Biogen Remains a Wide-Moat Neurology Innovator

We lowered our Biogen BIIB fair value estimate to $327 per share from $385 following the news that both phase 3 trials of Alzheimer’s drug aducanumab are being discontinued due to futility. We had previously assigned the drug a 60% probability of approval based on strong data in a smaller trial and the drug’s differentiation from other failed amyloid antibodies. While there is a still a chance that these drugs could work in the preventive setting, we are removing all amyloid antibody revenue forecasts (including BAN2401, which had mixed data in 2018 and had an uncertain path forward into pivotal trials) from our model.

The valuation impact was partly countered by our inclusion of the pending acquisition of Nightstar, which brings two ophthalmology gene therapy drugs into Biogen’s pipeline. We have removed aducanumab and BAN2401 from our valuation and had already removed elenbecestat (still in phase 3) from our model. We do continue to include a 25% probability of approval for tau antibody BIIB092 in supranuclear palsy.

We still believe that Biogen’s specialty-market-focused drug portfolio and novel, neurology-focused pipeline create a wide economic moat.

Building a Portfolio Outside MS Biogen's strategy has its roots in the 2003 merger of Biogen (multiple sclerosis 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, expired in 2018. However, we think a subcutaneous Rituxan as well as novel antibody Gazyva will allow for extended oncology revenue. Avonex and longer-acting Plegridy generate $2 billion in annual sales and remain the leading MS interferon franchise. Biogen acquired full rights to MS antibody Tysabri (more than $1.5 billion in annual sales) from partner Elan. However, pricing power and demand for Biogen's injectable MS portfolio are slightly eroding, now that a generic version of Teva's TEVA Copaxone has launched and novel high-efficacy drugs are reaching the market.

Oral MS drug Tecfidera had a strong launch and continues to show solid safety and efficacy data. However, continued scrutiny of formulation patents (which have been revoked in Europe and will have an inter partes review decision on validity in 2020) has led us to assume generic entry in 2021 in the United States. We do think that Vumerity (licensed from Alkermes) could improve gastrointestinal tolerability (head-to-head data against Tecfidera is expected in 2019), but this is likely to be only a partial offset, and we assume Biogen’s total oral MS drug sales will decline 20% in 2021. However, Biogen sees significant royalties on Roche’s novel high-efficacy drug Ocrevus (approved in the U.S. in 2017 and Europe in 2018) that help offset pressure on its MS franchise.

Outside of MS, Biogen has strong human genetic validation for its neurology pipeline, creating potential to offset MS pressure. Spinal muscular atrophy drug Spinraza (partnered with Ionis) should reach $2 billion in sales in 2019, although competition from Novartis NVS is on its heels. Following aducanumab’s failure in Alzheimer’s, we think the market underestimates Biogen’s pipeline, which includes a continuing partnership with Ionis and drug candidates to treat conditions including stroke, Parkinson’s, pain, and amyotrophic lateral sclerosis.

Barriers to Entry Are High 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 the company's dominant share of the MS market. We think barriers to entry are high for potential biosimilars to Biogen's products, and Biogen has a strong 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 company's wide moat. Returns on invested capital, which we think will average in the midteens during our 10-year explicit forecast period, easily exceed our 7.2% estimate of Biogen's cost of capital.

Rituxan remains the standard of care in several forms of hematological cancer, and collaboration revenue received from partner Roche boosts Biogen’s margins. Biogen’s Avonex is the leading interferon therapy in MS because of 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 company to see continued sales despite novel products with cleaner safety profiles. However, we expect combined sales of Tecfidera and Vumerity to decline from Tecfidera’s $4 billion in 2018 to $2 billion annually through 2023, based on generic Tecfidera threats.

With the exception of Tecfidera, all of Biogen’s current blockbusters are biologics. Biosimilar competition is a looming threat, but we think the significant manufacturing and development costs that biosimilar makers are expected to incur would slow any erosion of sales of these products, limiting the number of contenders 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 pushed the European launch to 2017. Tysabri is likely to be a lower-priority target for biosimilar entrants, given the risk monitoring and potentially serious side effects in certain patients.

High-Risk but Potentially High-Reward Pipeline Biogen's profitability depends on four key blockbusters and a high-risk but potentially high-reward pipeline. If physicians and payers fail to support Gazyva use over Rituxan despite strong superiority data in leukemia and a large lymphoma setting, Biogen and Roche could be vulnerable to competition from cheaper, biosimilar Rituxan in 2019 in the U.S., and revenue from the Roche collaboration feeds directly to the bottom line and boosts Biogen's margins. 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 were excluded from the CVS national formulary in 2016-17). Tecfidera's U.S. sales are seeing slower growth, partly due to concerns about cases of progressive multifocal leukoencephalopathy and gastrointestinal issues, and other oral drugs (Celgene's CELG ozanimod) are poised to enter the market. Generic versions of Tecfidera could enter the U.S. market in 2021 if Mylan MYL is successful with its IPR challenge (decision expected in 2020). The recent failure of Alzheimer's therapy aducanumab in phase 3 trials also demonstrates the high-risk nature of some of Biogen's chosen areas of focus within neurology.

Biogen’s year-end 2018 cash balance ($4.9 billion) and free cash flow (more than $4 billion annually) will help fund future repurchases and allow the company flexibility on the size of future acquisitions. The cash and investments on the balance sheet are 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, the company 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 in 2006-15, Biogen spent the vast majority of this cash on repurchases, with an average repurchase price over 2006-15 of $87 per share.