Bristol Myers Squibb (BMY)

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Bristol-Myers Squibb: A Combined Value And Growth Story

Aug. 6, 2017 11:36 PM ET|14 comments| About: Bristol-Myers Squibb Company (BMY)

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Summary

Bristol-Myers Squibb has tumbled from about $75 last year to $56 as of Friday largely due to one failed Phase 3 study in lung cancer.

Sometimes this large a price drop in a bull market provides a reason to look for undervaluation.

This article suggests that the company's substantial Phase 1-2 pipeline could be a "freebie", given the potential value of its marketed products and other assets.

Background

Bristol-Myers Squibb (NYSE:BMY) was formed from a merger of two old-line pharma companies more than a quarter century ago. At the time, it was a powerhouse. It began to hit much harder times in the late '90s and was forced to reinvent itself in the '00s. Unusually, in a compliment to management, it has been able to do so via its "string of pearls" acquisition strategy. This turned BMY into what is largely a biotech.

Probably the most important deal was to acquire Medarex. The shrunken BMY launched the novel oral anticoagulant Eliquis a few years ago in competition with Bayer's (OTCPK:BAYRY) Xarelto, which is marketed in the US by Johnson & Johnson (NYSE:JNJ). As a smaller player lacking much of the marketing clout and know-how, BMY turned to Pfizer (NYSE:PFE) to assist with marketing the product. PFE took the ball and did what it knows best - which is devise a brilliant marketing strategy that took Eliquis to first place, with worldwide revenues up 50% yoy to $2.3 billion in the first half of 2017.

While BMY is moving ahead with certain anticoagulant and cardiovascular R&D, its future - without a marketing partner - is planned to be in oncology first and what it calls immunoscience (a related field) second. Here, the company has a certain dominance with two market-leading therapies for cancer, Opdivo and Yervoy; two other less important cancer drugs, Sprycel and Empliciti; and a drug for certain autoimmune diseases, Orencia. It needs no co-marketing partner here, and has Opdivo and Yervoy largely to itself, unlike Eliquis.

The company also has a huge pipeline, which is a drag on current earnings.

Because of that, it makes sense to think of BMY as two companies - one an existing marketing company, and the other a pipeline company, in concept valued as a junior biotech would be. There is one big complication, though, because nearly 100% of the Phase 3 studies involve marketed products, largely Opdivo and Yervoy. I'll therefore include Phase 3 in this analysis and try to account for its cost later.

Overview of BMY's earning assets

To begin with, BMY has a favorable mix of sales. Per its Q2 earnings press release, the growth is attributed largely to these five drugs, with yoy growth rates as follows:

Eliquis - 51%
Opdivo - 42%
Yervoy - 34%
Sprycel 12%
Orencia 10%
The other important young brand is the myeloma antibody Empliciti, which only had sales of $55 million, but they were up 62% yoy.

For the first 6 months of the year, total revenues were $10.1 billion. Of this, only $2.26 billion came from older drugs. And while I won't go into the upside in this article, BMY is launching two hepatitis C drugs in three major provinces in China this quarter - so there may be some surprises if they start selling well.

The above 6 younger, growing brands are unusual amongst biotechs and Big Pharma. That's because, in general, the faster-growing the drug, the later the patent expiration in the US; with the EU generally, but not always, similar though not identical. What I have done is read through the presentation of patent situations in the latest 10-K (pp. 7-8; also see p. 11 regarding alliances) and have used my best guessing as to the approximate year of ultimate patent expiration. Some of the guessing relates to ungranted patent term extensions that have been applied for; other guesses relate to other issues. So, not factual but a working template that I'm using for now as an overview. These are my current estimates of the years that the above 6 BMY growth drugs either go generic (G) or look likely to be open to biosimilars (B):

Eliquis - 2027 G
Opdivo - 2027 or 2028 B
Yervoy - 2025 B
Sprycel - 2024 G
Orencia - 2021 B
Empliciti - 2029 B
What's positive for BMY here is that the fastest-growing drugs look to be without direction competition until perhaps 8-12 years from now. That provides lots of time to grow. It also provides time for new formulations to be developed or new patents to mature that I'm not aware of. This is a common tactic. Amgen (NASDAQ:AMGN) used it to extend the patent life of Enbrel, its lead drug, until the late 2020s rather than falling to biosimilars this decade. Celgene (NASDAQ:CELG) has done something similar with its lead drug, Revlimid.

In addition, Eliquis is given twice daily. A once-daily version might appear and extend exclusivity, as well as helping sales growth.

Finally, it's a positive that 4/6 of the above drugs are biologics. That gives the hope to BMY that it will retain a lot of its sales even when one or more biosimilars come to market.

What are these earning assets worth?

Of course, no one knows, but analysts are guessing at it. My guess is that they are worth, ultimately, close to BMY's current market cap of $92 billion. The way I estimate it is that the company is probably going to see Yervoy and Opdivo sales of some strength into and beyond the 2030 period; and as stated, I assume one or more of the above drugs will either get patent enhancements and/or an improved formulation. So what I've done is take analysts' consensus estimated revenues for 2018 of around $21 billion and extend that for 11 years. Some products will drop out, such as Sprycel and some of the currently-aged drugs, but most of them will keep growing. Given that the fast growers have late patent expiries and are medical breakthroughs, I'm simply guesstimating that the company can achieve $21 billion X 11 = $231 billion in cumulative sales from existing products. Exactly what discount rate to use is difficult. BMY current gets about 55% of its revenues from the US, where there are few truly effective cost controls on breakthrough medications, which almost all the above drugs are.

In any case, the next question is what the fully-costed pre-tax overhead is to achieve those sales. Based on 2016 and 2017 numbers, I hope it is conservative to use 50%. If I recall correctly, somewhere along the line BMY said it hopes to improve on this ratio - but only time will tell. 50% COGS and SG&A, which take partnership payments into account, give a cumulative pre-tax profit of $115 billion by this method.

What tax rate should be used? No one knows. BMY projects 23% for this year, so just for now I'll go with that. That gives $88 billion as after-tax profits projected.

Now, one thing that is not included in these projections is royalties from other companies than Merck (NYSE:MRK), which has settled with BMY regarding the latter's Opdivo-related patents. BMY is going after at least the three other companies marketing PD-L1 I-O drugs, and I expect settlements to be likely. That could add up to billions of dollars over the years.

Finally, BMY has a positive tangible net worth of $6.6 billion as of the end of Q2.

Putting it all together, investors in the company may be getting a mostly early-stage pipeline free. A lot depends on what the actual cost of the Phase 3 program is and will be, but I'm hoping that the numbers work out close when doing all the adding and subtraction.

As a double check to the above, I have worked on what BMY's EPS would be if it dropped all R&D. Doing so would make this a very cheap stock, taking billions out of the cost structure per year on a pre-tax basis. I'm not certain if the tax effects are symmetrical, but a simple calculation that you can do on your own suggests that given what I see as the likely product lives, with several of them rolling on after biosimilar entry, the stock may be cheap here on a fundamental basis if the pipeline comes through even moderately well.

The next section therefore discusses the pipeline, albeit briefly.

BMY's giant pipeline

The 2016 annual report shows the pipeline nicely on PDF slides 12-13.

A slightly more recent version of the oncology pipeline was shown on a presentation related to ASCO; see the crowded slide 12.

I would say that given a Phase 3-ready NASH asset and the proven quality of BMY's R&D department, this company could be a real contender in several ways. It's also important to remember as we think of these stronger companies that the best of them have reinvented their product lines over and over. A question for readers who know some of the history of Bristol-Myers and Squibb: Who remembers Capoten and Monopril? Plavix? Coumadin? Glucophage? Pravachol? Hydrea? Kenalog, Megace, Videx, Zerit?

So, to be very brief, while I'm no longer comfortable thinking about standalone junior biotechs with unproven product lines, processes, technologies and managements, I am comfortable with the successful, mature companies to get a positive return on invested capital over time from their R&D programs. In the case of BMY, the CEO is an M.D. with both product development and commercial experience; and the new head of R&D, Dr. Thomas Lynch, is a superstar oncologist with extensive experience.

If I can think BMY's current assets, mostly marketed products but also tangible net worth and intellectual property that can be monetized further, may be worth somewhere in the range of its market cap, then I'm willing to accept pipeline risk, especially with a reasonable dividend to pacify me if I get antsy over a failed clinical trial along the way (which always happens with large pipelines).

Implications of the above analysis suggest BMY may be perpetually in play

If you look carefully at the Phase 1 assets on the ASCO presentation, and if you are familiar with the I-O field, you will notice that by description, only a small number are novel. The novel ones do include a next-generation Yervoy that's in the clinic and a small number of others. But other acronyms look familiar.

This suggests to me that there are multiple synergies available if any of the following four companies acquires BMY: PFE, JNJ, Roche (OTCQX:RHHBY) and Novartis (NYSE:NVS). All have the heft to do the deal, and some have overlapping assets. In addition, the usual corporate synergies can be achieved.

One reason to own a stock of a company that's not too large to be acquired is that it makes it difficult to panic and sell on some bad news. The acquirers love to buy the dips.

Risks

As a company that's pushing hard on the pipeline, largely relying on Opdivo and Yervoy, a major risk is that it just gets it wrong. Another risk specific to Opdivo right now is that the majority of its US sales come from lung cancer, where it is not in great competitive shape. A more comprehensive list of risks is found in the 10-K and other communications and regulatory filings from BMY.

The company is aggressive right now, going for growth, and sometimes it just does not work out.

Concluding comments

In a high stock market, with the S&P 500 (NYSEARCA:SPY) trading around 23.7X likely GAAP EPS when Q2 results are finally reported, BMY is trading at a greater than 10% discount to the market. When it was at $70-75 last year, it was at a premium. Given its strong products and long product lives as I estimate them, and significant pipeline potential in a secular growth field of immuno-oncology, I'm comfortable that BMY may be undervalued on its own merits even in a "normal" market, and that it probably is relatively undervalued relative to the SPY. That I can imagine that a mega-cap behemoth might want to acquire it, rationalize the pipelines of the combined companies, and pay for the deal with cash flow from the acquired company, helps me plan for this stock to be a long-term holding.

Thanks for reading and sharing any comments you wish to contribute.

Disclosure: I am/we are long BMY,CELG,RHHBY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Not investment advice. I am not an investment adviser.
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https://seekingalpha.com/article/4095703-bristol-myers-squibb-combined-value-growth-story?app=1&auth_param=udil:1cofo1k:c84b56c4169695770e66e7cf73458aec&uprof=46

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