Image source: Centers for Disease Control and Prevention.
In case you missed it, biotech blue-chip Gilead Sciences (GILD 0.36%) reported its fourth-quarter and full-year financial results on Tuesday.
Growth concerns weigh on Gilead
The company, which is being propelled by the strength of its hepatitis C portfolio, generated $8.4 billion in product sales, a 16% year-over-year jump; $32.2 billion in annual revenue, a 31% jump from 2014; and $12.61 in adjusted EPS, a 56% catapult from the previous year. Furthermore, Gilead generated $20.3 billion in operating cash flow during 2015, of which it wound up returning $11.9 billion to shareholders vis-a-vis a $10 billion share buyback and $1.9 billion in dividend payments.
Despite all the hype and it's ridiculously strong results, all Wall Street has focused on is Gilead's "lack of growth" dilemma. Looking ahead to fiscal 2016, Gilead forecast $30 billion to $31 billion in sales, which at the midpoint would imply a 5% year-over-year sales decline. Gilead's been known to be a bit conservative with its sales guidance, but this was nonetheless disappointing for investors who've become accustomed to Gilead blowing Wall Street's consensus estimates out of the water.
The main culprit behind Gilead's forecast sales contraction? It looks to be a combination of increasing competition in the hepatitis C treatment arena, as well as a maximization of its production capacity. The latter would be relatively easy to fix by adding new manufacturing capacity, but the former has investors worried.
In late January, the Food and Drug Administration approved Merck's (MRK +0.91%) hepatitis C doublet, now known as Zepatier, for HCV genotypes 1 and 4. Its efficacy was very similar to that of Gilead's Harvoni in many respects, but the fact that treatment-experienced patients would be required to take a ribavirin along with Zepatier (ribavirins can cause anemia and rashes) will likely mean Harvoni remains the dominant genotype 1 treatment.
Image source: AbbVie.
Nonetheless, Zepatier is the first once-daily pill to challenge the dominance of Gilead's Harvoni. As icing on the cake, Zepatier also has a list price of $54,600 for a 12-week treatment, compared to Harvoni's $94,500. Zepatier's substantially lower price is fueling speculation of a price war among HCV drug developers, which would hurt Gilead's margins.
AbbVie's (ABBV +3.55%) Viekira Pak, the other competiting treatment in the HCV genotype 1 space, has taken a back seat to Harvoni because it can require a patient to take as many as six pills per day. However, a next-generation version of Viekira Pak that will be in the form of a once-daily pill is likely on its way to pharmacy shelves shortly.
In other words, investors are seriously wondering where Gilead's growth will come from next.
When the going gets tough, the tough go buy something
The interesting thing is that we were having this same discussion about Gilead about six years ago following the Great Recession. Gilead's P/E ratio was fairly low, like it is now, and the company was relatively cash-rich thanks to its highly successful line of HIV therapies.
Image source: Gilead Sciences.
So what did Gilead do then? It went out and paid a small fortune for Pharmasset. It was announced in November 2011 that Gilead was buying Pharmasset for a whopping $11 billion after the company's leading experimental drug, sofosbuvir, generated strong results in a midstage hepatitis C trial. Sofosbuvir went on to be wildly successful in late-stage studies and was eventually approved under the trade name Sovaldi. Harvoni is a cocktail drug containing Sovaldi and ledipasvir. In 2015 alone, these two drugs (Sovaldi and HarvonI) were responsible for $19.1 billion in sales! I'd say Gilead got its money's worth out of this acquisition.
Gilead ended 2015 with a veritable boatload of cash -- $26.2 billion in cash, cash equivalents, and marketable securities, to be exact (though it's important to note that it also has $22.8 billion in long-term debt). With the expectation that it'll be generating around $20 billion per year in operating cash flow, and that between $8 billion and $12 billion will be left over following its dividend and buyback activities, it's very much within reason to expect that Gilead could be preparing to go shopping.
As one more tidbit of evidence, Gilead also recently announced a change at the CEO position. Effective March 10, CEO John Martin will step aside after 20 years of leading Gilead and assume the role of executive chairman. John Milligan, the current President and COO, will be promoted to the CEO role. Milligan's imprint as incoming CEO could be a transformative acquisition.
The company that Gilead should consider buying right now
So what should Gilead buy?
To be honest, there are probably a dozen companies that might make sense for it to acquire. Gilead's got its hands in everything from infectious diseases to cancer and inflammation, meaning there's no single therapeutic indication that Gilead might target. Yet one possible acquisition stands out to me as a glaring and obvious target for Gilead: Intercept Pharmaceuticals (ICPT +0.00%).
Intercept's lead drug is obeticholic acid, or OCA, which is being developed to target a number of liver diseases, including primary biliary cirrhosis (PBC) and nonalcoholic steatohepatitis (NASH). OCA is currently under review by the FDA as a treatment for PBC after demonstrating strong efficacy in the phase 3 POISE study. In POISE, 47% and 46% of patients receiving the 10 mg and 5 mg to 10 mg OCA doses met the primary endpoint compared to just 10% of the control group taking a placebo. The FDA did request additional clinical info from Intercept, which delayed the PDUFA decision date by three months, but it looks on track for a possible approval on, or before, its PDUFA decision date of May 29, 2016.
However, PBC just gets OCA's foot in the door -- it's the FLINT trial for NASH that turned heads. NASH is a disease that could affect millions of adults in the United States, and it can lead to liver cirrhosis, liver cancer, and even death.
Image source: Intercept Pharmaceuticals.
The full top-line data from FLINT, which was released in 2014, showed that 46% of OCA-treated patients hit the primary endpoint compared to just 21% of the people in the placebo group. The primary endpoint was at least a two point reduction in the NAFLD Activity Score with no worsening of liver fibrosis. The trial was actually stopped early by the independent monitoring committee due to the drug's superior efficacy. Furthermore, 35% of patients taking OCA saw an improvement in fibrosis compared to just 19% in the placebo arm.
Of course, OCA also came with concerns early on. There were worries shortly after the initial data release that elevated lipid levels in OCA patients' livers could be a risk factor for cardiac arrest. The final data released by Intercept from the FLINT trial, however, cleared OCA of being the cause of any of the noted cardiac events.
If approved to treat NASH, OCA could easily have blockbuster potential. Although analysts' estimates vary, with no NASH treatment currently on pharmacy shelves, most believe it could generate $4 billion to $6 billion in peak annual sales, though some forecasts are higher.
Now here's the real kicker: Shares of Intercept Pharmaceuticals are down more than 80% from the highs they set following the release of the FLINT trial data. Its current valuation of $2.4 billion means Gilead could scoop up Intercept at a substantial premium, for perhaps four months of its free cash flow.
The move would, in my opinion, make perfect sense considering the importance Gilead's pipeline places on liver diseases. It has TAF in late-stage trials for hepatitis B, as well as GS-4774 and GS-9620 in midstage studies for HBV, but it's also studying simtuzumab and GS-4997 in midstage trials for NASH. Having what could aptly be summarized as three of the top potential NASH treatments in its pipeline could make Gilead a force to be reckoned with.
I want to be clear that just because I think a buyout makes sense doesn't mean one is going to happen. Nor is it a smart investment decision to bank your money on a buyout. However, for Gilead shareholders, it's important to recognize that the company's growing cash situation and slowing growth does present a perfect opportunity to go shopping; and Intercept just might be that target.
