Since October 17, shares of Biogen are down almost 7%, underperforming the S&P 500, which is down almost 3%. The FDA announced on October 18 that it would be taking an additional 3 months to review Biogen Idec’s NDA for BG-12, and it declined to provide detailed reasoning. This PDUFA delay to sometime in March caused investors to assume that there were safety issues, due in large part to the fact that Abbot Laboratories (NYSE:ABT) was forced to halt trials of its kidney cancer drug bardoxolone. BG-12 and bardoxolone share some chemical similarities, so it is likely that investors feared that the FDA discovered safety issued with BG-12. Biogen denied that this was the reason for the FDA’s review extension, arguing that BG-12 and bardoxolone have distinct pharmacological profiles, and that the safety of BG-12 has been well established in multiple trials. Biogen Idec is likely correct in its assessment. Abbot’s drug was not rejected, but rather halted in Phase III tests when safety issues were discovered. BG-12 went through Phase III testing with no safety issues presented.
Furthermore, there is historical precedent for the FDA’s decision. Novartis (NYSE:NVS) also experience this 3-month extension with its Gilenya filing, as did Sanofi (NYSE:SNY) and its Aubagio filing. Both drugs were approved after their respective 3-month extensions. The complexity of these approval filings is likely what triggered the 3-month extensions. Given the importance of BG-12 to the future growth of Biogen (Merrill Lynch, for example, values BG-12 at $41 per share, or 23.16% of its $177 price target), the company’s Q3 earnings conference call was filled with questions regarding the PDUFA extension. George Scangos, Biogen’s CEO, took a good deal of time to address this issue. On the call, he said:
Why am I not surprised that's the first question? [Did Biogen Idec receive a reason from the FDA for the review delay?] Okay, look, technically, the answer to your question is, yes, it is a major amendment. But let's understand what the term -- major amendment is kind of a term of art. So in the normal review of an FDA -- of an NDA, the FDA asks questions of the sponsor and to which the sponsor, in this case us, response in writing. So the FDA has the ability to determine that any of those responses can be classified as a major amendment. And so by doing so, the FDA extends the PDUFA date for 3 months, and as far as we know, there is no other mechanism by which the FDA can extend the PDUFA date by 3 months. So the fact that a response is classified as a major amendment doesn't necessarily mean that there are problems with the application or the drug. It can mean only that the FDA believes it needs more time to review the application, the answers to the questions, and will not be able to meet the original PDUFA date. And we believe that's the case with our application. And as you know, Eric, a 3-month extension has been applied to a lot of other compounds, including recent approvals in MS. So we believe we're on track, and we have a 3-month delay.
This delay, while unexpected, is not without precedent, and it is unlikely to have any major effects on BG-12. This is the third time the FDA has requested an extension to review a new MS drug, and the chances of this third time being different from the first two is small. BG-12’s safety has been well established in many trials, as has its efficacy. And if and when BG-12 is finally approved, it may very well spark a second catalyst that will send Biogen Idec’s stock higher. That catalyst is capital deployment.
Deploying Cash & Catching Up to Peers
When most investors look at the biotechnology sector, return of capital to investors is on few investors’ lists of reasons to invest in the sector. The traditional “party line” in biotechnology is that cash is to be used for developing new drugs, or buying out companies with promising drugs in development, not buying back stock or paying dividends. However, the Big 4 biotechnology companies (Amgen, Celgene, Gilead Sciences, and Biogen Idec) are exceptions to that rule. Their balance sheets are strong enough to be able to not only invest in their pipelines, but also return capital to shareholders. Amgen, Celgene, and Gilead have all been deploying cash aggressively in 2012. Biogen, however, is the lone exception. The company has been a relative miser when it comes to deploying cash, and the latest quarterly filings of these 4 companies lays bare this fact. The table below breaks down the capital deployment of these 4 companies for the first 2 quarters of 2012 between 3 categories: buybacks, dividends, and acquisitions (each company’s name links to its Q2 2012 10-Q; only Biogen Idec and Celgene have filed 10-Q’s for Q3 2012).
Biotechnology Capital Deployment, Q1-Q2 2012
|Company||Buybacks||Dividends||Acquisitions, net of Cash||Total Capital Deployed||Total Capital Deployed as a % of Operating Cash Flow|
While it is true that for the first 6 months of 2012, Biogen Idec deployed more cash (as a percentage of operating cash flow) than Celgene, the figures for Q3 tell a different story. Taking that quarter into account, Biogen Idec deployed 75.48% of its operating cash flow. Celgene, on the other hand, deployed 119.27% of its operating cash flow. And assuming that Amgen and Gilead maintained their pace of buybacks and dividends, they out-deployed Biogen Idec as well. Biogen is choosing to let its cash sit on its balance sheet, and that trend continued in Q3. The company’s 10-Q for the latest quarter shows that just $53.22 million of stock was repurchased in Q3, and that the company made no acquisitions. And while it is true that Biogen is buying back more stock than Gilead Sciences, Gilead’s capital deployment strategy is focused on acquisitions, most notably Pharmasset. It makes little sense to chide Gilead for slowing down its buybacks when Pharmasset gives the company the leading position in the hepatitis C market. GS-7977, if approved, will bring in billions in sales for Gilead, and the hepatitis C market is much larger than MS, which supports Gilead’s decision to buy Pharmasset, as opposed to buying back stock.
Investors should not, however, view this as a sign of weakness on the part of Biogen. Rather, it should be seen as an opportunity. BG-12, if and when it is approved, is highly likely to be a blockbuster for Biogen. Analysts estimate that it will bring in $2.3 billion in annual sales by 2016. If Biogen can successfully launch BG-12, it is possible that management could take a more aggressive stance when it comes to deploying capital, either when it comes to acquiring new companies to fill its pipeline, or ramping up its buybacks. The question of whether or not to initiate a dividend is a thornier one. Amgen is currently the only biotechnology company that pays a dividend. But it is also the largest biotechnology company in the world, and there is debate as to whether or not Amgen can still be counted as a biotechnology company. Perhaps it should be considered a large pharmaceutical company, where dividends are expected.
When it comes to biotechnology as a whole, capital deployment is rarely considered. But with the Big 4 biotechnology companies, capital deployment forms a large part of their story. Buying up smaller companies is how they stay in the lead, and buying back stock helps insulate investors from fluctuations in earnings, something that smaller biotechnology companies are rarely able to do. Biogen Idec, however, has lagged its peers on both of these fronts. And therein lies the opportunity. The approval of BG-12, even if it is delayed by 3 months, could be the catalyst that Biogen Idec’s management needs to ramp up its deployment of capital, thereby giving investors another avenue to profits.