Competition Rising for Baxalta

Advate (and older, smaller product Recombinate) represent approximately 40% of Baxalta's revenue, and competition is rising. Advate's prophylaxis label and conversion of patients previously on plasma-derived products have allowed it to achieve strong growth. However, Biogen BIIB launched long-acting product Eloctate in the United States in 2014, which can support a three- to five-day dosing schedule (Advate can be given every three days), Novo Nordisk NVO is launching a me-too Advate in 2015, and Bayer BAYRY and Novo could both launch long-acting products in the next few years.

We think Advate's strong safety profile and Baxalta's pipeline investments will help shield the firm from competitive threats in the near term, but long-term threats look more challenging. Baxalta should gain approval for twice-weekly Factor VIII protein BAX 855 in late 2015, but more convenient (perhaps once-monthly) treatments from Roche RHHBY and Alnylam ALNY could reach the market as early as 2018, as both are rapidly moving to late-stage development. We think this is a significant step up in convenience and the probability of approval for these competitors remains higher than the probability that Baxalta's earlier-stage gene therapy treatments will successfully reach the market.

In immunology, Baxalta's prospects look brighter, with expanding plasma fractionation capacity and differentiated products. HyQvia, a long-acting version of immunoglobulin product Gammagard, is launching in the U.S. and Europe. HyQvia's improved convenience should translate into market share gains and better pricing power. In addition, the firm is making significant investments in novel immunology and oncology pipeline candidates, which we expect will partly counter the pressure from hemophilia competition.

Moat Based on Cost Advantages Baxalta's ability to continue to add new recombinant proteins to its hemophilia portfolio supports its intangible assets, and its position as one of the three truly global plasma players has afforded it significant cost advantages. While Baxalta's diversification and barriers to entry in hemophilia have declined, we still think the firm warrants a narrow moat rating, but we think plasma-related cost advantages now provide the foundation for this support.

Baxalta's key products include Advate, its blockbuster recombinant Factor VIII protein therapy for hemophilia A, and plasma-derived immunoglobulin therapy Gammagard for immune disorders. Advate is the leading product in the U.S. and is commonly used for prophylaxis of bleeding episodes in both children and adults. We think the small but significant improvements Baxalta has made to its product offerings--like higher-dose vials of Advate that allow for every-three-days dosing--confer significant convenience and safety advantages that will help it maintain market share in the near term. Cost advantages and intangible assets like pricing power and a strong research and development strategy are apparent in the immunoglobulin market. Global plasma supply and fractionation capacity are limited, and a stable oligopoly exists among Baxalta, Spain-based Grifols GRFS, and Australia-based CSL. Baxalta continues to invest in its plasma collection centers and its sizable manufacturing capabilities, making it a low-cost provider of plasma-derived therapies. We see large barriers to entry in the plasma protein business, given the capital-intensive nature of plasma fractionation, long lead time (five to seven years) until any new capacity could be approved, and the sizable experience of current players, which contributes to strong plasma yields and solid reputations. In addition, Baxalta's plasma-derived Gammagard sells at a price premium to products from CSL and Grifols, a tribute to the strength of the brand.

Competition and Capacity Constraints Are Risks New competition for Advate from the likes of Biogen and Novo Nordisk over the next few years could begin to erode Baxalta's dominant position in the U.S. market for hemophilia A products if its gene therapy pipeline fails and BAX 855 does not gain significant market share. In addition, Baxter's plasma fractionation capacity is currently constrained, keeping its antibody therapy (Gammagard) growth rates from exceeding market rates. Competitors like CSL and Grifols have stolen market share over the past couple of years, and Baxalta could have difficulty regaining lost share. While we think Baxalta's spin-off will boost long-term growth, dis-synergies from the split could wind up outweighing the benefit.

Hematology Will Weigh on Growth We assign a $34 fair value estimate to Baxalta. Overall, we think a return to strong Gammagard/HyQvia supply and the launch of new pipeline products will help counter Advate pressures over the next few years. We assume 7% top-line and 5.5% bottom-line growth for 2015-19, as competition should weigh on margins and Baxalta will depend on new opportunities in oncology and immunology to begin to change this dynamic. Overall, we assume average annual hematology growth (hemophilia, inhibitors, and sickle cell anemia) of 4% through 2019 and 0% for 2019-24. We assume Baxalta's share of the hemophilia A market drops from 46% in 2014 to 28% by 2024. We assume relatively steady growth for immunology (non-hemophilia plasma-derived products including immunoglobulin, as well as new biosimilar products and pipeline products from SuppreMol) at 10% going forward. We assume that oncology revenue could surpass $1 billion by 2024.

We use a below-average systematic risk rating and a 7.5% cost of equity for Baxalta, as revenue growth prospects remain relatively independent of economic weakness. We have assumed that separation costs fall slightly more heavily on Baxalta, where we model dis-synergies at 2.5% of sales for the second half of 2015, but falling significantly (to 1% of sales) by 2019. We use a 5% Stage II EBI growth rate, before heading to perpetuity growth in year 16.