LLY - Hutchmed: We Explore Pharma In China

Summary

• With pharma sector lacking in our portfolio, we are looking to add some if we find a good risk/reward situation.
• HUTCHMED (China) being a part of CK Hutchison Holdings, a huge conglomerate, is developing well.
• By 2035, it is estimated that 25% of the global population will be directly affected by cancers. Any solution to this problem is welcome.

Investment thesis

It is our belief that one of the most important things an investor can do is to start by deciding on what he/she put in their portfolio. A well-diversified portfolio may not get you super rich very fast, but it should protect you from going broke if done well.

Healthcare and pharma are areas presently lacking in our portfolio after we exited GSK (GSK) some time ago.

In our investigative journey, we came across a small biopharmaceutical company called HUTCHMED China (HCM), which is 38.5% owned by the large conglomerate CK Hutchison Holdings (CKHUY), a company that is covered here in SA by us.

Let us take you on our journey of learning about this company, to see if we think that it is worth an allocation from us.

Introduction to HUTCHMED (China)

HUTCHMED is a small but global biopharmaceutical company developing high-quality, novel oncology and immunology drug candidates for patients across the world. Their market capitalization is $3 billion.

They discover, develop, manufacture and market targeted therapies and immunotherapies for the treatment of cancer and immunological diseases.

The company has about 960 scientists plus about 820 staff working on the commercial side of their business.

As of 31st of December 2021, they had advanced 13 oncology drug candidates into clinical trials in China, with seven also in clinical development in the U.S. and Europe.

It has listings in London, Hong Kong, and on the Nasdaq.

In December 2020, the Holding Foreign Companies Accountable Act was signed into law. It provides that if the U.S. Securities and Exchange Commission determines that a U.S.-listed company has filed audit reports issued by a registered public accounting firm that has not been subject to inspection by the Public Company Accounting Oversight Board for 3 consecutive years beginning in 2021, SEC shall prohibit such company's shares or ADSs from being traded in the U.S.

HUTCHMED is one of the companies on this list. Under the current terms of the Act, the Company's ADSs will be delisted from the Nasdaq Stock Market in early 2024.

The Company's ADSs each represent 5 ordinary shares.

Should it delist on the Nasdaq, investors can continue to trade HUTCHMED's shares in London or Hong Kong.

Show me the money

The latest result we have at this moment is the 2022 interim report which was published in August of last year. The revenue from the 1st half of 2022 was up 28% to $202 million.

As can be expected of these biopharma companies, which are in a ramp-up mode, they do not make money. It costs a lot of money to develop new medicine.

Let us look at their balance sheet.

Cash on hand as of 30th June 2022 was $467.5 million. That was down $120 million from a year ago. They also have $358.7 million in short-term investments.

The good thing is that there is no debt to banks, or issued in the form of bonds. However, they have as accruals and advance receipts $233.6 million. The accruals are mainly costs related to R&D, salaries, marketing, and administration.

We do have some concerns that they will have to issue a lot of new shares to fund this ramp-up period.

HUTCHMED is authorized to issue 1.5 billion shares. Up to 30th June 2022, they had a total of 894.3 million shares outstanding. That is an increase of 120.1 million shares from the same period last year. This kind of dilution is quite substantial.

FY 2022 financial results will come out on 28th February 2023, so we will then get an update on how things are going for HUTCHMED.

Product developments and sales

From HUTCHMED 2022 Interim Report we learn something about the products being marketed and those that are in the pipeline.

• Savolitinib (ORPATHYS® in China)

In late June 2021, ORPATHYS® became the first-in-class selective MET inhibitor to be approved in China. They partnered with AstraZeneca (AZN) and launched ORPATHYS® in mid-July 2021. More than 1/3 rd of the world's lung cancer patients are in China and among those with NSCLC, approximately 2-3% have tumors with MET exon 14 skipping alterations. According to HUTCHMED, this represents about 13,000 new patients per year in China. MET also plays a role in multiple other solid tumors, with an estimated total incidence of 120,000 new patients per year in China.

AZN introduced a patient access program in 2021 that subsidizes the use of this drug through progressive disease. As a result, sales grew significantly in the first half of 2022 delivering revenue from sales of $23.3 million and $13.8 million in revenues from manufacturing fees and royalties in the first half of 2022.

Savolitinib is an oral inhibitor of MET. In global partnership with AZN, this drug has been studied in NSCLC, PRCC47, and gastric cancer clinical trials with over 1,500 patients to date, both as a monotherapy and in combination.

In February 2022, a $15 million milestone payment from AZN was triggered by the initiation of start-up activities for the SAFFRON study. In total, AZN has paid HUTCHMED $85 million of the total $140 million in upfront payments, development, and approvals milestones that are potentially available.

• Fruquintinib (ELUNATE® in China)

This drug is approved for the treatment of third-line metastatic CRC for which there is an approximate incidence of 83,000 new patients per year in China. They estimate that in FH of 2022, approximately 14,000 new patients were treated with it in China resulting in in-market sales of $50.4 million, up 26% versus the year before.

Under the terms of our agreement with Eli Lilly & Co. (LLY), HUTCHMED manages all on-the-ground medical detailing, promotion, and local and regional marketing activities for ELUNATE® in China. They consolidate as revenues approximately 70-80% of ELUNATE® in-market sales from manufacturing fees, service fees, and royalties paid LLY. In the first half of 2022, they consolidated $36.0 million in revenue for ELUNATE®, equal to 71.4% of in-market sales.

Following negotiations with the China NHSA44, ELUNATE® continues to be included in China's National Reimbursement Drug List for a new two-year term starting in January 2022. To get this renewal, HUTCHMED agreed to give a discount of 5% relative to the 2021 NRDL price.

In January 2022, ELUNATE® was approved in the Macau Special Administrative Region. This was their first drug to be approved in Macau.

Fruquintinib is marketed as Elunate by HUTCHMED with LLY as a treatment for certain patients with metastatic CRC. The drug is not approved for use outside of China.

Fruquintinib was approved in China in 2018.

HUTCHMED has started a rolling submission of a new drug application ((NDA)) for Fruquintinib with the U.S. FDA, which is expected to be completed in H1 2023. A filing is also planned in the EU and Japan.

• Surufatinib (SULANDA® in China)

It was launched in China in 2021 for the treatment of all advanced NETs45 for which there is an approximate incidence of 34,000 new patients per year in China.

In 2021, it was sold as a self-pay drug. HUTCHMED used means-tested early access and patient access programs to help patients afford the drug. Despite these access programs, the duration of treatment was often affected by the economic constraints of patients.

Following negotiations with the China NHSA, Sulanda was included in the NRDL starting in January 2022 at a 52% discount. As a result of inclusion in the NRDL and its continued marketing activities, patient access to the drug, as well as the duration of treatment, have been expanding with total sales in the first half of 2022 increasing by 69% to $13.6 million.

Business prospects

On 23rd January this year, we learned that HUTCHMED has signed a licensing agreement with Takeda (TAK) of Japan to develop and commercialize the oral cancer drug Fruquintinib outside of mainland China, Hong Kong, and Macau.

Under the agreement, Takeda will pay HUTCHMED $400 million upfront and up to $730 million in additional potential payments in regulatory, development, and commercial milestones, plus royalties on net sales. Takeda will get an exclusive worldwide license to develop and commercialize Fruquintinib in all indications and territories outside of mainland China, Hong Kong, and Macau.

That is good news.

It is estimated that by 2035, as much as 25% of the global population will be directly affected by cancers. There are five main therapeutic modalities for cancer: surgery, radiation, chemotherapy, targeted therapy, and immunotherapy.

Immunotherapy represents conceptually a unique way of dealing with cancer which is to focus on eliminating cancer indirectly by harnessing the power of the host's immune system.

We are not experts in this field. The only thing we understand is that any effort to treat cancer and, hopefully, one day get on top of it, must be taken seriously.

Risks to the thesis

One of the risks with any pharmaceutical company is the costs of developing the products and the duration it takes from development to being granted approval for sale.

One of the obstacles HUTCHMED has faced in getting access to the U.S. market for their product Surufatinib is that the U.S. FDA in a letter to HUTCHMED received in April 2022, after the NDA15 filing was accepted in June 2021, following Fast Track and Orphan Drug designations in 2020 and 2019, respectively The letter indicates that they want to see a multi-regional clinical trial that includes subjects more representative of the U.S. population and aligned with current U.S. medical practice.

We do not know if this is valid or is motivated by political "tick for tack" tactics. Hopefully, it is not as it seems the importance of collaborating across borders on very important health issues should trump any differences they may have.

Our thoughts are that the market in China with its 1.4 billion population should be big enough to make money for HUTCHMED if the products they want to sell are effective.

We do not see any risks from HUTCHMED delisting from the Nasdaq. This is the same for all Chinese companies, as the liquidity in Hong Kong and London is sufficient. For HUTCHMED, it is not a problem to raise more capital as long as their business model and their products have good potential for commercialization.

The share price

If we look at the share price over one year, it is down 26%

But if you had the fortune to buy HCM when the Hong Kong Stock market was at the recent bottom in November last year, you would have doubled your money by now.

Where it goes from here is anybody's guess. We do not have a crystal ball and will not try to put a price target on it.

Conclusion

Why are the smart people in CK Hutchison Holdings putting money and effort into this company?

Their founder, Li Ka Shing, is not only a shrewd and intelligent businessman but also a philanthropist that puts a lot of money back into society. Research and development on cancer are one of them.

Nevertheless, we do not think that HUTCHMED is a charity.

It could become much bigger than what it is today.

The problem is what is the probability of that happening? That is what we as investors need to consider.

We try to listen to wise investors and learn from what they have said and done in the past. Warren Buffett stated that he as an investor only invested in something that he fully understood. That was his thinking in the past. We are not so sure he knows a lot about the technology behind Apple Inc. (AAPL), so over the years, he has evolved as an investor and is certainly open to new ideas from his team.

To conclude, we feel that we need to learn more about this business and gain a better grasp of the probabilities of HUTCHMED's potential success before we buy shares in it.

As such it is a Hold stance for now.

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