As Roche Circles, Alexion’s Q2 Results Highlight Standalone Value

Shares of Alexion Pharmaceuticals (ALXN) have seen a choppy 2013 as concerns over Soliris supply and growth met rumors that Roche (RHHBY) was seeking to acquire the company. But on a standalone basis, shares of Alexion continue to offer long-term value, as evidenced by its Q2 2013 results. The company is continuing to grow Soliris sales and is making material progress in moving its pipeline through the clinic. Whether or not Alexion ultimately gets acquired, we continue to believe that investors should have exposure to the Soliris manufacturer.

Roche & Alexion: Deal or no Deal?

Before we delve into Alexion’s Q2 results, it’s prudent to discuss Roche’s rumored interest in the company. On July 12, Bloomberg reported that Roche had an interest in Alexion; the news organization cited sources close to the large pharmacueitcal who claimed the company was in the process of lining up billions in financing to make a bid for Alexion. ALXN immediately surged to as high as $125.65, but have since declined to below $108 as no official bid has emerged. There has been no official denial from either Roche or Alexion, and sell-side analysts remain split on whether or not a deal will materialize, which we discuss below.

No Deal: Too Expensive, With No Strategic Rationale

Critics of an Alexion takeover begin their arguments with the company’s sheer size, as well as its multiples. With a market capitalization of $21 billion, Alexion is the 6th largest biotechnology company in the world by market capitalization, behind Regeneron (REGRpcN) and the “Big 4” biotech companies. And that does not take into account the premium needed to sway Alexion’s board of directors. For Roche, a takeover of Alexion would be the company’s largest deal since the takeover of Genentech for $47 billion in 2009. Furthermore, Alexion does not fit the traditional M&A target for Roche aside from Genentech, most of Roche’s acquisitions focus on companies with technology platforms, such as Illumina (ILMN), rather than commercialized drugs. Secondly, with shares of Alexion trading at 32x Next Twelve Months projected earnings, it’s possible that Roche’s shareholders will decry the deal as too expensive. Alexion’s forward multiples are made even less palatable by the fact that there’s little in the way of synergies between the two companies. The majority of pharmaceutical/biotechnology mega-mergers (such as Pfizer/Wyeth, Merck/Schering-Plough) are justified in part through the expected synergies, both in costs and revenues. There’s not a great deal of synergy between Alexion’s Soliris franchise, its ultra-orphan pipeline, and Roche’s predominantly oncology-focused business. In fact, analysts have cited Alexion’s highly specific slate of products as a prime reason why no pharmaceutical company is likely to make a bid, as synergizing the deal is a difficult maneuver. Furthermore, with pro forma operating margins above 42%, it’s unlikely that Roche will be able to squeeze much in the way of cost savings out of Alexion, or boost gross profits by terminating collaboration agreements. Alexion actively shuns collaboration agreements (for large-cap drug companies, these agreements are not struck out of necessity, but rather convenience, the opposite of development-stage companies, where such agreements are almost always struck to ease the burden of developing a drug); its entire pipeline has either been internally discovered or fully acquired, and the company commercializes Soliris on its own.

Let’s Make a Deal: Roche Needs Diversification

Proponents of a Roche-Alexion deal point to the company’s need and desire to expand beyond its oncology business. A large portion of Roche’s oncology portfolio will be exposed to biosimilair competition in 2016. Roche has had a rough go of diversifying. In mid-July, Roche scrapped development of aleglitazar, in Phase III trials for the treatment of diabetes, due to incidents of kidney impairment and heart failure in patients. Roche had publicly stated that aleglitazar had potential global peak sales of at least $2.1 billion, and that sales could reach as high as $4.1 billion. On the company’s first-half earnings call on July 25, Daniel O’Day, head of Roche’s pharmaceutical business, stated that the company is “seriously considering” abandoning all R&D projects related to metabolic and heart disease. And as we have noted before, Roche’s efforts to expand its genetic sequencing business have faltered meaningfully, with multiple partnerships scrapped due to an inability to develop compelling sequencing technology. A takeover of Alexion would give Roche control of a rapidly growing drug, one that’s not only free of competition but is well-insulated from potential biosimilars. In addition to Soliris, a takeover of Alexion would give Roche a pipeline of compelling orphan compounds. And with Roche’s net debt set to fall within its target range of 0-15% of total assets soon (it currently stands at 22.9%), the company should have room to finance the acquisition.

Will a Deal Happen?

At this point, its not a question we’re prepared to answer. But we do believe that talks are ongoing due to recent statements from management and Roche’s history of M&A.

On its own earnings call, Roche’s executives declined to refute reports of a bid for Alexion, saying that they “do not comment on market rumors.” Although Roche CEO Severin Schwan refused to comment on orphan drugs and diseases, Daniel O’Day did, saying that the company is “not discouraged at all about smaller subsets of patients.” O’Day also noted that outside innovation serves as a good complement to the innovation occurring inside Roche. Schwan also noted that Roche will be focused on “bolt-on” acquisitions, but did not elaborate on precisely how the company defines a bolt-on acquisition. Given that Roche’s own market capitalization is over 200 billion Swiss francs, even a company the size of Alexion may be considered a bolt-on acquisition. Roche has now had two weeks to refute reports of its interest in Alexion, yet the company has not done so, saying only that it is not discouraged by the size of orphan disease patient populations.

For its part, the first commentary from Alexion’s executives came on its own Q2 earnings call on July 25. CEO Leonard Bell was asked specifically about his view of the potential strategic move of “an orphan franchise like what you have here” to a large pharmaceutical company. Dr. Bell started his answer by saying that Alexion does not comment on market rumors. But instead of leaving his answer at that, he began an extended discussion of Alexion’s future prospects:

As we’ve said in the past, we don’t comment on any rumors. And as we’ve been talking about, probably extensively in the monologue part of the call so far, although I think we may have more opportunities in the rest of the hour, I’m sure. Alexion is currently operating from an unprecedented position in our history. From all perspectives, as I look around, R&D, commercial operations, manufacturing and, really, overall senior management, we believe that we’re seeing the results in our quarterly performance. And as importantly, we are also poised to take advantage of the breadth and accelerating number of significant opportunities that we see in front of us. As we look down this road, we see, first and foremost, continued strong growth in Soliris in each of its 10 — to each of its 2 currently approved indications. We see also see 5 highly innovative compounds across-the-board now being investigated in 10 additional severe and ultra-rare indications, which we expect to result in a continuous series of anticipated major product approvals from 2014 through 2018. With execution of a strategy now taking the current and future Soliris franchises, as we described earlier in the call, through to 2030 and beyond, together with the benefits of a stronger and wider global manufacturing and supply platform here in the United States, increasing in Singapore and, as we noted just moments ago, now in Ireland, with an expanding experienced senior leadership team and an equally strong balance sheet with another quarter of strong financial performance. As I look back, just over past 4 years, we moved from a company with a single product approved in a single disorder then to a second indication and now, closing in on a robust and continuous series of new products and indications, major launches over the next 4 years. As we look ahead, we’re tremendously excited.

Dr. Bell’s statement makes clear that Alexion sees a great deal of potential in both its commercial business and its pipeline, and implicitly suggests that investors should take note. Dr. Bell argues, tangentially, that shares of Alexion are undervalued; shares are up less than 9%, versus a 47% rally for the NASDAQ Biotechnology Index (shares are up 13% since our initial December 2012 report).

The notion that talks between Roche and Alexion are ongoing is further supported by Roche’s M&A track record. Aside from Illumina, Roche has historically been a successful acquirer. Roche pursued Ventana Medical Systems for nearly seven months before the company finally acquiesced to a $3.4 billion takeover after Roche succeeded in nullifying the company’s poison pill and prepared to mount a campaign to oust Ventana’s board before the two companies finally agreed on a deal in early 2008. And, Roche fought for 10 months to gain control of the 44% of Genentech that it did not own; the company actually lowered its offer amidst the financial crisis and went hostile with its bid before the two companies finally settled on a $47 billion price, or $95 per share, up from Roche’s initial $89 bid, and its lowered hostile $86.50 offer. Roche was quick to exploit loopholes in Illumina’s corporate charter and bylaws in an attempt to gain control of the company’s board to push through its hostile takeover attempt; this was one of the few times in which Roche has failed to complete a bid. History has shown that when Roche wants a company, more often than not, Roche gets its way. If Roche truly wants to own Alexion, it will.

That being said, Alexion’s management team and board are shrewd executives, and given that Dr. Bell has been at the helm of the company since its founding, he has a keen sense of the company’s value, and will not support an offer that doesn’t include a fair premium for Alexion’s investors.

Continued Exposure to Alexion is Warranted

At present levels, we continue to believe that there’s value Alexion on a standalone basis, as demonstrated by the company’s second quarter results. The company once again beat estimates on both the top and bottom lines, with sales growing by nearly 35% and EPS surging over 55% year-over-year driven by continued management of expenses. Alexion also raised its 2013 sales and EPS guidance once again; the company boosted sales guidance to $1.525 billion at the midpoint (versus a prior midpoint of $1.5125 billion) and boosted EPS guidance to a midpoint of $2.99 (versus a prior midpoint of $2.92). Alexion’s new EPS forecasts imply full-year earnings growth of more than 40%, outstripping the company’s projected 34% rise in full-year Soliris sales.

Alexion is continuing to see progress in both the commercial expansion of Soliris, as well as its clinical programs. CCO David Halal noted continuing growth in Alexion’s core markets (the United States, Japan and western Europe) as well as expansions into new territories including Russia, Turkey, and Brazil. The company confirmed its forecast to launch in Korea by the end of the year and disclosed that it’s targeting Argentina and Colombia for further expansion in South America. In England, Alexion is putting to rest the recent controversy surrounding the government’s stance regarding Soliris in aHUS. England’s Clinical Priorities Advisory Group (also known as CPAG) released new clinical guidelines that cover aHUS patients with currently functioning kidneys, as well as those on dialysis who qualify for transplant. Reimbursement discussions for Soliris in aHUS are continuing in France and Italy and have been completed in Germany and Belgium.

Aside from continued expansion of the market for Soliris, Alexion is moving rapidly towards the launch of new products and expansions of Soliris’ label into new indications (which we have covered in detail in prior reports). Soliris has now received orphan drug status for the treatment of NMO (neuromyelitis optica) in both the United States and Europe, and registrational Phase III trials will commence by the end of the year. Most notable is the fact that in May, Alexion secured breakthrough therapy status for asfotase alfa in perinatal, infantile, and juvenile-onset HPP. The key here is that the FDA’s designation aligns with the age of onset, not the current age of the patient, allowing Alexion to market HPP into a much larger market. Should asfotase alfa receive FDA approval (Alexion reiterated its target of filing for approval in the United States and Europe by mid-2014), the company can market it to both juvenile and adult patients, as long as the age of onset was less then 18 (as a reminder, existing estimates for asfotase alfa call for peak sales of up to $1.1 billion).

Alexion initiated dosing in several of its other clinical programs in recent months; Phase I dosing of cPMP, for the treatment of Molybdenum Cofactor Deficiency Type A, commenced in July, as did dosing in a Phase I trial of ALXN1007. To date, the company has been cagey as to which indications ALXN1007 is being developed for.

Much of Alexion’s Q2 earnings call was dedicated to discussing the “life-cycle” of Soliris. For Alexion investors, the company’s dependence on Soliris has long been seen as its Achilles’ heel; Alexion’s P/E multiples cannot be sustained if it sees disruptions to either the flow of Soliris or if the drug were to face competition. Management noted that Soliris’ core patents hold terms out to 2020, and currently pending patent applications may extend its patent protection beyond that. We note that a search of for PNH clinical trials indicates only two non-Soliris trials. Both are Phase II trials being run by the Institute of Blood & Hematology Diseases Hospital in China and are evaluating the use of levamisole (marketed as Ergamisol) and cyclosporine A for the treatment of “classic PNH” as well as PNH associated with a bone marrow failure syndrome. And a search for aHUS trials shows that Alexion stands alone.

Dr. Bell stated on the company’s earnings call that the company is developing two “next-generation” compounds to succeed Soliris (this does not include ALXN1102/ALXN1103, which are in Phase I trials for the treatment of PNH), and outlined a goal of securing regulatory approval for at least one of these two compounds by 2018. Despite a lack of competition, Alexion is taking potential threats to Soliris seriously and is working diligently to diversify its slate of approved products and indications as quickly as it can to ensure that the effects of possible future competition can be mitigated. With continued growth in Soliris sales and profits, as well as a diverse pipeline, Alexion is well positioned to deliver for investors. Even as Roche circles, we believe that Alexion is a strong standalone contender.