Saturday, July 9, 2016

Gabelli Research Says Gilead's HCV Sales To Crash Badly And Soon: Analysis


A bull on Gilead Sciences nonetheless foresees rapid decline in its global HCV product sales from $19 B last year to only $6.7 B in 2020.

This severe projected drop raises the question of why J&J wants to enter this market around that time.

It also may explain the very low relative P/E for Gilead's shares.

This article goes into global detail and finds reason for much better global sales.

While quite speculative, my much more bullish scenario may be no more so than Gabelli's or the Street's views.


One of the unanswered questions about Gilead (NASDAQ:GILD) is why it's been trading at such a low P/E relative to its biotech and Big Pharma peers. I've been saying for a long time that its surge in earnings, matched by an increase in its market cap of as much as $120 B (or more) from 2011 to last year's peak, meant that it should trade at a discount to the market, probably a significant one. My guess going into 2016 was for it to trade around half the market multiple, perhaps 12X this year's GAAP EPS.

The year's not over, but given the Q1 disappointment and the unanticipated 30% price cut in Japan, my expectations for this year are lower than I thought, but the relative P/E for GILD in the 7-8X TTM range most of this year compares with a TTM P/E more than triple that for the market as a whole.

This still appeared a bit inexplicable, until recently, when Barron's blog reported on the following estimate for GILD's HCV sales going forward, from Gabelli Research:

    Gilead dominates over 90% of the Hep C patient share with Harvoni and Sovaldi, the blockbuster drugs that generated $19.1 billion of sales in 2015. Though the Hep C revenue is expected to decline at 17% CAGR to $7.6 billion by 2020, we believe the future cash flow generated by Hep C is still worth over $40 billion.

What's pretty about this gloomy projection is that the Gabelli analyst also says this:

    We believe that Gilead is the most undervalued stock in the biotechnology industry.

Just think if she agreed with me on GILD's HCV prospects!

Herewith, my updated analysis on GILD's intermediate- and long-term prospects for HCV sales, beginning with a brief summary of where these have been.

Where HCV sales have been

Last year saw the completion of the roll-out of Sovaldi and then Harvoni in the US, EU, Japan and most other wealthy countries.

From the company's Q4 and FY 2015 press release of Feb. 2

    Three Months Ended         Twelve Months Ended
            December 31,         December 31,
            2015         2014         2015         2014
    Antiviral products:                                
    Harvoni - U.S.         $     1,707             $     2,001             $     10,090             $     2,001
    Harvoni - Europe         587             83             2,219             103
    Harvoni - Other International         1,051             23             1,555             23
            3,345             2,107             13,864             2,127
    Sovaldi - U.S.         660             1,178             2,388             8,507
    Sovaldi - Europe         259             459             1,601             1,546
    Sovaldi - Other International         628             95             1,287             230
            1,547             1,732             5,276             10,283

This shows the tremendous fluctuations in Sovaldi and Harvoni sales in the three regions shown in different time points. Without analyzing those in detail, a takeaway is that there's no steady-state demonstrated for either of them as of year-end 2015.

Then there's Q1, which disappointed many. From the Q1 press release of April 28:

            Three Months Ended
            March 31,
            2016         2015
    Antiviral products:                
    Harvoni - U.S.         $     1,407             $     3,016
    Harvoni - Europe         555             477
    Harvoni - Japan         887             -
    Harvoni - Other International         168             86
            3,017             3,579
    Sovaldi - U.S.         645             421
    Sovaldi - Europe         280             483
    Sovaldi - Japan         202             -
    Sovaldi - Other International         150             68
            1,277             972

Also no steady-state yoy, but steadier qoq.

A number of explanations were offered by GILD for the huge drop-off in Harvoni sales in the US yoy. These included:

        shorter treatment durations
        negotiated price reductions
        adverse payor mix.

At this point, that sort of litany is deeply embedded in the Street's views of GILD's HCV prospects.

At this point, this sets up the potential for a classic value play which is the opposite of a value trap. However, as I began saying more than a year ago, if this thesis is correct, it takes time to actually return cash or other shareholder value via share count reduction; it does not set up a big move up in P/Es. That's because no doubt the HCV is maturing - but I think the Street could either be correct, low or very low in its estimates. Here are my counter-arguments that suggest there may be more profit for GILD (and its competitors) in this space than the Gabelli report, and probably the general Street consensus, are modeling.

If HCV markets are dying, why are the smartest companies investing so much to get into them?

One of the reasons I'm taking the "over" on this sort of estimate is J&J's (NYSE:JNJ) eagerness to enter this market. I discussed this recently in an article on Achillion (NASDAQ:ACHN), which has a licensing deal that gives JNJ access to its HCV portfolio, and which is saying that soon, JNJ will begin a Phase 2b set of studies on both a 2-drug and 3-drug combo for HCV.

Given these are 2b studies, with Phase 3 to come, then the regulatory approval periods, followed by often-long, pricing-related delays in the EU, JNJ can't really even get going globally until 2020. If the global HCV market is so shrunken that GILD, with an estimated current 90% global market share, is down to $7 B or less from $19 B in 2015, why would JNJ be interested?

By the time it gets to market, assuming that its only major reason for the Alios acquisition was its HCV "nuc," then between that large cost, the investment in ACHN, milestone payments to ACHN, and costs of product development, it may be spending $3 B to bring its products to market. And unless it proves in Phase 3 that its products are the best, better than those of GILD, then it has to compete on some combination of price and bundling (which involves a lightly-concealed discount). By 2020, all important global markets for modern HCV meds will be addressed by GILD and probably at least one competitor. Even if GILD's market share drops to 67%, then the Gabelli estimate (from a GILD bull!) implies a global HCV market of $10 B, far lower than today even as distribution to all markets finally will have occurred. (This excludes the authorized generics GILD is allowing, which will supply the poorest countries.)

And if that $10 B continues dropping beyond 2020 at anything like the implied rate by this number, what's left to interest JNJ to make such an effort for so little ultimate reward?

JNJ's pharma division is about as smart, knowledgeable and focused as Big Pharma gets. Its ongoing apparent commitment to bringing a doublet and/or a triplet product into Phase 3 and likely thence to market is that JNJ is in the camp that the HCV commercial market is going to stay more robust for a longer period than the analysts think. The same goes for the continued efforts of MRK and ABBV with their R&D program. At some point, these companies recognize that they need limited, not rampant price deflation to mutually benefit. Overall, the action of GILD's competitors in HCV implies optimism about the worthiness of this global market.

In this article, I break Gilead's addressable HCV market into five sections. Starting with home:

The US may remain a large HCV market for many years

A. Overview

According to Norbert Bischofberger, GILD's EVP of R&D, in his presentation last month at a healthcare conference, GILD estimates there are still 3.2 million people with HCV in the US, and says it's being conservative with that number. Looking out over the next 10 years and beyond, I'll adjust that number upward for 3 reasons:

        new cases from the current population
        treatment failures

If immigration leads to about 1.5 million new residents annually who will have health insurance, and if there is an HCV rate of 2%, that's 300,000 over 10 years. The new case rate has been pretty low in the US, but since needle-sharing is now the swing factor in infections, I think we can add another 300,000 total cases over the next decade or so from new infections. Finally, if there's a 4% treatment failure rate out of (say) 2.5 million people treated, that adds another 100,000.

So, if 3.2 million is conservative, we can get to about 4 million as the addressable population by about 2026-7. This is before any patent expiration on any GILD HCV drug or combo.

Over this period, I'm estimating that 3 MM, or 75%, end up diagnosed by 2027, of whom 2.5 million get treated.

If GILD can average an 80% market share over this period, which I think is doable, that suggests 2 million Americans are left to be treated by a GILD HCV drug. Let's say this is spread over 12 years, meaning about 160,000 Americans get treated annually, and that as GILD has been saying for some months, the flow of patients is going to get smoothed out. There are practical and financial limits to the capacity of the system to handle new treatments, and most of the very severe cases have already been cured.

This number represents a significant drop from the 55,000 estimated patient starts in Q1, per the conference call (p. 6), so I hope it's realistic.

What about pricing? And, specifically, in 2020?

No one knows, not even GILD. However, the industry may be viewing ABBV's deep discount ploy on Viekira Pak with Express Scripts (NASDAQ:ESRX) in 2014 a failure. So, while I'm not privy to MRK's marketing plans with its recent HCV entrant Zepatier, for now we have a standard 3-player market for combo products to cure HCV. And especially when GILD introduces its pan-genotypic SOF/VEL combo next month (PDUFA date is June 28), we will be in a nolo contendere situation for which company has the utterly dominant product line.

When a situation like this occurs, it harms the second-tier competitors to start a price war. The incumbent will match any price, mostly retain its dominant market share.

B. Estimating the dollars

In the US in Q1, HCV product sales were just over $2 B, but that was depressed by a large and unanticipated level of rebates. If there were 55,000 patient starts, that suggests $40,000 per patient (technically, per start).

Between a continuation of the trends toward more Medicaid/VA etc. payors, shorter duration of treatment, and greater competition from at least MRK and eventually possibly from JNJ, I'm going to pull from thin air a pricing reduction to $30,000 per case in 2020. (Readers will please understand how much guesswork is going into this - but Gabelli and the Street are guessing as well.)

If the number of patients treated by GILD in the US drops to the 160,000 year number in 2020 (which could be both too low and too high), multiplying that by $30,000 gives $4.8 B in sales revenues.

Moving on:

The EU adopted a "lower for longer" treatment strategy

The northern European countries traditionally have had very low prevalence of HCV. This has begun to change with changing, accelerated migration patterns into northern Europe.

Southern Europe, principally the richer/larger countries of Italy and Spain, has had a much higher prevalence. Given two studies both indicating around a 2.6% prevalence rate in Italy from less than 10 years ago, there may be 1.5 million HCV patients in Italy. Spain may have as many as 1 milion cases. Romania, a much less affluent country, has had one estimate of 600,000 cases, with almost none of them treated. That country, under better EU economic circumstances, might become a significant market for GILD with assistance from the EU.

When GILD was a hot stock 1-2 years ago, it was saying that at least 100,000 patients per year could be treated out of Europe, maybe more, but that the authorities had strict national budgets that would limit utilization.

If GILD maintains a very high market share, even a decline in pricing to $20,000 per case, driven by similar factors as in the US could be lucrative. Its products could treat 100,000 patient per year, a very small fraction of the apparent need, in that case giving GILD revenue of $2 B per year in 2020.

This might be conservative; I hope it's balanced.

Next, Japan:

Japan - significant pricing pressures, but the market remains large

Based on prior published estimates of the number of patients in Japan in need of cure of their HCV, and the number treated to date, there may be 1 million HCV patients to be treated in Japan, with a high diagnosis rate.

In Q1, GILD's HCV sales in Japan were $1.1 B, and that number was depressed somewhat by the 30% (approximate) price cut for both Harvoni and Sovaldi. GILD says it is unaware of further special price cuts coming this year; Japan routinely lowers drug prices every two years. Rather than annualizing near $4.4 B, the effects of the price cuts, shorter treatment durations and growing competition normalize that number to more like $2 B. Then I assume some loss of market share and some drop-off in patients treated by 2020 to guesstimate $1.5 B in HCV revenues for GILD in Japan in 2020.

As a running total, I'm at $4.8 B (US), $2 B (Europe) and $1.5 B (Japan). That totals $8.3 B.

There are two more types of markets, China and ROW (rest-of-world) ex-China. Beginning with the latter:

It may not be a small world after all for the ROW for GILD ex-China

The rest of the world outside of the US, Europe and Japan brought in $318 million in sales from Sovaldi and Harvoni in Q1, up from $154 million yoy. So it was already a $1.7 B annualized business.

This could grow substantially.

GILD basically segmented the HCV needs into 3 parts. One was the US, wealthy Europe plus Japan and the usual other richer countries such as Canada and Australia. On the other end of the spectrum were the many very poor and often highly needy countries such as India, many African countries, etc. These countries are being supplied via licenses to India-based generic companies; the list is found on PDFs on a GILD web page.

Many countries, though, that are not "rich," are absent from this list. In addition to China, some prominent ones are: Brazil, Argentina, Chile, Mexico, Turkey, Thailand, Malaysia, and the richer Asian countries such as Singapore, S. Korea and Taiwan. Also absent are several high income Middle Eastern countries such as Israel, Saudi Arabia and Kuwait.

A caveat: in all these countries, it makes a big difference to GILD's revenues and a smaller but still large difference if it uses a marketing partner rather than handling all sales. As GILD may sell to a government buyer that then distributes the drugs no charge, or use a marketing partner in whole or in part in different countries, I'm going to just guesstimate sales possibilities on a national basis. But GILD may not get all revenue from those sales.

What pricing will GILD receive in different markets?

One website asserts that the lowest price that GILD is charging anywhere is for retail clients, as it were, in Egypt, where the price is said to be $6000 for a 12-week course of Sovaldi. (Egypt, with a horrible HCV burden, is also the beneficiary of the generics program.)

This may be reliable information, as the same website lists $7000 for the price in Brazil, similar to the $7500 that Datamonitor Healthcare also says is the price in Brazil. Presumably, Harvoni would be the same price.

Basically, my hypothesis is that A) there are several billion dollars worth of annual sales potential in these countries by 2020, and B) there's a free call option embedded in this opportunity, as Street expectations may approach zero and therefore sales might beat for years to come.

Let's explore this.

South Korea and Taiwan

Take two strong economies with relatively high per capita income, namely S. Korea and Taiwan. My understanding is that it is soon beginning or has begun sales in both countries; again, whether it is sharing revenues with a marketing partner is not known to me.

South Korea has about 50 million people. One survey indicated an HCV prevalence of 1%. That's 500,000 cases, clearly with a margin of error. If 8% of the afflicted patient population got treated yearly, that would be 40,000 new patient starts annually. With a per capita GDP perhaps at $30,000 by 2020, and global HCV reimbursements correlating fairly well with that metric, I'll assume a lower selling price per patient start than in Japan, say $15,000 per treatment in 2020. That would mean $600 million in annual revenues for HCV treatments in 2020 across all manufacturers.

Taiwan has 23 million people. A study suggested an HCV prevalence of 2.7%, with a wide error range. That suggests about 600,000 potential cases to be treated. With a per capita GDP perhaps approaching $25,000 by 2020, maybe Taiwan would be paying $14,000 per patient start in 2020. With a higher prevalence than in S. Korea, it may be difficult to identify and treat the same percentage of the infected population as in that country. Estimating that suggests perhaps $500 million in revenue in 2020 from Taiwan.

So these two countries together might comprise a $1.1 B market in a few years. Can GILD dominate that market to achieve close to $1 B in sales under these assumptions? With the leading group of HCV products, I don't know why not - but as always, no guarantees exist. But I'll pencil in $1 B from these two countries in 2020, again understanding these are guesses and distribution profits (GILD vs. a local marketing company) are unknown to me.

The rich ROW

One can add up all the rich ROW countries and get to about 100 million in population: Canada, Australia, New Zealand, Israel, Persian gulf monarchies, Singapore, Hong Kong (if a distinct market from China), a few other localities such as Bermuda, etc. Most of these countries have low prevalence of HCV, such as 1% in Australia and 0.7% in Canada. The total patient population may be 800,000. Since these are rich and well-doctored countries, I'm penciling in 60,000 cases treated annually with GILD drugs. If pricing averages $25,000 per case, that would imply $1.5 B in HCV product sales from these countries in 2020. (My guess is that these areas are basically where the ROW revenues in Q1 came from.)

The not-so-rich ROW

There are a number of countries with per capita GDP in the $10,000+ range, such as Malaysia, Thailand and Mexico, that GILD left out of the generic agreement. Brazil is the most populous such country aside from China, which is discussed in its own section. It's extraordinarily difficult to guess at the commercial potential to GILD of this market. As an example, an important 2015 article, Disease burden of chronic hepatitis C in Brazil, lays out the health and economic needs to treat HCV in Brazil, which has an estimated 2 million cases of HCV. Brazil has the ability to treat many cases per year. If it treats 100,000 patients per year with SOF/VEL (when on the market there) at $7500 per patient, as the article suggests could be a good national strategy (though it does not get into the cost of the medication), Brazil alone could represent $0.75 B in annual revenues, say in 2020.

However, this is an unknown group of opportunities. Putting them all together, I'm going low on this group, estimating all of it together as only a $0.5 B annual opportunity for GILD. So, before getting to the great unknown of China, here's the tally of possible GILD HCV sales in 2020:

        US, Europe and Japan: $8.3 B
        South Korea and Taiwan: $1 B
        Rich ROW: $1.5 B
        Poor ROW: $0.5 B.

Cumulative total: $11.3 B.

Now to the Big One, China.

The Chinese HCV market: riddle, mystery, enigma

No one knows how large China's HCV problem is. GILD estimates 10-20 million infected people, but some estimates are much higher, such as over 40 million (I really doubt that.) I think it's best to use the low end of GILD's estimate, or 1% or so of the population, say 13 million cases.

Now, if we take similar reasoning to that of the Brazilian doctors above and China tries to cure 5% of its infected population of, say, 13 million, annually, then we're looking at 650,000 treated cases annually. If GILD gets 70% of them, that's 500,000 cases.

The next question, at what price. Dr. Milligan, GILD's CEO and President, addressed that briefly in the Q1 conference call, saying (bolded emphasis added):

    So, Brian, I'll start with the China question. So in terms of timing for China, there is a fairly fixed process. And according to the recent processes, we could possibly have sofosbuvir on the market in 2017. As you may have seen, there are new - the Chinese government is working hard to try to accelerate review and approval of HCV drugs because currently none are on the market of the direct-acting antivirals, and that could help us accelerate the timelines into China, and we are working on that. Particularly of interest to us would be accelerating the timeline for sof/velpatasvir because there are so many different genotypes in China. Genotyping is not common in China, and this could provide a very good option for the people of China. So there's hope, but we can't guarantee of course that we can accelerate that approval beyond its current timeline, which is 2019.

    The Chinese market is fairly large. Between 10 million and 20 million people are thought to have HCV. I don't want to get into public discussions of pricing, but I do think there's a price/volume relationship that would work for us and for the Chinese health system that could be very, very good for us both.

I like the "very, very good" phraseology. That language in conjunction with the term "price/volume" tells me that the parties are well into the deal-making phase. If GILD does right by the Middle Kingdom, it can do right by GILD.

So, what's the price per treatment that would go with a dominant market share, such as 70% (or more) and that would be very, very good for GILD?

My guess is there's a price level below which GILD will not go. It has the best products, and if it devalues them too much, it's like Apple (NASDAQ:AAPL) or Mercedes knocking its price point way, way down. So I doubt that any price per treatment below $6000 would be "very, very good" for GILD.

There may be a nice deal that the parties could work out, though, that partly finesses the issue of price per treatment. Might there be a co-promotion deal where GILD gets to do some marketing in the big urban areas, but the Party's favored company or companies get(s) the rest of the marketing business? And maybe GILD commits to manufacturing Harvoni and SOF/VEL in China, both to fill all China's needs and for export within GILD's growing Asian market. One can let one's imagination run a bit on this topic.

The more complex and comprehensive the deal, the more both sides can claim victory - maybe rightly so.

So I'm going to pencil in $3 B in China sales, equalling 500,000 X $6000 for 2020.

There may be significant upside potential and downside risk here.

That brings this whole speculative exercise to $14.3 B global sales for GILD's HCV meds in or around 2020, compared to Gabelli's $6.7 B. Obviously this is a guess, and an undetermined part of my guesstimate includes gross sales some of which will go to a local marketer where GILD has no presence.

A final thought on my number is that I'm trying to be objective, leaving upside possibilities that could be substantial. There could be less price deflation than assumed, and China's sales could be greater, perhaps substantially so, than thought. GILD's market share could erode more quickly and to a greater extent than I model.

If JNJ does not bring its HCV first-line product to market, that could be a material positive.

So, overall, I'm comfortable with GILD. Maybe I'm dreaming, but there may be a lot of excess worry in Gabelli's and the Street's consensus for HCV sales that is unwarranted. That thought, based on the above analysis, gives me a comfort level that GILD's HCV-related sales are probably not going to surprise the Street to the downside in 2020.

At the very least, it should be interesting to see what actually happens.

Concluding points - GILD (again) as excellent relative value

One of the positives that may be under-appreciated is SOF/VEL. This pan-genotypic combination for HCV can cure almost all infected patients with one pill daily for 12 weeks. It will be especially useful for genotypes 2 and 3, where Harvoni is not adequately effective. As soon as SOF/VEL comes to market, GILD will be able to bundle its sales with Harvoni. Also, SOF/VEL could replace Harvoni, which I think was the company's original plan. However, Harvoni proved so safe and effective that the idea evolved to leave it as the lead drug for genotype 1 in richer countries where genotyping of all HCV cases is routinely performed.

I, therefore, think that SOF/VEL can be important not only in China and other regions where genotyping is not widely done, but perhaps in wealthier regions. (This assumes its label is strong.)

Internationally, SOF/VEL is an important differentiator. Then, down the road, is the triplet that's in Phase 3, but GILD is not looking at the triple combo as first-line therapy in general. But, success with it would give GILD a truly comprehensive product line. What GILD has done in HCV (and HIV/AIDS) is an example of continuous process (product) improvement.

Much of my thinking underlying the above estimates is that as an infectious disease, HCV is a major public health issue. In a perfect world, eradication should be the goal, and I think that in a growing number of countries, there will be public health imperatives to move toward that goal.

The question of pricing is real. For now, the system is working much better than GILD's critics were saying two years ago. The company has spent about $15 B in development of its HCV line, according the jury that found for MRK in the sofosbuvir trial, in buying Pharmasset, then getting Sovaldi/Harvoni out the door. Given all the risks, in a capitalist system, GILD deserves a high ROIC. Meanwhile, free competition has given the public lower prices as less needy patients get treated; and the trend toward lower prices is baked in the cake unless general inflation gets hot again. Lower prices will enable national systems to move toward HCV eradication; a win-win for the public and the pharma companies.

Meanwhile, what ABBV has done with its flagship product Humira can perhaps provide a guide for what GILD may do with its HCV line. Humira keeps pushing into international markets. My analysis suggests that GILD can surprise the Street over time by expanding steadily, even relentlessly, into market after market. The need is certainly there, and we will just have to see about ability and willingness of different countries to pay GILD's bottom line price.

Beyond HCV, there may be good news brewing about the roll-out of TAF-based products for HIV/AIDS. GILD and the analysts are in sync that the Genvoya launch (Stribild but with TAF as the tenofovir component) has gone extremely well. That's just what I had expected and now expect that this presages strong results for the entire TAF-based line. Unfortunately, HIV disease remains not fully diagnosed, and where it is diagnosed, too many infected people do not begin treatment early, even though they would benefit from doing so. Perhaps the greater safety parameters that TAF brings to the table will help alter that fact more towards earlier treatment, to the advantage of patients and to GILD as well.

Finally, the company is presenting a more coherent R&D picture. I've been catching up on some background articles on some of GILD's prominent pipeline products and look forward to a future article on what I've learned.

The best argument I see for GILD is not that it is dirt cheap, but that in comparison to almost all other financial assets (and I watch and think about many), it's a classical investment at a time when some metrics of P/Es and interest rates are at record low combined yields. There's risk in GILD stock, for sure. Over time, though, its earnings may rise again after digesting their immense rise beginning in 2014. As has happened throughout the last 50 years with so many of today's Big Pharma companies or their predecessors, GILD may have long-term growth potential from here. In any case, the very low relative P/E affords patient investors a number of ways for the stock to hold up even if the future is less bright than hoped.

Thus I remain overweight GILD within an underweighted allocation to equities, and look to accumulate it either on dips or more good news that the Street again ignores.

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