Regeneron: Solid Q1 Creates Platform for Further Upside

Since our original report on Regeneron Pharmaceuticals (REGN) in mid-December, shares of the company have rallied over 47%, versus a rise of over 27% for the NASDAQ Biotechnology Index, as a confluence of positive developments, both internal and external, have served to create a more favorable environment for Regeneron. And while REGN may be at all time highs, we believe that long-term investors should continue to hold shares of Regeneron. The company’s competitive position has strengthened over the past several months, its pipeline is progressing, and even at these levels, Regeneron, while not necessarily “cheap,” is by no means overvalued given what has transpired over the past several months, and in particular, this past week.

Firing on all Cylinders in Q1

Regeneron’s latest rally came on May 3, with shares rising over 6% on the back of strong Q1 results and raised guidance. For Q1, Regeneron posted revenue of $439.664 million (+89.68% Y/Y) and pro forma EPS of $1.78 (+381.08% Y/Y). Sequentially, sales rose by over 6%, with Eylea sales rising 13.77% sequentially, and 153.23% year-over-year. Both revenue and EPS beat consensus estimates calling for EPS of $1.41 and revenues of $424.26 million. Margins also continued their expansion, with operating margins rising to 46.87% in Q1 2013, versus 19.61% a year ago. Gross margins rose as well, expanding to 90.88% (based on net product revenue) from 90.39% a year ago. Regeneron ended Q1 with over $1.36 billion in cash & investments (alongside $302 million in senior convertible notes due October 2016). 2013 guidance for Eylea sales was also raised, from a previous $1.25 billion midpoint to $1.2875 billion. As CEO Leonard Schleifer noted on Regeneron’s Q1 conference call, the company is benefitting from a more favorable competitive environment. On Wednesday, shares of Regeneron soared, rising over 10%, as Allergan (AGN) announced that it is delaying the development of DARPin, its Eylea competitor. Allergan reported that Phase II data for DARPin does not support “moving directly into Phase III,” and that this will result in a delay of 1-2 years versus the company’s previous development timeline. With this delay, it is believed that the earliest DARPin could secure regulatory approval is 2019, by which point in time Regeneron is likely to be far less dependent on Eylea than it is today. However, while the Regeneron of today is highly dependent on Eylea, the company’s Q1 performance highlights that for the time being, this is a material positive.

Eylea continues to siphon market share from Lucentis, both here in the United States and around the world, and further gains are likely. Eylea currently holds 27% of the global anti-VEGF market, and its share outside the United States is under 10%. Importantly, reformulated Avastin, which has a presence here in the United States, forms a smaller part of the international market, thereby allowing Eylea to compete directly with Lucentis. However, here in the United States, Avastin has yet to present headwinds to Eylea, demonstrating that price alone will not dethrone Eylea. And potential changes in the regulatory environment present an opportunity for further upside. As a reminder, Avastin must be reformulated for use in treating AMD, and the meningitis outbreak of 2012 put an unprecedented level of scrutiny on compounding pharmacies. In late April, the Senate Health Committee introduced a bipartisan bill [with the support of Sens. Tom Harkin (D-IA), Lamar Alexander (R-TN), and Pat Roberts (R-KN)] that would give the FDA direct oversight over compounding pharmacies, as opposed to the state regulators that currently oversee such pharmacies. Any tightening of regulation could pose risks to Avastin, which has a market share of 50% in the United States, as measured by unit volumes. However, while a tightening of regulation on compounding pharmacies could pose further risks to Avastin, Regeneron does not need such an outcome to continue taking market share. Robert Terifay, Regeneron’s head of commercial operations, noted that on average, 10-12 AMD accounts are switching from Avastin to Eylea each week. And although these are typically smaller accounts, they nevertheless highlight that Regeneron can continue to gain share even without the presence of external catalysts. At the time of Eylea’s launch, Avastin had 60-65% market share by total eyes treated, and that has now fallen to 46% as of the end of Q1. And in macular edema following CVRO, Eylea has now captured 21% of the market as of the end of the quarter. However, while Eylea’s domestic sales continue to grow, there are potential headwinds, specifically potential share losses related to sequestration. Although the company did not see any sequester-related weakness in Q1, the company did note that because of slight reductions in Medicare reimbursement rates, physicians could begin to consider Avastin, and this is something to watch during the course of the year. We expect more color on the company’s Q2 call.

Internationally, sales of Eylea continue to grow as well. Eylea is now approved in 15 countries, but for the time being, the bulk of international sales are occurring in Japan and Australia, where Eylea is making meaningful share gains. It now holds 48% of the Japanese market, and 42% of the Australian market. Total international sales reached $65 million in Q1, and Bayer, Regeneron’s international Eylea partner, expects that peak sales will reach 1 billion euros if Eylea is able to secure approval across all expected indications (AMD, CVRO, DME, and myopic CNV).

Eylea Market Expansion

With a market capitalization of nearly $26 billion, Regeneron has now surpassed even Alexion Pharmaceuticals (ALXN) to lead the 2nd tier of biotechnology companies (as measured by market capitalization). And like Alexion, Regeneron’s success stems from the growth of one drug, and the company’s continuous ability to expand its slate of approved indications. Phase III trials for the use of Eylea in treating macular edema following branch retinal vein occlusion (also known as BVRO) have now completed enrollment, and 2 Phase III trials (one in the United States and one international) of Eylea in DME (diabetic macular edema) have also completed enrollment, with top-line data from the international Phase III trial to be released by the end of 2013 (the United States trial requires 2 years of efficacy data, which according to Regeneron is due to FDA requirements). A third Phase III trial in Russia and Asia is in the process of enrolling patients as well. Prior to international DME data, Regeneron will report clinical data from its Phase III trial of Eylea in mCNV (myopic chroidal neurovascularization), and the company has stated that positive clinical data can form the basis of international regulatory approval for Eylea in this indication.

Pipeline Progress

Regeneron’s pipeline is anchored by alirocumab (previously known as REGN-727), the company’s PCSK9 antibody designed to lower cholesterol, which is currently in multiple Phase III ODYSSEY trials. Top-line data from the first trial, expected in Q3 2013, and the market potential for alirocumab is promising. A recent survey of cardiologists conducted by Goldman Sachs showed that awareness of PCSK9 antibodies (alirocumab and AMG-145) is high, with cardiologists planning to prescribe these drugs to 25-50% of their patients within a year of a potential PCSK9 commercial launch. Goldman Sachs models peak alirocumab sales at $3.5 billion, with broader PCSK9 global peak sales of $5-$10 billion. Sarilumab (an IL-6R antibody), Regeneron’s other late-stage clinical asset (for the treatment of rheumatoid arthritis in patients that fail to respond to anti-rheumatic drugs) is set to see top-line Phase III data in early 2014. Along with long-time collaborator Sanofi (SNY) (more on this later), Regeneron has also begun a Phase III combination trial of sarilumab and DMARD’s in rheumatoid arthritis patients that fail to respond to TNF-alpha inhibitors (such as Humira, Simponi, or Enbrel)

Within Regeneron’s earlier stage programs, Phase IIa data for dupilumab (formerly known as REGN-668; for the treatment of moderate to severe asthma with elevated eosionphils will be presented at a meeting of the American Thoracic Society, and positive proof of concept data of dupilumab in atopic dermatitis was presented in March, and multiple dupilumab Phase IIb trials will begin in late 2013. And alongside its Q1 earnings, Regeneron also announced that it is acquiring full global rights from Sanofi to two antibody development programs, one for PDGF receptors/ligands in all indications, and ANG2 receptors/ligands in ophthalmology. Under the terms of the agreement, Regeneron will pay Sanofi a total of $15 million upfront, $45 million in potential milestone payments, and a single digit royalty on any sales. Despite pressure form analysts to discuss these programs, Regeneron was cagey, declining to comment further on its Q1 call about these programs, and merely stating that an IND for a combination of its PDGF receptor and Eylea is set to be filed in the 2nd half of 2013, and that its ANG2 antibody is already in clinical development. However, given Regeneron’s shrewd management of its deal with Sanofi (as well as its other global collaborations), it is unlikely that Regeneron acquired full rights to these programs without s substantial reason for doing so. As 2013 progresses, more details are likely to be released about the future of these programs.

Regeneron & Sanofi: Partners, or Something More?

Although much of Regeneron’s rally since our initial December report can be traced to commercial catalysts, both internal and external, a portion of Regeneron’s rally has been caused by renewed speculation about its relationship with longtime partner Sanofi, which has worked with Regeneron for well over a decade. In mid-February, Sanofi, which already owns nearly 17% of Regeneron, filed plans that would allow it to boost its stake in Regeneron up to 30%. Under the terms of the agreement between Sanofi & Regeneron, Sanofi cannot boost its stake past 30%, without the consent of Regeneron, until 2022, 5 years after the expiration of their collaboration agreement. Naturally, this has caused speculation that Sanofi would move to gain full control of Regeneron. However, there are both clear reasons, as well as clear hurdles for any takeover of Regeneron. Although Sanofi is not a partner with regards to Eylea, its collaboration with Regeneron covers the company’s antibody platform, which includes alirocumab, which if approved has market potential that we believe could exceed that of Eylea. In addition, the agreement between the 2 companies covers 6 other compounds, including dupilumab. Here, we would like to draw parallels to our prior coverage of Pharmacyclics (PCYC). We have noted in previous reports on Pharmacyclics (PCYC) that the unique nature of that collaboration, where Johnson & Johnson is responsible for 60% of development costs related to Ibrutinib, but will receive only 50% of any potential profits. It can be argued that such a structure may cause Johnson & Johnson to begin rethinking its deal with Pharmacyclics, and debating whether or not it is worthwhile to take control of the entire company. Regeneron’s deal with Sanofi, however, is far more favorable than the deal between Pharmacyclics and Johnson & Johnson.

Regeneron inked its agreement with Sanofi in 2007, receiving an $85 million upfront payment in the process (with a pledge by Sanofi to fund up to $160 million of R&D annually through 2017), and the unique structure of this agreement, creates clear benefits for Regeneron, as it meaningfully reduces development risk for Regeneron. The terms of the agreement can be explained best via a timeline.

  1. Upon the discovery of an antibody, Sanofi has the option to license it per the terms of the agreement. If the company does so, it has the responsibility to fund upfront any development costs until Phase III trials, upon which Regeneron will begin paying 20% of development costs.
  2. Although Regeneron is required to reimburse 50% of the costs borne by Sanofi, it is required to do so only from any potential profits generated via sales of the antibody in question. In effect, this de-risks the clinical process for Regeneron, in that it bears no costs until Phase III trials, thereby negating losses stemming from failed programs, and even in Phase III trials, it pays only 20% of R&D costs. Of note, Regeneron is not required to utilize more than 10% of quarterly profits towards repayment of Sanofi’s development costs, for the terms of their agreement require reimbursement of 50% of costs throughout the course of the agreement, and not in any particular quarter.
  3. If an antibody covered by this program is commercialized, profits and losses will be split equally in the United States. Internationally, Regeneron’s profit share will range from 35% to 45%, and its share of any losses is capped at 45%. In addition, Regeneron is entitled to up to $250 million in milestone payments after cumulative international sales of any antibodies covered by the agreement reach $1 billion in a rolling 12-month period.

The terms of this agreement clearly favor Regeneron. Sanofi bears virtually all of the development costs for antibodies covered by this agreement, and it is reimbursed only incrementally. And if a clinical program fails, Sanofi receives no reimbursement at all. And as alirocumab continues to progress through Phase III trials, the billions of dollars in potential global sales may lure Sanofi into making a bid for all of Regeneron.

There’s one key hurdle: Regeneron’s size. The surge in Regeneron’s stock price, to a new all-time high of near $270 on May 3, has pushed the company’s market capitalization to nearly $26 billion, catapulting Regeneron into the upper echelons of the biotechnology sector, and making it the largest 2nd tier biotechnology company (excluding Gilead (GILD), Amgen (AGMN), Celgene (CELG), and Biogen Idec (BIIB)). Even with its present 16.7% stake, the value of the remaining shares of Regeneron is over $20 billion, and the premium needed to sway Regeneron’s management team and board of directors towards a deal can easily push the cost towards $25 to $30 billion. Acquisitions of this size are not a common occurrence within the biotechnology and healthcare sectors, and given that Sanofi’s last multi-billion takeover (Genzyme) occurred only in 2011, the company may not wish to deploy capital at the levels needed to convince Regeneron to sell. That being said, Sanofi does have room to finance a deal for Regeneron. Sanofi shares closed at an all-time high on May 3 (shares have risen over 47% in the last 12 months), and Sanofi ended Q1 2013 with 7.44 billion euros of debt. With its stock at an all-time high, and credit ratings of A1 from Moody’s and AA- from S&P, Sanofi has room to issue the needed capital, and given Sanofi’s patent expiration issues (the company estimates it lost 562 million euros of profit due to the loss of key patents in Q1 2013), shareholders and bondholders may not be opposed to the issuance of new equity and debt to finance a takeover of Regeneron. Although this is “educated speculation” for the time being, it is speculation that may grow as alirocumab continues to progress towards potential commercialization, and more investors begin to question whether Sanofi can resist the allure of billions in potential sales, to say nothing of Regeneron’s existing Eylea franchise and pipeline assets.

Valuation & Conclusions: Buy, Sell, or Hold?

As we noted in our original report on Regeneron, the company’s shares certainly did not meet the traditional definition of “cheap.”  However, given the company’s growth potential, we argued that shares were not overvalued, and worth purchasing. But with shares nearly 50% higher since then, does the same ring true today? The answer depends on time horizon. For traders, it may be time to take profits. Shares have rallied nearly 50% in less than 5 months, and with an RSI of over 85, Regeneron seems somewhat overbought, at least in the near-term. Consolidation is a possibility as well, given the strong uptrend that Regeneron has seen. But, for long-term investors, there is little reason to sell. Regeneron is emerging as a core biotechnology holding, with a growing grip on the AMD market and potential in multiple other macular-related diseases. The company has now amassed over $1 billion in net cash & investments, and its competitive position has continues to strengthen. At the time of our original report, Regeneron traded at over 64x trailing pro forma 12-month earnings, and currently, despite a rally of nearly 50%, shares now trade at less than 44x trailing pro forma 12-month earnings (2012 EPS of $4.66 plus the $1.41 EPS spread between Q1 2012 and Q1 2013), due to the continued growth that Regeneron has seen over the last several quarters.

How can this be reconciled with a drop in 2013 consensus EPS estimates (per Reuters consensus estimates) from our previous report? At that time, consensus estimates for 2013 stood at $4.89, versus a present $4.56, representing a drop of 6.75% in 2013 estimates (there is a difference in EPS calculations for 2012 in what Regeneron stated was its 2012 pro forma EPS of $4.66, and what Reuters generates).

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The decrease in estimates can likely be traced to Regeneron’s increased R&D expenses. In Q1 2013, total R&D costs rose by nearly 20%, and in its 10-Q, Regeneron disclosed that project costs for alirocumab have risen by over 345% to $31.2 million. Per the terms of its agreement with Sanofi, Regeneron is responsible for 20% of R&D costs once Phase III trials commence, which means that earnings are likely to see incremental pressure. However, Regeneron is forecast to post EPS growth of over 50% in 2014, and with shares trading at less than 39x 2014 estimates, Regeneron’s valuation is not stretched. For investors that do not yet own Regeneron, it may be prudent to wait for a pullback before initiating a position, given Regeneron’s rally over the past several months. However, investors currently holding shares of Regeneron have little reason to sell. Regeneron’s financial strength continues to improve, Eylea is continuing to take market share, and Regeneron’s pipeline continues to make progress. And with a halt in the development of DARPin, long-term estimates are likely to increase to reflect a more favorable competitive environment. In just a few years, Regeneron Pharmaceuticals has become the 5th largest biotechnology company (as measured by market capitalization), and over that time frame, has shown that its perch is well deserved. The company continues to execute on all fronts, and is benefitting from multiple tailwinds, including a shrewd deal with Sanofi, setbacks amongst competitors, and the development of a pipeline that, if successfully commercialized, is likely to hold even more long-term potential than Eylea.

In connection with REGN, PropThink has taken a long position.