As the maker of Sovaldi, Gilead’s
2Q14 net income grew an explosive earnings 376% yoy. Yet it is trading at 10x
2015E earnings, what’s the catch?
I see bloggers and even
professional analysts projecting earnings for Gilead then apply a single multiple
to the entire company’s earning. This approach has two problems. First, as
Sovaldi now constitute over 50% of product sales, it’s better to value it
separately. Second, it ignores Sovaldi’s unique ability to cure patients and
decrease its own target market size. In other word, Sovaldi is a melting ice
cube, thus has to be valued with a different multiple.
The approach
Ideally I would project out Sovaldi
earnings versus other parts of Gilead; value them separately, then add up the 2
parts. Before committing the time however, I’d like a shorter plausibility
check. Here I will do the reverse. First, value GILD ex-Sovaldi; second, back
out Sovaldi’s implicit market valuation; third, check this again the Hepatitis-C
market size to see if that valuation is reasonable. This approach saves me from
having to forecast whether revenue and earnings should be up 400% vs 300% (or
200% for that matter).
1) Ex-Sovaldi valuation & implied Sovaldi price per share
Gilead’s management is kind
enough to give us assumptions for 2014E excluding Sovaldi, so projecting the ex-Solvadi
income statement is relatively easy.
Management’s assumptions are below including
and excluding Sovaldi:
With ex-Sovaldi EPS going from
~$2 to $2.7 per share the next 2 years, apply a 20-18x multiple would get
roughly $40-55 per share for the non-Sovaldi business.
2) Implied Sovaldi valuation and years to break even (at current cure rate)
With GILD
trading ~$91 per share, this would imply the market is valuing Sovaldi at $35-50.
Sovaldi is expected to contribute $5.9 per share of gross profit for 2014 ($10bn
2014E sales and ~95% gross margin), so the current price requires 5-9 years of 2014E
like gross profits.
Is the Hep C market big enough to
last 5-9 years before Sovaldi and its competitors cure everyone? Keep in mind the
analysis so far eases the hurdle for Sovaldi: 1) the payback period is probably
longer because we assumed Sovaldi gross margin falls right to the bottom line. In
reality some cost is incurred by Sovaldi. 2) the EPS numbers shown above
assumes $8bn of share buyback per year, this boosts the ex-Sovaldi valuation
and lowers the Sovaldi break even.
3) HepC market size
A simple market size
analysis below shows that at a current annual cure rate of 139k patients, the
market can support 6-11 years at the current pace of Sovaldi monetization. The
management case assumptions below mostly came from p31-33 of 2Q14 presentation slides.
I got the annual cure rate of 139k patient as follows: for the first 2 quarter of 2014, total Sovaldi
patients and revenue were 80k and $5.75bn, respectively. So $10bn of expected 2014E
revenue scales to about 139k patients.
At the
surface, this should easily be able to accommodate the 5-9 years of sustainability
implied by the stock price. Keep in mind though, this is assuming the following:
i.
No
price cuts. Regulators and PBMs have been making some noises here. However, their
sabre rattling is based on some really high patient assumptions. CVS for
example, cited 3mm
of eligible patients versus my forecast of 390 -800k U.S. patients under care
above. If we ever get to 3mm patients getting treated then clearly there needs
to be a steep cut in Sovaldi prices. But then again, if that’s what regulators
and PBMs are using to justify the price cuts then we’re not anywhere near that.
ii.
GILD
takes 100 %mkt share. In reality Merck and Abbvie are both about to come out
with their own HepC products. Merck is more of a threat to take market share
but ABBV can cut prices in its desperation to drives sales and recoup its
investments.
iii.
Same
pricing and margin outside of US. This
is unrealistic as gross margins will likely be lower in Europe due to some of
the single payer systems there. GILD is getting about $60,000
in Europe for a course of therapy with Sovaldi.
iv.
Same
volume & pricing mix across all genotypes. There could be some shift here and
I may need to break it down further. For
example which genotype is more profitable?
And do those get treated earlier or later
v.
No
discount for time value of money. This is less material
With
the above negative factors (and gun to my head), I’d guess the HepC market supports 7-8
yrs of current monetization. So GILD’s stock price at least passed the plausibility
check. The market is pretty efficient after all.
So now
what - do I suck it up and do that long form detailed model? Just because
something is plausible doesn’t mean it’s worthwhile. What’s the upside?
Counter-argument & other factors
·
Maybe
ex Sovaldi GILD is worth more. Stribild is a blockbuster in its own right and
has been growing >100%. 20x multiple
may actually be too low for the non-Sovaldi business.
· Market size could turn out much larger. Diagnosed rate and treatment rate assumptions can make huge differences. I already adjusted management assumptions upward in my base case. What does a realistic upside case look like?
· Market size could turn out much larger. Diagnosed rate and treatment rate assumptions can make huge differences. I already adjusted management assumptions upward in my base case. What does a realistic upside case look like?
·
Other
countries outside of US/EU5/JP. Other parts of Europe, China, India and others won't be very profitable but they are
still worth something.
·
Sovaldi
revenue will likely ramp up from its current 2014E levels. This is irrelevant
because faster cure rate just shifts revenue forward. Remember the HepC market
size is finite no matter how fast your ramp up. In real life faster sales gets
you some benefit because a back ended revenue is exposed to competition and
price cuts. On the other hand, faster cure rate also lowers the market size
because now you have fewer patients to infect others (taking away that already
low new patient growth rate of 1-3%).
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