Description

Company Description

Mitsui Sugar is Japan's largest domestic sugar refiner with approximately 25% market share and is an affiliate of the trading company, Mitsui & Co, which owns 30%. The company sources raw sugar (30% domestic / 70% overseas), refines it, and then sells the refined sugar mainly to food & beverage companies. The industry is regulated to create an artificially high domestic price which supports local beet and sugarcane growers. Effectively the government taxes Mitsui Sugar and their competitors on sugar imports at a rate that fluctuates with international sugar prices. This regulatory system makes the sugar business quite stable and relatively insulated from movements in international spot sugar prices. To illustrate this, the company's operating profit has been between ¥6.0 and ¥6.5b over the past four years. Capex has averaged only 70% of depreciation over the past five years and the business spins off a lot of cash. This is not a growth business and should decline in the long-term with Japanese population but it's likely to be quite steady in the medium-term. The stock is trading at around 12x earnings which I think is about fair value without factoring in any benefit from Gilenya royalties.

What is Gilenya?

Gilenya (generic name is fingolimod) is the first oral treatment for MS and it is expected to be a blockbuster drug. Gilenya does not cure MS but it can significantly decrease the number of relapses and slow down physical problems associated with MS. In MS, the immune system damages the myelin sheath that protects nerve fibers in the central nervous system (CNS). Exactly how Gilenya works in MS is unknown but it is thought that it results in fewer white blood cells entering the CNS to attack and damage the myelin sheath.

Gilenya received FDA approval in September 2010 and EU approval in March 2011. The US approval is very favorable because it includes both first-line and second-line therapy while the EU approval is only for second-line therapy. Novartis reported $13m of Gilenya sales in the December quarter. However sales should ramp up quickly as Novartis estimates that they had over 2,000 US patients already on the therapy by mid-January with many of them initially receiving free treatment while they are going through the reimbursement process.

Why Does Mitsui Sugar Have Patent Rights to Gilenya?

The active ingredient in Gilenya is derived from a fungus used in ancient Chinese herbal medicine. The discovery was made by Japanese scientist Dr. Tetsuro Fujita who partnered with Yoshitomi Pharmaceutical and Taito Co. to research and develop the drug (see link to Bloomberg story below). Yoshitomo was later acquired by Mitsubishi Tanabe and Taito was acquired by Mitsui Sugar in 2005. The drug was first synthesized in 1992 and after exploring use as an anti-rejection medication for organ transplant recipients, focus later switched to treating MS patients. In September 1997, Mitsubishi Tanabe licensed out the global marketing rights for the drug outside of Japan to Novartis.

http://www.bloomberg.com/news/2011-02-02/himalayan-fungus-aids-mitsubishi-tanabe-sales-with-multiple-sclerosis-drug.html

How big will Gilenya be?

The current market for MS drugs is about $10b globally. There are approximately 900k MS patients globally of which ~60% have a relapsing-remitting form of the disease. About 400k of the MS patients are taking therapy and about 90% of these are on one of the ABCR therapies (Avonex, Betaseron, Copaxone, Rebif). Three of these drugs (ABR) are interferons and all four require daily or multiple injections each week. Tysbari has about 10% of the market, requires frequent intravenous infusions, and carries well known health risks.

Gilenya is thought by analysts to have significant market potential for several reasons. First the drug received a very favorable first-line FDA approval with no blackbox warning or other restrictions due to its efficacy and safety. Gilenya has shown a 52% reduction in relapse compared to the standard of MS care, the interferons. Second, Gilenya will be the first approved oral MS treatment and will be far more convenient for patients then the existing injection or infusion therapies. Finally, more then half of MS patients are thought to be currently off therapy due to issues experienced with other treatments including flu-like symptoms, site reactions, and injection pain.

In the US, Gilenya is priced at approximately $48,000 p.a. which is a 40-50% premium to current injectable treatment pricing. The pricing in Europe will be lower then the US with prices in Germany set around $30,900 p.a.

Sell-side analysts that cover Novartis and Mitsubishi Tanabe have significant expectations for Gilenya based on positive approvals and initial uptake. I'm not a pharma expert so I'm relying here on sell-side estimates. Consensus for annual global sales of Gilenya ranges from $200m to $700m in 2011, $600m to $1.6b in 2012, and $2.0b to $5.0b in 2016. The original patent on Gilenya expires in February 2014. However, as I understand it, US patent law allows patents to be extended based on the sum of its clinical trial period and the review period up to a maximum of five years. So the exclusive marketing rights are likely to be extended to August 2019.

How Much Royalty Income Will Mitsui Sugar Collect?

The two key variables to calculate Mitsui's royalties are 1) sales assumptions for Gilenya discussed above and 2) Mitsui Sugar's share of Gilenya royalties. The company has not disclosed what percent royalty it will collect on Gilenya but we do know a few things to narrow down the potential range. First, Novartis has said that they are paying more then 15% and less then 20% in total royalties on Gilenya. This 15-20% royalty pool will be divided by the three Japanese parties: Mitsubishi Tanabe, Mitsui Sugar, and Dr. Fujita. Second, we know that Mitsubishi Tanabe has guided analysts that its share of the royalties is approximately 10%. This leaves between 5% and 10% to be shared by Mitsui Sugar and Dr. Fujita. Third, we also know that Mitsui Sugar gave up global manufacturing rights and domestic co-development rights in exchange for its royalty share. Several experts I've talked to believe that global manufacturing rights are typically worth at least a 2% royalty. So I think a fair and conservative to estimate that Mitsui Sugar will get between 2% and 5% royalties on global Gilenya sales.

Using an estimate range of $2.0b to $5.0b for peak Gilenya sales and a royalty rate of 2% to 5% gets you to a pretax profit uplift of $40m to $250m for Mitsui Sugar in the medium-term. This compares to the company's current pretax profit of about $80m. So profits could rise in the medium-term by 50% to more then 300%. Needless to say Gilenya royalties are likely to be transformational for the company and I think the stock is potentially a multi-bagger.

Mitsubishi Tanabe and Mitsui Sugar will record royalty revenues with a one quarter lag from when Novartis books Gilenya sales. Therefore we should start to see royalty income booked to a very small extent in the March quarter and increasingly so in the coming quarters. I think over the next year it should become clearer exactly what Mitsui Sugar's royalty rate is.

Risks

If Japan removed trade barriers on sugar imports this would be negative for domestic sugar refiners. However this system has been in place for decades and there are no signs of it changing. There are also political motivations to support farmers, maintain some food self-sufficiency, and to keep the southern islands populated and free of Chinese influence.

Gilenya sales may not live up to expectations. At this stage I think very little is built into the share price for Gilenya so this is probably more of a risk if the share price rises significantly and starts to build in lofty Gilenya expectations.

Management might do something stupid with the cash windfall from Gilenya royalties. Historically the company seems to have allocated capital well by consolidating the industry and conducting small share buybacks but this is Japan so you never know.

Catalyst

Sell-side coverage