2023-09-05 23:24:03 ET
Summary
- Q2 2023 earnings showcasted robust performance and raised forecast for 2023 non-GAAP adjusted cash receipts.
- Royalty Pharma enters strategic partnership with Ferring Pharmaceuticals, investing $300 million upfront for royalties on bladder cancer drug.
- Debate over VX-121 royalties is overstated, with limited impact on Royalty Pharma's valuation.
- We maintain a buy rating on Royalty Pharma.
Positive Q2 2023 Earnings and Ferring's deal
Q2 2023 earnings call: Royalty Pharma plc (RPRX) reported robust earnings, painting an optimistic picture for investors. The company's non-GAAP adjusted cash receipts tallied at $545 million and importantly, an impressive EBITDA margin of 91.4% was shown similar to previous quarters. Significantly, a surge in interest income resulted in a 6% adjusted cash flow outperformance. On a positive note, Royalty Pharma raised its 2023 non-GAAP adjusted cash receipts forecast (exclusive of new investments) to a range of $2.90-2.975 billion. In our view, the results were generally positive and underscore the company's sound operational performance.
Breaking the silence with the Ferring's deal
In late August, Royalty Pharma entered into a strategic partnership with Switzerland's Ferring Pharmaceuticals, which was a major deal since the early 2023 Puretech deal. This comes shortly after Ferring secured FDA approval for two groundbreaking treatments.
Under the terms of the agreement, Royalty Pharma will invest $300 million upfront, with a potential $200 million in milestone payments, contingent on Ferring's achievement of specified manufacturing objectives by 2025. In return, Royalty Pharma will garner royalties, starting at 5.1% of the U.S. net sales of Ferring's bladder cancer drug, Adstiladrin, which will rise to 8% upon milestone payment, lasting until the early-to-mid 2030s.
The allure of the deal is rooted in the background and potential of Adstiladrin. The drug is a pioneering gene therapy for high-risk patients with Bacillus Calmette-Guerin (BCG)-unresponsive non-muscle invasive bladder cancer (NMIBC) and has showcased promising results in clinical trials. The Gene therapy presents an innovative solution, reducing the need for surgical bladder removal, a prevalent approach for such patients.
Interestingly, this will be the first gene therapy in Royalty Pharma's portfolio and the second gene therapy royalty deal after another US-based royalty-focused private equity, Healthcare Royalty Partners's Hemgenix/uniQure (QURE) deal that closed recently.
In our view, for Royalty Pharma, this venture not only enhances its diversified royalty portfolio but is also anticipated to positively impact its stock price. The reason is the strategic alignment with a cutting-edge treatment for a widespread health issue like bladder cancer, representing 75% of all new bladder cancer cases in the U.S., demonstrates Royalty Pharma's forward-thinking approach and commitment to addressing areas of high unmet patient needs. In the synergy front, this union ensures the financial bolstering Ferring's needs for commercialization, further clinical development, and expanding manufacturing capabilities of Adstiladrin, while Royalty Pharma positions itself to reap the benefits of the drug's anticipated success in the market.
The VX-121 Debate seems overblown
The investor debate surrounding VX-121 royalty implications has been mentioned in seeking alpha as a key overhang . Royalty Pharma obtains royalties from Vertex's Trikafta, which includes elexacaftor, ivacaftor, and tezacaftor. Vertex's VX-121, a novel triple-therapy, introduces the inclusion of vanzacaftor, which doesn't qualify Royalty Pharma for royalties, and a deuterated ivacaftor, which is currently under litigation. However, the VX-121 royalty debate's financial ramifications have been largely overstated. Even in a pessimistic scenario where Vertex triumphs in litigation, the negative effect on NPV per share should be limited to <5%, considering the portfolio diversification and the sheer massive size of the portfolio of Royalty Pharma (market cap of ~$18Bn). Therefore, while the debate is significant, it is not the paramount driver of valuation discrepancies. Furthermore, after the stock sold off 30% during the last 12 months, we believe there is a limited downside from here.
What's Hindering Stock Performance, and Why We Think thing Will Change
We believe Royalty Pharma's underperformance compared to the broader sector (i.e., healthcare sector ETF ( XLE ) or biotech ETF (XBI)) isn't necessarily a reflection of operational inefficiencies. A combination of an absence of earnings surprises, sporadic catalysts (deal announcement has recently slowed down), and a lack of takeover premiums places the stock at an inherent disadvantage versus traditional biotech or specialized pharma companies. According to Fintel , around 50-60% of the longstanding pre-IPO investors have exited the stock; this may have led to the recent sell-off.
However, in our view, the stock's pivotal inflection point is anticipated in the near future with more accretive deals coming considering the macro backdrop and continued appetite for capital across the biotech sector, potentially providing a more substantial push to support the stock price. Furthermore, share repurchase programs should help support the stock price moving forward as well.
Risks
Investing in Royalty Pharma is not without its set of risks.
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Dependence on Underlying Assets: Royalty Pharma's earnings primarily come from royalties of the drugs in its portfolio. If any of these drugs face issues like recalls, side effects, loss of patent protection, or competition from newer drugs, it can significantly impact the company's revenue. Additionally, if the underlying companies developing these drugs run into financial or operational challenges, Royalty Pharma's income stream might be jeopardized.
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Regulatory and Litigation Risks: Since Royalty Pharma's revenues are tied to the pharmaceutical industry, any changes in regulatory policies (like drug pricing, approval processes, etc.) can have direct consequences on its financials. Moreover, there might be legal challenges or disputes over patent rights, royalties, or other contractual obligations, which can be time-consuming and expensive.
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Lack of Diversification: While Royalty Pharma's portfolio is diversified across multiple drugs and treatments, the company is still largely confined to the healthcare and pharmaceutical sector. This focus makes it vulnerable to sector-specific downturns, policy changes, or innovations that might disrupt the industry.
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Capital Allocation and Deal-making Risks: Royalty Pharma's growth is partly dependent on its ability to identify, negotiate, and secure new royalty deals. A wrong bet on a drug that fails in clinical trials, doesn't get regulatory approval, or doesn't achieve anticipated market success can result in substantial financial losses. Additionally, there's always a risk that Royalty Pharma might overpay for a deal, especially in a competitive environment.
Additionally, there's the challenge of attracting specialty healthcare investors who may perceive Royalty Pharma more as an asset manager than a direct biotech play. Other concerns include potential royalty disagreements, such as the aforementioned VX-121 debate, and potential industry shifts or policy changes that might influence future earnings.
Conclusion: maintaining buy rating
Despite the aforementioned challenges, we believe the buy rating on Royalty Pharma remains well-founded. The company's ability to consistently report strong financials, as demonstrated in Q2 2023, underscores its inherent fundamental value and the non-correlated nature of the royalty strategy, which has proven itself as an established asset class. While debates like VX-121 introduce a layer of uncertainty and their financial implications (of implication to its stock price), even in the most pessimistic scenarios, we expect the impact to remain limited, and the recent negative price action seems to be overblown. We expect a positive re-rating of the stock in the short term with continued accretive deals that the company makes. The company continues to build value via its capital allocation and equity appreciation, and even with challenges ahead, its inherent value remains underappreciated.
For further details see:
Royalty Pharma: We Continue To Like The Strategy And Sell-Off Is Overdone