Since we initiated coverage of Cubist Pharmaceuticals (CBST) in mid-May, shares of the antibiotics manufacturer are up over 26%, as the company secured a key legal victory in its battle with Hospira (HSP) over the company’s plans to launch a generic version of Cubicin (a full trial is still set for February 2014). In addition, shares of Cubist have risen due to two key strategic acquisitions that the company announced in late July: the takeovers of Trius Therapeutics (TSRX) and Optimer Pharmaceuticals (OPTR). These acquisitions bring Cubist several antibiotic assets that will meaningfully expand its product portfolio and are complementary to the company’s existing product base and pipeline. As we’ve noted in prior coverage, Cubist should be viewed as a long-term investment, and these acquisitions, which we discuss below, will be a source of long-term upside for the company.
Q2 Results
After a somewhat disappointing Q1 2013, Cubist’s 2nd quarter results offered a more upbeat picture of the company’s commercial franchises. Cubicin sales grew 13.46% on a year-over-year basis, better than the 9% year-over-year growth recorded in the first quarter. Consolidated revenue beat estimates by $3.87 million, and increased by 12.24% year-over-year to $258.779 million. We note that Cubist’s consolidated revenue growth was impacted by volatility in the company’s “service revenue, which fell from over $8.6 million to less than $3.7 million. Cubist’s service revenue represents the recognition of the quarterly service fee the company is entitled under its co-promotion agreement with Optimer for DIFICID (more on this asset later), and fell on a year-over-year basis due to the fact that Cubist earned a $5 million sales milestone payment in Q2 2013. This revenue will cease to be recognized once the merger with Optimer is closed. Although Cubist’s revenues showed growth, its earnings did not, falling by 25% to 42 cents per share, and missing estimates by 13 cents a share. Cubist’s earnings were weighed down by a huge surge in research & development spending; pro forma R&D expenses surged over 49% to over $100 million as Cubist ramped up spending on its various late-stage assets, led by CXA-201 (which has been covered at length in prior reports). In addition to the pro forma increase in R&D spending, Cubist also restructured its agreement with Hydra Biosciences, which covers CB-625, as well as other TRPA1 (transient receptor potential ankyrin repeat 1) inhibitor compounds. In exchange for a $15 million payment to Hydra, Cubist is no longer required to make any milestone payments (the same goes for Hydra, as the original agreement, struck in October 2009, was a bilateral collaboration agreement covering TRPA1 inhibitors), which could have totaled “ hundreds of millions in aggregate, for success across multiple indications,” according to Cubist CFO Michael Tomsicek.
Both Cubicin and Entereg, the company’s other franchise, saw growth during the quarter. As noted above, domestic Cubicin revenue increased over 13% in Q2, and market share rose to 14.2% for the 12 months ending May 2013, up 50 basis points from the 12 months ending May 2012. International sales are continuing to grow as well; international revenue recognized by Cubist increased over 31% to $14.959 million. Cubicin is commercially available in 53 different countries, and Cubist has partnered with multiple pharmaceutical companies, including Novartis (NVS) and AstraZeneca (AZN) to market the drug internationally, and receives royalties for international sales. Entereg also saw growth in the quarter, with sales increasing by over 27% to $12.386 million. We note that Entereg itself is not central to the Cubist story; the company acquired Entereg as part of the $415 million takeover of Adolor Pharmaceuticals in October 2011. Cubist itself has said that it expects peak Entereg sales of just $100 million; the real motivator behind the Adolor takeover was ADL-5945 (now known as CB-5945), in Phase III trials for the treatment of opioid induced constipation (also known as OIC). Given the competitive nature of the OIC market, as well as safety concerns with other mu-opioid receptor assets, there is skepticism regarding CB-5945’s prospects. Cubist management reiterated their expectations that their Phase II CB-5945 program, including a 1-year safety study (as opposed to a CV outcomes trial) and 3 efficacy studies would be sufficient to file for approval, citing conversations with the FDA that took place in June. The Phase III safety trial is ongoing, and enrollment in the Phase III efficacy trials has begun.
Alongside its Q2 results, Cubist reaffirmed its full-year targets for both revenue ($1-$1.045 billion) and pro forma operating income ($230-$250 million). We note that 2013 will be the first year of Cubist’s long-term “Building Blocks for Growth” strategy, a 5-year roadmap through 2017 under which Cubist is targeting $2 billion in annual sales and $700 million in pro forma operating income by the end of 2017, representing a nearly 116% increase in revenues versus full-year 2012 levels, and a 155% increase in pro forma operating income over that 5-year timeframe. The takeovers of Trius and Optimer will go a long way towards helping Cubist reach those 2017 targets, and we believe that these acquisitions have positioned Cubist for further upside.
Acquiring a Portfolio of Complementary Assets
Trius Therapeutics
Cubist’s takeover of both Trius and Optimer gives the company ownership of several complementary assets and does so on what we believe are attractive terms. Under the agreement with Trius, the company will be acquired for $13.50 per share upfront, for a total of $707 million (not including the nearly $70 million in net cash and investments held by Trius). In addition to this upfront payment, Cubist will also issue a non-tradable CVR (contingent value right) for every Trius share worth up to $2, assuming that sales milestones for tedizolid are met. The CVR will be worth $1 if tedizolid sales reach $125 million in the United States, Canada, and Europe by 2016, and $2 if sales reach $135 million (we note that PropThink raised the possibility of a Cubist offer for Trius in May). Cubist has decided to maintain the collaboration agreement Trius has in place with Bayer, electing not to terminate it to gain sole global control of tedizolid . The terms of the agreement give Bayer exclusive rights to tedizolid in China, Japan, Africa, Latin America, the Middle East, and most other Asian countries. In exchange for these rights, Bayer will be paying 100% of costs required for approval in these territories and will fund 25% of the costs of developing tedizolid for the treatment of pneumonia. Cubist will now be entitled to double-digit royalties from Bayer, as well as up to $69.1 million in milestone payments tied to various developmental, regulatory, and commercial milestones, which will help defray the cost of acquiring Trius.
Cubist continues to expect that tedizolid will be launched in late 2014, assuming a NDA is filed in the 2nd half of 2013 as planned and taking into account tedizolid’s QIDP (qualified infectious disease product) designation. A Phase III trial of tedizolid in bacterial pneumonia is also planned for the 2nd half of the year pending final clearance by the FDA. We note that this deal will be synergistic; Cubist does not expect to make material investments in its sales force to market tedizolid and will integrate it into its existing SG&A structure. In Europe, Cubist expects to file for approval within the first half of 2014. Unlike in the United States, there is no avenue for accelerated review of antibiotics in the European Union, meaning that Cubist will have to go through the standard regulatory review process. However, management has noted that the review process for tedizolid may help create a more favorable environment for CXA-201 if and when that product enters the regulatory review process in the European Union. Peak sales estimates for tedizolid are as high as $350-$400 million for North America, and around $750 million on a global basis.
In addition to a near-term commercial opportunity for tedizolid in ABSSI, the drug is also being tested in HAP/VAP and is now in Phase II trials for the indication. But just as importantly, Cubist has gained control of Trius’ pre-clinical gyrase & topoisomerase IV program, also known as the GyrB/ParE dual target program.
This program, targeting Gram-negative infections, is expected to be used against fluoroquinolone-resistant strains of bacteria, and Trius has said that the inhibiting both gyrase and topoisomerase will lead to both increased potency, as well as lowered resistance. Cubist’s executives have said that as part of their takeover of Trius they examined the company’s pre-clinical platform and are “very interested.” We expect more color to emerge on Trius’ pre-clinical program in 2014 as ongoing toxicology studies near completion.
Optimer Pharmaceuticals
While the Trius deal has widely been viewed as a strategically sound acquisition, the takeover of Optimer has been met with some skepticism. For those unfamiliar with Optimer, the company markets Dificid (fidaxomicin) for the treatment of CDAD (Clostridium difficile-associated diarrhea). Dificid, approved in May 2011, was the first CDAD antibiotic to be approved in 25 yeas. Skepticism can be traced to the structuring of the takeover, which is heavily back-end loaded. Under the terms of the deal, Optimer’s shareholders will receive just $10.75 per share, well below Optimer’s closing price of $13.40 on July 30, the day the takeover was announced.
The premium offered to Optimer’s shareholder lies in the CVR to be created as part of the deal. This CVR, which will be publicly traded (unlike the Trius CVR), will pay Optimer shareholders up to $5 based on milestones through the end of 2015. The CVR will be worth $3 if Dificid sales exceed $250 million through the end of 2015, $4 if they exceed $275 million, and $5 if they exceed $300 million. Cubist will be paying $535 million for all outstanding shares of Optimer, and up to $266 million for the CVR, for a total transaction value of $801 million (excluding over $77 million in net cash & investments held by Optimer as of the end of Q2 2013). There has been skepticism regarding Dificid ever since the drug secured FDA approval in May 2011, including here at PropThink. Part of the issue stems from the issue of generic vancomycin, which is also approved to treat CDAD, but does so at a far lower price (around $10 per day versus over $200 for Dificid), which has led to a split as to whether or not Dificid’s superiority over vancomycin (included in its label) will be enough to persuade physicians to consider the long-term cost effectiveness of Dificid relative to vancomycin, or if it will relegate the drug to treating vancomycin resistant CDAD. Peak sales estimates for Dificid are around $250 million on a global basis.
Optimer pre-announced its Q2 2013 results alongside Cubist’s takeover offer, reporting that Dificid sales increased by 24.52% on a year-over-year basis to $18.967 million (Dificid generated $69 million in domestic and Canadian sales in the last 12 months). Optimer is currently unprofitable, due not to elevated R&D costs, but rather high SG&A costs (over $30 million in Q2 2013). Cubist has room to lower these costs via the use of its own sales force and commercial infrastructure, and given that it has been co-promoting Dificid since April 2011, Cubist has the expertise to promote and market Dificid on its own. Internationally, Cubist will be maintaining Optimer’s agreements with AstraZeneca and Astellas. AstraZeneca is responsible for commercializing Dificid in Latin and South America. Optimer (and now Cubist) is also eligible to receive up to $22 million in sales milestones, as well as double-digit royalties on sales (in the form of payment for supplying Dificid to AstraZeneca, which has the economic equivalent of being a royalty). Astellas is responsible for commercializing Dificid in Europe, the Middle East, Africa, and Japan. For Japan, Optimer is entitled to up to $70 million in regulatory and commercial milestone payments, as well as a high-single digit royalty. In Europe, Dificid has already been approved, and is marketed as Dificilir. Under this agreement, Optimer is entitled to a further 65 million euros ($86.23 million at current exchange rates) in potential milestone payments, as well as double-digit (high teens to low twenties) royalties on Dificilir sales.
Optimer’s pipeline consists of only Dificid, which is in Phase III trials for the prevention of CDAD in HSCT (hematopoietic stem cell transplant) patients, as well as Phase II trials for the treatment of CDAD in pediatric patients. We note that Cubist is developing its own CDAD treatment, surotomycin, which is now in Phase III trials. On its conference call regarding the Trius & Optimer takeovers, Cubist’s executives stressed that they see Dificid and Surotomycin as ultimately complimentary products, due to both their differentiated mechanisms of action, as well as the severity of the CDAD cases in question. Cubist COO Rob Perez noted that, “If surotomycin is approved, we believe seriously ill patients will benefit from having another complementary option with a different mechanism of action for the treatment of CDAD.” Although generic vancomycin exists as a potential treatment for CDAD, Dificid’s label specifically cites superiority over vancomycin in creating a sustained clinical response, when measured by recurrence within 25 days after the end of treatment. Given that Dificid makes up the entirety of Optimer’s approved and clinical assets, we find it unlikely that Cubist would have acquired the company if it did not have at least a semblance of a longer-term strategy for ensuring that Dificid does not detract from any potential surotomycin sales, and vice versa.
The Financial Impact: Favorable Terms, Favorable Potential
The acquisitions of Trius and Optimer not only bring Cubist control of a compelling portfolio of antibiotic assets, but do so on favorable terms, which we break down below.
Trius & Optimer Takeovers (in Thousands)
|
Trius Therapeutics |
Optimer Pharmaceuticals |
Total |
|
|
Up-Front Purchase Price |
$707,000 |
$535,000 |
$1,242,000 |
|
Maximum CVR Payout |
$111,000 |
$266,000 |
$377,000 |
|
Total |
$818,000 |
$801,000 |
$1,619,000 |
|
Net Cash on Hand, Q2 2013 |
$69,572 |
$77,509 |
$147,081 |
Cubist will be paying out approximately $1.242 billion upfront for all outstanding shares of both Trius and Optimer (Cubist commenced a tender offer for all outstanding shares of Trius on August 13), and up to $377 million in payouts tied to the CVR’s associated with these deals. These takeovers will leverage up Cubist’s balance sheet; the company ended Q2 2013 with just over $1 billion in cash & investments, as well as $375 million of debt (in the form of convertible notes due October 2017). CFO Michael Tomsicek has said that these takeovers will be financed “mostly” with Cubist’s existing cash balance, but that the company is also in the process of preparing new debt offerings, with the offering scheduled to be placed over the next several weeks. Tomcisek also affirmed that Cubist’s balance of cash and investments would not fall below a level where the companies internal R&D programs would be put in jeopardy, or a level below which the company would lose strategic flexibility to pursue new business development opportunities. That said, M&A transactions of this scale are tabled for the time being, with Cubist’s business development focus now set on smaller, development stage companies, such as the agreement struck with Adynxx in February 2013 in which Cubist received an exclusive option to acquire the company after the release of Phase II data for AYX1, Adynxx’s experimental pain reduction treatment. Cubist expects to close both deals by the end of the year; meaning that the cash the company will bring in from Trius and Optimer will likely be lower then the present $147 million. Optimer has, on average, burned $28.191 million per quarter so far this year, and Trius has burned $14.214 million per quarter. Assuming these burn rates hold, we model that Cubist will acquire around $62.27 million of net cash from both Trius and Optimer.
The Optimer takeover is estimated to be accretive to Cubist’s EPS in the first year after the closing of the deal, likely due to the SG&A synergies that Cubist will be able to extract from Optimer. Current consensus estimates for Optimer call for the company’s standalone revenue to increase by over 53% to $135.89 million in 2014. That, combined with likely SG&A expense reductions may very well allow Cubist to achieve its goal of making Optimer a profitable part of Cubist’s business by the end of the year (existing estimates call for Optimer to reach profitability on a standalone basis in 2016). Regarding Trius, Cubist did not provide an explicit timeframe for when the transaction would be accretive, but did note that on a combined basis both deals would become accretive to EPS in 2015. Cubist’s internal estimates for both Dificid and tedizolid call for peak sales of $800 million at the midpoint of guidance ($600 million-$1 billion).
Sales, should estimates prove accurate, will help preserve Cubist’s long-term cash flow, which has been a source of concern to investors as generic threats to Cubicin near. As we’ve laid out in prior reports on Cubist, this is not as material of an issue as investors believe. Cubist has already taken steps to preserve as much Cubicin profit as possible via an agreement with Teva (TEVA), which will launch generic Cubicin (daptomycin) in December 2017. The agreement will likely allow Cubist to maintain 60% of existing Cubicin operating profit, and with peak CXA-201 sales estimated to reach $1.3 billion, and the sales generated by Dificid and tedizolid phosphate, Cubist is well prepared to manage the emergence of generic competition to Cubicin. We note that tedizolid has patent protection through 2026 and that Dificid is protected through 2027 (the existence of generic vancomycin makes this less relevant given that Dificid is essentially already exposed to generic competition).
Conclusions
The takeovers of Trius Therapeutics and Optimer Pharmaceuticals bring a slate of highly complementary antibiotic assets to Cubist Pharmaceuticals, and we believe that these deals have positioned Cubist and its investors for strong growth. Tedizolid is a compelling antibiotic asset that is complementary to Cubist’s existing commercial operations, and it will build the foundation of Cubist’s emerging European business. And, Cubist should extract more from Dificid than Optimer could on its own, via both reduced SG&A expenses and a more integrated commercial operation. With a solid existing set of commercial franchises, a new franchise on the horizon (tedizolid), as well as a compelling pipeline (led by CXA-201), the new Cubist is set to become a – if not the – leading global antibiotics company.
In connection with CBST, TSRX, PropThink has taken a long position.
