Summary: Alexion (ALXN) is a pharmaceutical company focused on rare diseases. Over the past 3 years, a new management team has undertaken a turnaround with mixed results: margins have improved but corporate m&a activity/capital management have been underwhelming. It’s a controversial situation, and the stock has traded in a range for the past several years, though the company currently trades at a fairly compelling valuation, implying upside from cash flow generation or a buyout.
Business Overview: Alexion was founded in 1996 to focus on rare and ultra-rare diseases. The company currently sells 5 medicines (Soliris, Ultomiris, Strensiq, Kanuma and Andexxa) and targeting 7 diseases. Its two largest products are Soliris and Ultomiris, targeting the C5 complement protein. Total sales this year are projected to be $5.6 billion. The company has no net debt and generates approximately $2 billion per year in cash flow.
Key Pillars of the Thesis:
1.Increased focus on efficient capital allocation. Since taking over in 2017, the current management has increased operating margins nicely but has also made some questionable acquisitions. Going forward, it appears there will be increased focus on returning cash to shareholders, while certain investors actively push for a sale of the company.
2.Management of risk to core product franchise. To reduce the risk of a generic version of Soliris from Amgen in 2025, the company continues to shift patients from Soliris to its less expensive, more convenient product Ultomiris.
3. Potential upside in pipeline products and indications. In 2017, the company had only 2 products in its pipeline. Today, it has 10 products that could be launched by 2023 with peak sales of $7.3 billion. It is also at the beginning of expanding its neurology franchise.
4. Attractive valuation.
#1. Increased focus on efficient capital allocation. For much of this year, there has been increasing investor focus on Alexion’s capital allocation process. Four core areas have been of focus:
Margin improvement. On this score, the management team has done a very nice job. Operating margins have improved from 41% to nearly 54% this year. We do not model additional upside to the margins as the company has said that would require underinvestment in r&d, but we do expect them to remain in the above 50%.
Business development. Since the current management team came on board, they have spent $4 billion on various acquisitions: Wilson Therapeutics ($855 million in 2018), Syntimmune ($346 million in 2018), Portola ($1.4 billion this year) and Achillion ($960 million in 2019).
To date, these acquisitions have been underwhelming. The development of the Syntimmune lead product (FcRN blocker/ALXN1830) has been delayed by nearly 2 years, moving the start time for its pivotal study from YE2019 to 2021 earliest. The lead product acquired 9 months ago in the Achillion deal (danicopan/ALXN2040) just failed in the clinic about a month ago.
The Portola deal was of questionable strategic fit and seemed a high price for a product that has struggled to find its market, so Alexion’s market cap dropped in excess of the deal price on the day of announcement.
Analysts have recently publicly complained that the $4 billion spent on acquisitions could have been used to buy back approximately ⅙ of the current market cap. With its most recent earnings release, management was more measured about its approach to BD going forward, pledging to return more of the future cash flows going forward.
Buybacks. At a 54% operating margin and 15% tax rate, Alexion generates in excess of $2 billion per year in cash flow. On the recent earnings call, the management team pledged to use 20-25% (~$500 million) of cash flow generated this year to buy back shares. They pledge to return an additional ⅓ of average annual cash flow from 2021 to 2023 to shareholders.
Potential sale. Elliott Advisors and various sell-side analysts have spoken publicly about the potential for Alexion to sell itself at an attractive premium. While it’s certainly possible, and could be accretive to a number of buyers at a premium multiple, we’re not counting on this. Several of the potential buyers have new CEOs focused on bolt-ons. Others might have capital constraints. And in December of last year, the Alexion board rejected Elliott’s call to put it up for sale.
#2. Management of risk in the core product franchise. Part of the reason Alexion has focused so heavily on BD is because the company is highly reliant on one key product franchise, Soliris/Ultomiris, which is 85% of revenues. Ultomiris and Soliris are monoclonal antibodies that target complement protein C5 and stop the destruction of red blood cells outside blood vessels. 80% of C5 revenues come from treating Paroxysmal Nocturnal Hemoglobinuria (PNH) and Atypical Hemolytic Uremic Syndrome (aHUS). PNH is the uncontrolled destruction of red blood cells by C5 complement part of the immune system, while aHUS is overactivation of C5 that results in the formation of blood clots in small blood vessels throughout the body.
Soliris was the original drug in these indications, but its patents/market exclusivity begins to expire in 2021. To protect the franchise, Alexion developed Ultomiris, which has a much longer duration of action than Soliris so it requires less frequent dosing (every 8 weeks versus every 2). Alexion also priced Ultomiris at a 30% effective discount to Soliris.
Agmen initiated a patent challenge against Soliris in 3q19. Just prior to trial, Alexion settled with Amgen, delaying risk of the generic entrance in the US until 2025. This settlement buys Alexion time to convert patients to Ultomiris, which has patents and exclusivity into the 2030s.
Ultimately, we believe that the company will switch 90% of patients from Soliris over to Ultomiris.
Beyond the issue of generics, there are legitimate competitors under development for the C5 franchise out there, and it makes for volatile trading in reaction to news. In many rare diseases, the embedded relationship between the patients and the company mean that new entrants have difficulty entering the market.
#3. Potential upside in pipeline products and new target indications for existing products. Alexion does have 10 products in its pipeline that could launch by 2023. Per the company, peak sales of these products would be approximately $3-4 billion.
For the C5 franchise, they are moving to expand Ultomiris to a range of neurologic disorders including ALS (which alone could be a $2.7 billion opportunity if successful) and primary progressive multiple sclerosis (PPMS). The company has already gotten approval to treat patients with a severe form of myasthenia gravis (gMG), a chronic autoimmune neuromuscular disease that causes weakness in the skeletal muscles, and neuromyelitis optica spectrum disorder (NMOSD), which is an autoimmune disease that attacks the central nervous system, destroying the brian, optic nerve and spine.
#4. Attractive Valuation. Market expectations for the company are fairly muted. It is currently trading at 10x this year’s consensus earnings of $11.05 and 7x EV to this year’s consensus EBITDA of $3.4 billion. Over the next several years, we expect the company to generate cash equivalent to 50+% of its market cap. At 10x 2023 EPS of $13.60 plus the accrued cash, we expect upside over the next several years to $160, up 40% from here.
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