the Credit Suisse Healthcare Conference last November (quote courtesy of S&P Capital IQ).
I mean, the companies that we have invested in, a number of them have gone from being private companies to -- through IPO, to being very valuable public companies today. We do have small equity stakes in a lot of these companies, most of them in fact. Usually, it's in the 5% to 15% range.
Celgene gets in early -- often pre-IPO. As such, it is usually able to pay a relatively small amount for a lot of access early on.
Take its recently signed collaboration deal with Juno Therapeutics (NASDAQ:JUNO) as a good example: Celgene paid $1 billion upfront to get a 10% stake in the biotech, a seat on its board, and access to its CAR-T cancer-fighting drugs for potential commercialization.
Juno's pipeline is phase 2 or earlier, which undoubtedly helped hold down the cost of the collaboration for Celgene because it increases both the length of time until potential commercialization, and the potential risks -- after all, 90% of the drugs that make it to phase 1 never make it to market, and the odds are still well under 50% at phase 2. It also allows Celgene to participate in a still-young company's potentially meteoric growth, particularly because the agreement gives Celgene the option of owning up to 30% of Juno in the coming years.
I had to dig back into the mid 2000s for examples of Gilead taking equity in other companies without just buying them outright.
It didn't take nearly that much effort to find additional Celgene equity infusions in various biotechs over the last two years. In January 2014, Celgene paid $75 million for an equity stake in NantBioScience and greater exposure to its work in personalized medicine. In Feburary 2014, Celgene coughed up $50 million for equity in Abide Therapeutics and access to two incoming drug candidates targeting inflammation and immunological disorders. Celgene paid an unspecified amount in October 2014 for equity in Sequenta and access to its ClonoSIGHT cancer test based on gene sequencing. In September 2015, Celgene paid $150 million, including an equity infusion, for Nurix to focus on early production of two drugs targeting inflammation and immunological disorders. The list goes on, and on, and on.
If it's so great for Celgene, why doesn't Gilead do it more?
Celgene's interest in these companies is usually pretty different from Gilead's. Celgene is often interested in a whole platform and its opportunity -- see CAR-T with Juno above -- as opposed to a single, specific drug. And because it's not just a "one and done" kind of deal, purchasing a small stake in the outside company makes sense for Celgene as it looks to understand the company over a longer time period, and retain optionality in it.
Additionally, letting the company remain independent -- as opposed to, say, buying it -- gives Celgene two additional benefits. First off, it's cheaper to buy part of a company than the whole company, which lets Celgene spread its bets out among relatively risky companies instead of concentrating its risk in a few. Keeping the smaller biotech independent also leaves the scientists that company employs free to do drug discovery their own way instead of bringing them into the Celgene way of doing things.
I suspect the latter reason is the more attractive one for Celgene, as it leaves the smaller biotech better able to do what it's already proven it can do: discover drugs that Celgene hasn't. With more resources at their disposal, and with the freedom and nimbleness that remaining small and independent allows, those biotechs may have a greater opportunity of driving value for Celgene shareholders than they would as a part of Celgene.
By contrast, Gilead's management usually seems to know exactly what drug they're looking for in a few large deals, and plunks down the big bucks on something that's ready for phase 3 or commercialization -- whether that means licensing a drug, or just buying the company outright.
What about Galapagos?
It seems like Gilead wanted the Galapagos drug -- minus royalties, of course -- and didn't want to pay the premium for the rest of the company. I suspect that Gilead's analysis of the price for the entire company precluded a full buyout given the revenue Galapagos could expect from the rest of its pipeline.
Gilead seems to be trying to beef up its autoimmune pipeline and better understand its opportunity and potential niche in that disease space before committing huge resources to it. If so, this might be a dress rehearsal of sorts before Gilead throws some big money into snapping up more assets -- including, perhaps, the rest of Galapagos.
It is also distinctly possible that this signals a shift in Gilead's M&A strategy toward licensing and diversifying the pots it has its fingers in without making big bets on any one space (or, put another way, the Celgene model). This would indicate that Gilead plans to try and carve out niches in a number of spaces -- most likely cardiovascular, cancer, and autoimmune diseases, as management has hinted at over the past year -- while it continues to deliver on its core liver and HIV competencies.
That shift would be interesting since it would be the precise opposite of what big pharma has been doing during the past few years, as companies have divested non-core assets and slimmed down.
Given that we only have one data point, it's too early to predict that this deal signals any shift in Gilead's external growth strategy. What we do know is that management is delivering on its stated interest in expanding its autoimmune disease footprint. And given that the company is sitting on plenty more cash, I'm expecting to see several more deals in the near future as the company bolsters its pipeline.