The Bull Case for SNY’s Diabetes Franchise – Update

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Richard Evans / Scott Hinds / Ryan Baum

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@SSRHealth

January 23, 2015

The Bull Case for SNY’s Diabetes Franchise – Update

  • Consensus expectations for SNY’s basal insulins (Lantus/Toujeo) appear too low. Expectations fell 28% after SNY warned last October that US pricing had weakened, and have fallen to the point that consensus now expects 2017 sales to be lower than 2014 sales
  • This seemingly ignores the facts that in the US (66% of global Lantus sales) unit demand for basal insulins is growing at 10%, Lantus’ unit share of the basal insulin market is growing; and, both SNY and its key competitor (Levemir/NVO) increased list prices of their products by 11.9% in the month following the warning
  • In short, consensus expectations for Lantus (and the follow on product Toujeo) have failed to adjust for recent volume, share, and pricing trends, all of which point to substantially higher than consensus sales
  • As an entirely separate matter, we believe SNY’s pre-phase 3 pipeline is undervalued – so much so that SNY’s share price would have to increase by roughly 45% in order to more accurately reflect the apparent amount of innovation in the pre-phase 3 pipeline. To be clear, this is on an all-else-equal basis; i.e. we would argue SNY is roughly 45% undervalued even if consensus figures for Lantus and Toujeo were correct, though we don’t believe they are
  • Taken together, we see two powerful – and independent – reasons to believe SNY is substantially undervalued

Where we’re BULLISH: Biopharma companies with undervalued pipelines (e.g. VRTX, BMY, SNY, GSK); Biopharma companies with pending major product approvals (e.g. TSRO, ALKS, HLUY, EBS, BMY, BCRX, CBST); ABBV and ENTA on sales prospects in Hep C; SNY on undervalued basal insulin franchise, in addition to undervalued pipeline; AZN and LLY on the likelihood that excess SG&A/R&D spending must be reined in; CFN, BCR, CNMD and TFX on rising hospital patient volumes; XRAY and PDCO on rising dental patient volumes and rising average dollar values of dental products and services consumed per visit; CNC, MOH and WCG on bullish prospects for Medicaid HMOs; and, DVA and FMS for the likely gross margin effects of generic forms of Epogen

Where we’re BEARISH: Biopharma companies with overvalued pipelines (e.g. GILD, ALXN, SHPG, REGN, CELG, NVO, BIIB); PBMs facing loss of generic dispensing margin as the AWP pricing benchmark is replaced (e.g. ESRX, CTRX); Drug Retail as dispensing margins are pressured by narrowing retail networks and replacement of AWP (e.g. WAG, CVS, RAD); Research Tools & Services companies as growth expectations and valuations are too high in an environment of falling biopharma R&D spend (e.g. CRL, Q, CVD, ICLR ); and, suppliers of capital equipment to hospitals on the likelihood hospitals over-invested in capital equipment before the roll-out of the Affordable Care Act (e.g. ISRG, EKTAY, HAE, VOLC)

Summary

SNY shares have fallen roughly 14% since the company warned last October than Lantus sales would fail to meet expectations, principally because of price competition in the US[1]. 2017 consensus for SNY’s WW diabetes franchise has fallen 28%, from $9.9B to $7.1B. 2017 consensus is now lower than consensus for 2014 ($7.3B)

This is occurring despite the facts that:

  1. Both SNY and their only basal insulin competitor NVO took identical and near-simultaneous 11.9% US price increases in November – after the October warning
  1. Lantus’ share of US basal insulin prescriptions is increasing
  1. The prescription growth rate in the US basal insulin market is 10%

Consensus for Lantus / Toujeo has fallen too far

On December 5th of last year we argued[2] that consensus expectations for Lantus had fallen too far, for two main reasons. First, Lantus’ competitor Levemir is a highly imperfect substitute for Lantus. Because Levemir often must be taken twice daily, it’s unrealistic to believe that payors will shift large numbers of well-regulated Lantus patients to Levemir. And for similar reasons it’s highly unlikely payors would deny prescribers the option of using Lantus for new patients. Second, Lantus and Levemir have a history of price cooperation, as opposed to a history of price competition. For more than six years, the companies have taken similar price increases on similar dates. Five of the last twelve price increases have been identical percentages for both products, and on average the companies take their price increases within twelve days of one another

Since SNY warned in late October, both companies have increased the US list prices of their products by matching amounts. Specifically, SNY increased the US list price of Lantus by 11.9% on 11/7/2014, and NVO followed on 11/18/2014 with an identical 11.9% increase for Levemir (Exhibit 1)

Crucially, Lantus’ market share has been recovering. Lantus’ new prescription (NRx) share was 71.4% on 1/9/15, up from a low of 68% on 11/14/2014 (Exhibit 2). Lantus total prescription (TRx) share is now 75.1% (Exhibit 3). Unit growth in the US basal insulin market remains robust at roughly 10% TRx growth (Exhibit 4)

Despite strong unit growth, stable to improving market share, stable to improving prices, and the pending introduction by SNY of an improved replacement for Lantus (Toujeo), consensus expectations for basal insulins generally, and SNY’s specifically, have continued to decline. 2017 Lantus US consensus fell by nearly 25% immediately following SNY’s October warning, and has been slipping gradually since (Exhibit 5). Expectations for SNY’s follow-on basal insulin Toujeo also remain weak (Exhibit 6). On a combined basis, consensus expects SNY’s basal insulin business to be smaller in 2017 than in 2014

The argument has been made that the declines in consensus, and in SNY’s valuation, have as much to do with concerns of pending generic challenges to Lantus as to problems with market share and price. We find this argument hard to accept, primarily because the vast majority of total changes to valuation, and to consensus, occurred in the immediate wake of SNY’s October warning about market share and price. At that time, the market already knew the moving parts of the Lantus generic risks, and these hadn’t meaningfully changed – SNY sued LLY in January of 2014 (and again in July) thus delaying LLY’s generic version of Lantus until at least July of 2016. In February of 2014 Merck announced its plans to enter late-stage clinical testing with its own follow-on version of Lantus, but this can’t reasonably be expected to reach the market for 3 or more years, since MRK has to complete clinical testing and navigate the regulatory process, never mind the inevitable patent lawsuits. Since October there’s been no new evidence to suggest SNY will have any less time to switch Lantus patients to Toujeo

This strongly implies that the moves in Lantus consensus, and in SNY’s valuation, have everything to do with the market share and pricing concerns raised by the October warning. Since share and pricing trends are far more robust than consensus and share price reflect, we view SNY as meaningfully undervalued

… and the pipeline is too cheap

We solve for the market value of companies’ pre-phase 3 (aka ‘hidden’) pipelines by subtracting from enterprise values the net present values of all other assets. We then compare the apparent market value of the hidden pipeline to the amount of innovation the hidden pipeline contains, as determined using patent data. The combined market value of hidden pipelines for the 22 largest (as determined by R&D spending) publicly listed pharmaceutical companies is roughly $1 trillion; the market value of SNY’s hidden pipeline is roughly $10.4 billion – meaning the market value of SNY’s hidden pipeline is about 1.1% of the market value for all 22 companies’ hidden pipelines. However despite being given only 1.1% of the market value for pre-phase 3 pipelines, patent data indicate SNY has about 7.5% of the pre-phase 3 innovation held by all 22 companies – which implies SNY’s pipeline is undervalued (Exhibit 7). We estimate SNY’s share price would have to increase by roughly 45%, all else equal, for its pipeline to be fairly valued (Exhibit 8) – another reason we believe SNY is meaningfully undervalued. Our portfolio of stocks with undervalued pipelines has outperformed the peer group in every quarter since inception in November 2012. Cumulative outperformance is 1.6x the peer group[3]

  1. Lantus US sales are roughly 66% of Lantus global sales
  2. “The Bull Case for SNY’s Diabetes Franchise”, SSR Health LLC, December 5, 2014
  3. “Relative Price and Value of pre-Phase III Pipelines for the 23 Largest Drug & Biotech Companies” SSR Health LLC, November 20, 2014
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