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Biogen Remains Undervalued

Its MS market dominance and neurology pipeline support a wide moat.

Tecfidera Launch Ensures Multiyear Dominance Biogen's strategy has its roots in the 2003 merger of Biogen (MS drug Avonex) and Idec (cancer drug Rituxan). Rituxan's market penetration is already high, and patents in the United States, where Biogen derives its profit share from Roche, expire in 2018. However, we think a subcutaneous Rituxan as well as novel antibody Gazyva will allow for extended oncology revenue. Avonex generates $3 billion in annual sales and remains the leading MS interferon therapy. Biogen acquired full rights to MS antibody Tysabri (almost $2 billion in annual sales) from partner Elan. A diagnostic test can isolate patients with the lowest progressive multifocal leukoencephalopathy risk, which allows the 50% of patients who have not been exposed to the JC virus to benefit from Tysabri's strong efficacy profile with low PML risk. That said, older products like Avonex could see pricing power and demand erode now that a generic version of Teva's TEVA Copaxone has launched and novel high-efficacy drugs are reaching the market.

On the basis of a strong launch and solid safety and efficacy data, we expect oral MS drug Tecfidera to see peak sales of $5 billion in 2019. Four recent cases of PML and European pricing pressure have weighed on Tecfidera’s growth, but we think the drug’s pricing power and demand will remain strong in the U.S. until patent expiration, which we assume will be 2020. We also think Biogen could see significant royalties on novel high-efficacy drug ocrelizumab (estimated launch 2016) and multi-billion-dollar sales for its in-house remyelinating anti-LINGO drug (which missed phase 2 endpoints but could continue to phase 3).

Outside of MS, Biogen has strong human genetic validation for its neurology pipeline, creating potential to offset MS pressure. Spinal muscular atrophy drug nusinersen could reach $2 billion in peak sales and launch in 2017, and Alzheimer’s drug aducanumab had strong phase 1 data that could allow for multi-billion-dollar potential if approved (estimated 2020).

Strong R&D Maintains Leadership Biogen has achieved strong profitability on the success of three marketed products in the fields of oncology and neuroimmunology, and the introduction of Tecfidera secures its dominant share of the MS market. We think barriers to entry for potential biosimilars to Biogen's products are high, and the firm has a solid research and development strategy for maintaining its leadership in MS, where pricing power is strong, patient need for novel therapies is high, and the pipeline has been particularly productive. These factors contribute to the firm's wide moat. Returns on invested capital, which we think will average above 20% during our 10-year explicit forecast period, easily exceed our 7.5% estimate of Biogen's cost of capital.

Rituxan remains the standard of care in several forms of hematological cancer, and Biogen’s margins are boosted by collaboration revenue received from partner Roche. Biogen’s Avonex is the leading interferon therapy in MS, thanks to its long-term safety record and relatively convenient once-weekly injections. Biogen’s third drug, MS drug Tysabri, is achieving blockbuster sales based on outstanding efficacy despite rare but serious side effects, and we think efforts to target the drug to patients least likely to experience side effects will allow the firm to see continued sales despite novel products with cleaner safety profiles. We expect newly launched Tecfidera to achieve peak sales of $5 billion globally, based on its convenient oral administration and relatively strong efficacy and safety profile.

With the exception of Tecfidera, all of Biogen’s current blockbusters are biologics, and while biosimilar competition is a looming threat, we think any erosion of sales of these products would be slowed by the significant manufacturing and development costs that biosimilar makers are expected to incur, limiting the number of competitors and their ability to compete on price. Data quality may also be an issue with biosimilars; the first application for an Avonex biosimilar was rejected based on insufficient efficacy, and delays and discontinuations with Rituxan biosimilars have pushed back their potential launch dates in Europe. Tysabri is likely to be a lower-priority target for biosimilar entrants, given the risk monitoring and potentially serious side effects in certain patients.

Biosimilar Competition a Risk Biogen's profitability depends on four key blockbusters and a high-risk but potentially high-reward pipeline. If future Gazyva data do not support superiority over Rituxan in key hematological oncology indications like non-Hodgkin's lymphoma, revenue from the Roche collaboration (which feeds directly to the bottom line and boosts margins) could begin to decline as biosimilars enter the U.S. market as early as 2018. Tecfidera's U.S. launch is beginning to see slower growth, partly because of concerns about four recent cases of PML. Avonex and Tysabri sales are still being adversely affected as patients are switching from one Biogen product to another. Biogen delayed its Tecfidera launch in Europe as it awaited a decision on regulatory exclusivity; while it received 10-year protection in late 2013, similar oral drugs from Dr. Reddy's RDY, Alkermes, and Forward Pharma could still compete with Tecfidera globally by the end of the decade, and patent litigation could result in revoked patents and royalty payment requirements. In the meantime, pricing pressure in Europe has been more severe than Biogen anticipated. While Plegridy is likely to help Biogen maintain its lead in the interferon market, we expect generic Copaxone to weigh on sales of injectable MS therapies. Biogen's MS portfolio has enjoyed tremendous pricing power in the U.S., and insurers could begin to find ways to put pressure on future price increases as more competitors reach the market (Avonex and Plegridy are excluded from the CVS national formulary for 2016).

Biogen’s current cash balance ($6 billion at the end of 2015) and free cash flow (exceeding $3 billion annually) will help fund future repurchases and tuck-in acquisitions. The firm’s $6 billion in cash and investments on its balance sheet at the end of 2015 is matched by a similar amount of debt, with most maturities in the 2020s. Biogen issued $6 billion in debt in 2015 to help fund its share-repurchase program. Historically, Biogen has focused on returning excess cash to shareholders via buybacks, but its limited acquisition and collaboration record is strong, and we expect more tuck-in acquisitions. Of the $15 billion in free cash flow generated since 2006, Biogen has spent the vast majority of this cash on repurchases, with an average repurchase price over 2006-15 of $87 per share.

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