On Gilead $GILD

(A longer post for your weekend reading pleasure.)

For shareholders of the most wildly profitable biotech in history, it’s been a rough three months, but on any comparative basis, last week’s action was truly hideous.

GILD finished its week of horror closing -5.5% Friday at $82.7 on high volume, massively underperforming the +2.5% gain in the S&P 500 –this is just for the day– as it breached the important $87 technical level overnight. The week’s -11% fall was largely due non-stop, galactically negative, yet-not-really-new newsflow:

1. The AIDS Healthcare Foundation files another federal antitrust complaint against GILD
2. Using what appeared to be a national PR campaign, Massachusetts’ AG reveals her inquiry into GILD along with her written request that it “reconsider its pricing structure” as her office examins whether Gilead’s pricing is an “unfair trade practice,” in violation of Massachusetts law
3. MRK receives regulatory approval for its HCV treatment, which has a similar label and TAM to ABBV’s HCV treatment, Viekira Pak
4. ABBV reports sales for Viekira Pak that misses street estimates and lowers 2016 HCV growth outlook to $2B
5. GILD reports leadership shift as +25 yr President & COO takes the role of CEO while +20 yr former CEO remains in role of GILD board executive chair

The week’s news combined with a.) 2016’s ytd market bleed (IBB and XBI ETF selling have been relentless, both down >-20%)  b.) continued USD fx strength that is hurting S&P500 international sales, c.) next Tuesday is a key GILD earnings report, updating the market on the HCV treatment outlook — apparently, it’s all been too much.

GILD shares have fallen like the violent snows of a nor’eastern blizzard: unwanted, non-stop and in far too great a quantity, to the tune of -25% in a straight line since its Oct 27 earnings report, and -20% since GILD’s pre-ER corporate buyback blackout period began nearly 5 weeks ago. (For those who are interested in such things, the buyback window reopens next Thursday, Feb 4.)

But is such a severe reaction warranted?

EXECUTIVE SHIFT

From Bloomberg:

Gilead was founded in 1987 by Michael Riordan, a physician with a Harvard MBA. He named the company for the “balm of Gilead,” an ancient healing resin mentioned in the Bible. Riordan sought to commercialize so-called antisense treatments for genetic disorders, but his plans fizzled in the lab. In 1996, Riordan was replaced as CEO by Martin, who’d joined Gilead from Bristol-Myers Squibb hoping to pursue antiviral therapies based on his research on nucleotides, organic molecules that serve as building blocks of DNA and RNA. The company’s chairman was Donald Rumsfeld, who stepped down in 2001 to become President George W. Bush’s secretary of defense. Martin later took on the chairman’s title as well.

The messaging around current chair and former CEO Martin’s most recent transition on Friday could have been handled more effectively.

This is a recurring GILD theme under Doc Martin’s (sorry) tenure, as outbound messaging and communications have been a weak spot.

(Are you listening new CEO Milligan? Please find a brilliant certain-someone who can *use their words*, specifically in ways that public markets, investors and various government officials will appreciate. And then, immediately loan that person to China’s PBOC! Hah! We kid the Chinese. Seriously though, please hire a talented PR professional ASAP & give your beleaguered shareholders a break.)

Mr. Martin is a 64 year old billionaire who has, well, a billion reasons to have someone else deal with this going forward.

Meanwhile, John Milligan, Gilead’s new 54 year old CEO joined in 1990 as a research scientist, with a Ph.D. in biochemistry. He became CFO in 2002, and President & COO in 2007. Milligan is polished, an excellent public speaker, deeply technical, highly financially literate and very much liked by the Street. The guy has been groomed for the CEO chair for nearly a decade.

Martin will still be involved on strategy and with Milligan, the franchise is in excellent hands.

POLITICAL TARGET

As the NYT writes: “GILD’s prices, and the demand for its treatment, have strained the budgets of state Medicaid programs and prison systems, forcing many of them to restrict treatment to those most seriously ill.”

This being the case, it’s unfortunate that politicos appear default-set to demonize GILD as a rabid profiteer.

Apparently, whether you’re a politically ambitious state AG, US Senator or Presidential hopeful, GILD is your godsend. Democrat or Republican, Conservative or Liberal, GILD is your pre-fabricated *bad thing to hiss at* campaign-hot-button; a witch dipped in oil, straight out of central casting, matches & stake included.

But understand why they take this approach. To properly fund state & federal medicare budgets, a public discussion about the complex issue of HCV would include raising taxes –full stop. That doesn’t win elections.

Sadly, this is a public conversation that does need to take place, because even a rudimentary cost benefit analysis shows massive reductions in lifetime total healthcare spend for all the $300k liver transplants and $1M cancer treatments that are no longer required by cured patients. In this light, Harvoni is the highest value healthcare bargain of the millennia.

This is perhaps THE major problem facing pharma/biotech and society, and we need a functioning government to intermediate and lead.

The current regulatory environment, including patent protection expiry, the nature of antibiotics efficacy and political witch hunting have created an industry where a company would be crazy to spend scarce resources inventing drugs that a.) cure b.) physicians want to limit prescriptions for (efficacy) c.) politicians jump to demonize if priced for (gasp!) profit.

Incentives matter, and as with politicians, we can also understand why pharma/biotech companies have taken their approach, yes? So enjoy your viagra, just pray you don’t catch Zika, ebola, MRSA, etc…

(And if you think GILD is 100% innocent angel in all this, well, probably not. If it really did delay on filing for TAF approval just to maximize patent exclusivity for its HIV lineup, while allowing patients on tenofovir to succumb to bone loss and kidney damage…ugh. I hope it’s not true. But we may find out eventually via the federal case filed by the AIDS Healthcare Foundation this week. Sometimes, our capitalist/democratic system deserves a little hating on. To borrow from Churchill, it truly is “the worst system, save all the rest.”)

Strangely, the AG’s letter does not go into detail on how GILD’s pricing might violate MA state law. As another lawsuit –previously filed by the Southeastern Pennsylvania Transportation Authority, which said Gilead’s high prices violated a California law against unfair competition– was already dismissed by a federal judge, the legal grounds of this case appear tenuous.

Conclusion?

Politicians –as well as pharma/biotechs– appear to be proving out a fundamental law of Smithsonian economics when they act in their own self-interest.

This is my shocked face.  😐

COMPETITION

Speaking of economic laws, here’s one: “The solution to high prices is high prices.”

Enter MRK into the fray.

Zepatier, MRK’s new once-daily pill was approved by regulators on Thursday night and will be priced (list) at $54,600 for a 12 week course of treatment, versus $94,500 for GILD’s Harvoni.

Using apples to apples numbers, it remains possible, even probable, that the MRK after-discount price won’t be too far away from GILD’s net. Although we won’t know if MRK will truly be cheaper until the extent of their discounts are known, historically, net prices paid by insurers, aka “payers” usually demand large discounts in return for access to their patients.

IMHO, it’s this uncertainty that explains why GILD gapped down so much today. *IF* MRK provides as steep a discount as GILD, then the market projects GILD to have to match price, ergo less margin, less cash flow, lower PE, less buybacks, etc…

However –and most importantly– MRK’s new Zepatier is seen as an inferior course of treatment compared to Harvoni. From Citi:

Merck has priced the newly approved HCV doublet Zepatier at a 35% discount to the list price of competitor drugs from AbbVie and Gilead Sciences. We believe the discounted list pricing strategy (before rebates) is necessary in this highly competitive segment, given narrower indication and the prior-treatment mandatory liver function testing highlighted in the drug label. Zepatier requires liver function testing prior to, and during treatment. This compares unfavourably to Technivie’s updated labels which recommends hepatic laboratory testing only during the first 4 weeks of treatment and the unencumbered label of Gilead’s Harvoni. While Merck’s US label for their HCV agent is clearly inferior to incumbent competitors, we expect the launch of Zepatier to further drive net price reductions for the all market participants. We note that Merck’s focus will now be tilted towards next-gen all-oral triplet therapy (eta 2018) to better challenge Gilead and AbbVie.

Given MRK’s label issues, including availability for two out of six genotypes (1, the most common, and 4, which is rare), the added costs of multiple tests (HCV liver tests appear to run $200-400 each), the requirement of patient liver function as well as possible negative side effects (it can cause liver damage in some percentage of users), it would seem possible that Merck may be more of a competitive threat to ABBV, given they share similar label issues, etc…

ABBV. The guys who have repeatedly underwhelmed the market with their HCV regimen sales and forward outlook.

…

Regardless, we’ll learn over the next year what MRK’s discounting and sales efforts mean in term’s of GILD’s HCV market share. At present, estimates suggest MRK HCV sales will eventually reach $2B. (But just to be on the safe side, the market went ahead and priced GILD for a dire case today.)

OTHER FUNDAMENTALS

It would appear a number of former shareholders believe HCV is a rapidly declining opportunity, perhaps due to impending threats including political pricing controls, increasing competition and the fact many of these drugs have a cure rate in the 90th percentile, or, as one well-known bio-journalist wrote, “it’s a race to patient zero.”

Maybe. But second derivative thinking suggests these conclusions may be premature. For example:

• U.S. HCV patients are estimated to be 3.7 MM, with 300.000 cured to date
• The EU 5 is estimated to have 2.5 MM patients and Japan 1MM, doubling the patient count
• Merck says it hopes to eradicate HCV by 2030

2030, by my count, is 14 years from now. Most companies are horrible at projecting 3 months from now (surprising how often this is the case even when they’re midway through the quarter they’re trying to project.) 14 years is an exceptionally long outlook.

I’ll add two more items: the extended GILD pipeline appears promising (All-genotype HCV ETA in June, new HIV this year, early stage Hep B, NASH, Oncology, etc…) and they now get 30-50% more for their M&A effort AND buyback bucks given the recent biotech selloff.

Who knows what they buy. But when they do, they prefer to pay up for the sure thing. (So it’s largely de-risked.)

TECHNICALS

Granted, when things get extreme, things tend to overshoot. And (trend) buyers are higher, sellers lower, etc…

However, I’ll argue that margin of safety is a real thing, GILD is not a stock at risk of going to zero, and the further it goes down, the more de-risked it becomes over a long time horizon. #bagholderquotes

GILD held $83(ish) at the close. On a long term chart -given that in times like these, everyone becomes a technical analyst- GILD looks to have spent a bit of time in 2014 accumulating between $60-80 – call it $75 as a probable (worst case?) low.*

*Keep in mind, given its market cap and liquidity, GILD is a core position for hedge funds, SWFs and ETFs the world over. Much like AAPL, your GILD shares serve from time to time (recently, all the time) as a source of funds for forced redemptions, sort of an institutional ATM.

(So on behalf of institutions everywhere, please accept their thanks. They’re surviving to sell another day – by selling your favorite holdings into the hole. This, by the way, is likely why the phrase about markets staying irrational longer than you can stay solvent exists. We don’t know how long the dump must continue. Risk management remains key.)

CONCLUSION

While GILD probably deserves a low PE until such time that they change minds regarding a sustainable growth path, a 7 PE is venturing deep into crazy town:

From RBC:

(1) Valuation is historical low 7-8x and below lows of 2008-09 when Street thought there’d be an HIV cliff

(2) FCF yield on Gilead now at 10-12%+. Even if HCV revenues fell by 30%, FCF yield would still be 8% and PE still 10x and cheap to trough HCV levels. (That means they can buy the company outright in ~12 yrs under a worst case scenario.)

(3) Gilead last reported $11B of their share buybacks remaining (largest in biotech) and we expect this to get more aggressive.

(4) Drug pricing seems more rhetoric than reality as Merck’s price sounds low but net price is not known and may not be different or drastic than what is already modeled by consensus to get Merck to 10% share.

(5) Cutting price in Hep C can get some modest share but has not led to material market share for AbbVie (today’s EPS report shows 7% share and Gilead 93% share still) and thus Merck will get some share but probably not dramatically turn the business upside down.

(6) Also, much of the HCV contracts are already locked up (Express Scripts/AbbVie) and Gilead has suggested much of their deals have technology clauses that protect any material formulary change against Gilead.

(7) We already wrote this month that formularies might actually start opening up to treating healthier patients as UnitedHealth Group and Anthem and if Gilead HCV scripts start going up in time, we think this would change the view on Gilead; this is 50% of the scripts written and not getting booked for revenue in 2014-15.

Sounds about right. Hang in bulls, it can’t continue this way for too long.

Seriously. At this rate, GILD will be able to acquire themselves with their own cash on-hand before ski season ends.

Enjoy the rest of your weekend, talk soon.

g

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