Shares of Medivation (MDVN) fell sharply on Monday June 17, closing down over 6% on news that Johnson & Johnson (JNJ) has acquired Aragon Pharmaceuticals for $1 billion ($650 million upfront with $350 million in potential milestones). The deal unnerved many investors, who view Aragon and ARN-509, its Phase II prostate cancer treatment, as a key threat, a threat enhanced when matched with Johnson & Johnson’s strong balance sheet and pharma experience. However, we believe that Medivation’s position is stronger than it appears on a number of fronts, and that the takeover of Aragon is not as material of a threat as the market first perceived.
Sources of Concern
Interestingly, Johnson & Johnson’s $1 billion deal doesn’t even cover the entirety of Aragon. Rather, it covers only ARN-509 and the company’s androgen receptor antagonist program, with the company’s breast cancer program set to be spun off into a new company to be headed by Aragon’s current management team. Three chief concerns caused Medivation to drop on the announcement of this deal:
- ARN-509 itself. Some see 509 as superior to Xtandi, including lower rates of seizures, and many expect 509 to move through the clinic quickly given Johnson & Johnson’s virtually unlimited resources.
- The lawsuit between Medivation and Aragon related to the rights surrounding ARN-509 (more details later). If Johnson & Johnson is willing to bet $1B on an asset whose patents might be stripped away, then surely it has done its due diligence and found Medivation’s legal claims to be weak.
- There is concern that Medivation let Aragon slip through its fingers by pursuing a litigious strategy rather than simply solving the issue altogether by taking control of the smaller company.
In our view, these three concers are overblown; even with Johnson & Johnson acting as a backer, the threat posed by Aragon has not increased materially, nor have Xtandi’s prospects diminished. With Astellas serving as its partner and backer, Medivation’s market position remains solid, and the company is poised for continued success in the prostate cancer market, and we address the concerns created by the Aragon-Johnson & Johnson deal below.
1) ARN-509: Little Differentiation or Chance for an Accelerated Development Path
With access to Johnson & Johnson’s balance sheet, the logical conclusion would be that ARN-509 can be developed much faster, thereby brining ARN-509 to market more rapidly than it otherwise would. However, therein lies a logical fallacy. If ARN-509 is as good of an asset as Medivation’s critics believe, then Aragon should not have had any material issue with raising further equity and/or debt to fund its desired ARN-509 program. Although Johnson & Johnson’s balance sheet can afford Aragon the ability to run more trials with more patients, it cannot make those trials progress any faster. ARN-509 is still in Phase II trials, and an M0 trial in pre-metastatic patients can take 5-7 years. Even if Phase III trials were to start by the end of this year, material data and potential FDA/EMA approvals would be 2018 events. By that point in time, Medivation itself would have made meaningful progress towards securing approval for Xtandi in CSPC (castrate-sensitive prostate cancer), a key sector of the prostate cancer market. ARN-509 is years away from potential regulatory approval, and we believe that claims regarding its superiority are also overblown. To date, Xtandi sales have not been affected by reported seizures, and per data from Astellas and Medivation, there is a 0.9% rate of seizures in patients who take Xtandi, leaving ARN-509 with little room for improvement. And despite claims that ARN-509 is clinically superior to Xtandi, existing clinical data suggests otherwise. While it may be possible to generate comparisons that do indeed show that ARN-509 is superior (in terms of PSA reduction), these comparisons are created by comparing the clinically active dose of ARN-509 to all tested doses of Xtandi, even those that have been deemed too low for clinical use. Furthermore, claims of potency are often based on pre-clinical mouse data, which an analysis by Citigroup showed yielded conflicting, statistically insignificant data. The same analysis also concludes that ARN-509 showed PSA reductions of greater than 50% in 49% of patients, versus 57% for Xtandi.
Under this methodology, Xtandi is the superior drug, not ARN-509. Although both Medivation and Aragon/Johnson & Johnson could start Phase III trials in M0 patients, it will still take years for either drug to see approval in this indication, giving Medivation more time to entrench itself in the market. Furthermore, data from Medivation’s Phase III PREVAIL study of pre-chemotherapy mCRPC patients may be available as early as this year; Medivation guided in April that its interim analysis will occur this year. ARN-509 is well-behind Xtandi in this indication. Johnson & Johnson’s balance sheet may remove financing risk as a hurdle facing ARN-509, but it does little to remove the other hurdles facing ARN-509. Aragon and Johnson & Johnson are years behind Medivation and Astellas in the prostate cancer market.
In any case, Johnson & Johnson’s acquisition of Aragon should be viewed as an endorsement of the growth potential of this market, potential that for now, Medivation is ready and able to capitalize on. Many investors have argued that this deal is an endorsement of Xtandi’s superiority over Zytiga in the present prostate cancer market, arguing that Johnson & Johnson needed to strengthen its product portfolio in the hope of effectively competing with Medivation.
2) Legal Concerns are Arguably Irrelevant
For many investors, Johnson & Johnson’s decision to take control of Aragon is a direct commentary on the weakness of Medivation’s claims against Aragon. Before we delve into this, some background is necessary. Both Xtandi and ARN-509 were created at UCLA, and members of the UCLA laboratory (Charles Sawyers and Michael Jung) that created these compounds were founders of Aragon. In May 2011, Medivation sued the UC system, arguing that its licensing deal with the system gives it rights to any follow-on compounds; given that ARN-509 is a “close structural analog” to Xtandi, Medivation argues that it has commercial rights to the compound.
However, in late 2012, the San Francisco Superior Court dismissed all charges, finding that neither the UC system nor Aragon breached the agreements in place between Medivation and the UC system. The court found that ARN-509 was synthesized before the agreement with Medivation was ever signed, therefore ARN-509 does not fall under the scope of the agreement. On April 15, 2013, Medivation filed its appeal, and two additional trials related to the case are set for July and October. Many observers argued that by taking control of Aragon, Johnson & Johnson is making a direct commentary on the weakness of Medivation’s claims. Surely Johnson & Johnson would not risk up to $1 billion on an asset that it might lose control of following upcoming trials? Clearly, Johnson & Johnson does not see Medivation’s claims as having merit and expects to prevail.
However, Medivation losing its appeal is irrelevant, for the company’s market position is unchanged no matter the outcome. If Medivation were to prevail (an outcome the market believes is unlikely), then it will gain control of ARN-509. The company can then choose to either scrap the drug or continue development, thereby rendering the entire issue moot. And if Medivation loses at trial once again, this issue is still superseded by issue #1, and the fact that ARN-509 is not only years behind Xtandi, but also rather undifferentiated.
3) Even Without Aragon, Medivation Has Astellas
Some industry observers have argued that Medivation should have simply taken control of Aragon rather than trying to litigate its way out of the problem (this assumes that Aragon is in fact a problem, a suggestion that we believe is flawed). But even if Medivation had wanted to take control of Aragon, it could not have done so on its own. The company ended its latest quarter with $271.481 million in cash & investments and carries nearly $199 million in convertible notes due April 2017 on its balance sheet. Assuming that $1 billion was the minimum price that Aragon was willing to accept, Medivation could never have done this deal on its own. It would have had to turn to Astellas to finance such a deal or issue large amounts of equity and/or debt to gain control of Aragon.
Although some may be asking the question “Why didn’t Medivation take control of Aragon?” we believe the proper question is “Why should Medivation take control of Aragon?” Presumably, Medivation has already done a thorough evaluation of ARN-509’s existing clinical data, reaching the conclusion that ARN-509 is not as strong of an asset as Aragon and Johnson & Johnson believe. And just as importantly, Medivation will not be facing a combined Aragon and Johnson & Johnson alone. The company is backed by Astellas, one of Japan’s largest pharmaceutical companies.
Astellas and Medivation began their collaboration in October 2009 with a $110 million upfront payment to Medivation. Under the terms of the agreement, the two companies both share 50% of the costs and profits of developing and commercializing Xtandi in the United States (there are two exceptions to this split: each company bears its own FTE costs, and Astellas bears two-thirds of the development costs supporting regulatory approvals in the United States, Japan, and Europe). Outside the United States, Astellas is responsible for all development and commercialization costs, and Medivation receives tiered royalties on all international sales, ranging from the low teens to the low twenties. Medivation is also eligible to receive up to $655 million in milestone payments ($335 million in development milestones and $320 million in commercial milestones). As of the end of Q1 2013, Medivation has received $58 million in development milestones.
Medivation is also required to share 10% of development milestones with UCLA, and the university is alleging that the agreement between Medivation and UCLA also covers 10% of all commercial milestones (this is one of the issues to be covered in trials later this year).
Xtandi’s international rollout is progressing well; the drug secured approval in Canada on June 3 for the treatment of mCRPC in patients that have been previously treated with docetaxel, and in April the CHMP recommended that Xtandi be approved in the European Union for the same indication. Medivation and Astellas also submitted their regulatory approval filing in Japan on May 24. Xtandi sales grew 31% sequentially in Q1 2013 to reach $75.378 million (as a frame of reference, Xtandi first shipped on September 13, 2012), and assuming approvals in Europe and Japan, Xtandi is poised to maintain its growth trajectory.
Conclusions
In the end, Johnson & Johnson’s deal to take control of Aragon will likely have little impact on Medivation. ARN-509 is years behind Xtandi, and even with Johnson & Johnson’s balance sheet, there is only so much that can be done to accelerate ARN-509’s development timeline. Furthermore, an apples-to-apples comparison would show that ARN-509 is not superior to Xtandi, and we believe that ARN-509 will pose little threat to Xtandi and Medivation. The rights issues related to ARN-509 are largely irrelevant, for Medivation’s market position will be unchanged regardless of the outcome of its litigation. And with backing from Astellas, Medivation has the resources it needs to compete effectively with a combined Aragon and Johnson & Johnson. At under $50, we believe that shares of Medivation are a compelling buy, and that in time, the market will see that the company’s competitive position remains strong.
