JMP initiates with $130 tgt. DNA $80 bill valuation potential...summary
JMP "Initiate CELG Outperform/$130 tgt. Potential to exceed DNA's $80 bill mkt cap (owns rights WW, DNA only in US. CELG Margins better). Tirumvirate of growth drivers (IMiDs/Abrax/Aprem). Pipeline firing all cylinders"
JMP Securities LLC
Biotechnology - Initiation of Coverage February 8, 2013
Celgene Corporation (1) - MARKET OUTPERFORM
Initiating Coverage at Market Outperform, $130 target; CELG Moves from Strength to Strength
o Initiating coverage with a Market Outperform rating and a $130 price target on Celgene Corporation (CELG) based on the synthesis of a DCF analysis (~$134) and a P/E multiple-driven approach (~$118). CELG is one of the premier small-molecule companies in the mega-cap biotechnology space, having been propelled to a valuation of more than $40 billion on prospects for its IMiD franchise: Revlimid (lenalidomide) and Thalomid thalidomide). Recent clinical success with Abraxane (nab-paclitaxel), Pomalyst (pomalidomide), and apremilast have highlighted the company’s successful execution of its diversification strategy, which, in our view, has served to increase the investment appeal of the shares.
• Product portfolio hitting on all cylinders. During FY12, the company’s supporting cast of drugs, mainly Vidaza (azacitidine) and Abraxane, have produced sales in line with or ahead of Street expectations. Both drugs have been a pleasant surprise: Vidaza, because of the continued lack of a generic azacitidine competitor to this staple hypomethylating agent (HMA), and Abraxane, for its steady growth, additional label indication in NSCLC, and positive top-line data in both melanoma and pancreatic cancer. Pomalyst, the third member of the IMiD family, also produced positive data on PFS and OS endpoints from the MM-003 study examining use of the drug in heavily pre-treated patients with multiple myeloma.
• Apremilast adds an entirely new dimension to the CELG story (shh! It came through R&D!).
In our view, apremilast could represent an incremental blockbuster franchise opportunity in the Immunology & Inflammation (I&I) space, potentially adding more than $3 billion in revenue to the top line by FY20. While we have been bullish on the apremilast franchise, results from the PALACE (psoriatic arthritis) and ESTEEM (psoriasis) trials exceeded our expectations.
• We expect the triumvirate of growth drivers - IMiD franchise, Abraxane, and apremilast - to fuel 23% three-year EPS CAGR, driving shares to $130 and beyond. On a big picture basis, we continue to believe that CELG shares will work their way significantly higher over the course of the next several years. Based on our out-year revenue projections, we envision the valuation of the company in the $50-60 billion range by 2014; by 2015-2016, the shares could trade upwards of $80-90 billion, in our opinion.
INVESTMENT THESIS – MY YOU’RE AGING WELL
Investors in CELG shares in the period between 2009 and mid-2012 endured a pattern of ups and downs in the share price. The shares seemed to be hyper-sensitive to the downside when faced with the inevitable challenges experienced in the biopharmaceutical industry. A Euro-crisis, a disappointing quarter, a secondary primary malignancy, and rehashed concerns over the patent life of Revlimid - all succeeded in taking the wind out of what appeared to (finally!) be a sustained rally in CELG in late 2011-early 2012. However, this extracurricular drama masked the fact that between 1Q09 and 4Q11, CELG never had a single quarter in which revenues dropped sequentially. The stock’s action, therefore, had more to do with investor perception about the direction of Revlimid sales, rather than the actual sales themselves. Such is life as a (mainly) one-product company. Over the course of the past year, however, CELG has largely avoided the turbulence of old, experiencing a number of enviable victories that we believe can significantly change the nature of the underlying investment thesis.
Recent developments, in our view, have begun to alter the perception of the investment opportunity in CELG shares. Specifically, with events such as the “hat trick” for Abraxane (label expansion into NSCLC, as well as positive Phase III trial results in melanoma and pancreatic cancer), positive Phase III data from Pomalyst, and, perhaps most especially, the overwhelmingly positive data from the PALACE and ESTEEM trials of apremilast in psoriatic arthritis (PsA) and psoriasis, respectively, CELG is becoming a more balanced and higher-growth company with less volatility.
Despite the size of CELG, there are examples of mega-cap companies that have experienced a stepfunction upwards to higher growth on the back of new product development. Specifically, shares of Gilead Sciences (GILD, Not Covered (NC)), with products such as Stribild, Complera, and of course, the acquisition of Pharmasset rose almost 80% last year on the back of those new products and M&A. Likewise, Biogen (BIIB, NC) also experienced similar growth based on positive Phase III data from trials of the MS drug, BG-12. Reaching back into the vault, we also remind investors of the performance of Genentech shares following the first positive Phase III trials of Avastin in mCRC.
One only needs to look at the historical performance of these stocks to see what happened. The common theme amongst all these companies is that a new product development cycle helped to create a step-function upwards to higher growth and the shares inevitably followed. We believe the same is taking place now at CELG, such that the uncertain regulatory future of Revlimid for the treatment of newly diagnosed multiple myeloma (NDMM) has a blunted effect on the share price. We believe the matter of NDMM will be resolved; in our view, it is a matter of when (FY14 in our opinion), not if. In the meantime, investors can take comfort in the fact that CELG now has additional positive value generating catalysts outside of Revlimid, and can better manage its business on a longer-term basis based knowing that Abraxane, apremilast, and Pomalyst will be there to support the main asset.
In summary, a fundamental thesis we have been vocal about is that we believe CELG has the potential to meet or exceed the valuation achieved by Genentech prior to its acquisition by Roche (RHHBY, NC), which eclipsed $80 billion. While Genentech clearly had outstanding products like Herceptin, Rituxan, and Avastin, the company only controlled its fate in the U.S., whereas CELG controls the economics of its drugs on a worldwide basis. In addition, Genentech’s gross margins were more in the mid-80% range, whereas CELG has margins well into the mid-90s (and, amazingly, margins continue to increase). Genentech’s tax rate was in the low- to mid-30% range, whereas CELG has used sophisticated tax planning to lower its tax rate to the high-teens. Genentech had three multi-billion dollar franchises (Herceptin, Rituxan, Avastin), while today CELG only has one (Revlimid). By 2015, CELG should have two (Revlimid, Abraxane), by 2016, three (add apremilast) and by 2019, four (add Pomalyst). With the coming wave of additional indications for Revlimid (NHL, CLL) and Abraxane,success in the company’s pipeline with apremilast, and its R&D collaborations with Acceleron, Agios, Epizyme, Foundation Medicine, and others, we believe a significantly higher market cap is exceedingly likely. We believe the company has admirably met the fundamental concerns thrown at it by investors and its execution will allow the one-time scares to fade into the distance.
In closing, we reiterate that we believe CELG has the greatest opportunity amongst the mega-cap biotech companies to assume the mantle of leadership. Though the company has had a significant move from ~$80 to $100 thus far in 2013, we anticipate that there remains ample room for shares to appreciate. We believe the company has the commercial products, pipeline, financial resources, and perhaps most importantly, the management to accomplish this goal. The diversification of CELG from primarily a Revlimid-driven story to one with four individual products driving significant growth has created a stronger, more stable, and faster growing company and combined with deft execution on the operating side of the business should fuel near-term appreciation, in our view. We see the company continuing to drive efficiencies on expenses, drawing additional leverage out of its business model as we project revenues to almost double from $5.4bn in 2012 to $10.3bn in 2016. Longer-term, we believe
CELG can surpass $15bn in revenue in 2020. CELG’s strong top line, EPS, and cash flow growth should please even the most jaded investor. We establish our initial 12-month price target at $130.
In arriving at our 12-month price target, we assessed the value of CELG shares with two approaches: discounted cash flow (DCF; ~$135) and on a 2013 P/E multiple (~$118) basis relative to peers. Each approach drew upon our initial forecast of product revenues and expenses for CELG through 2020, allowing us to arrive at free cash flow and EPS estimates for each year over that same time period. We view DCF as a better gauge of a company’s intrinsic value and weigh it more heavily in assignment of our price target.
FIGURE 1: Rationalization of Price Target Based on Valuation Methodologies