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Amgen's Innovation Counters Biosimilar Pressure

We hold revived enthusiasm for the firm's research engine.

Amgen's biologics are vulnerable to biosimilars because of their age and ease of manufacturing, and innovative branded drugs are also stealing share. While anemia drugs Epogen and Aranesp have recently seen growth--tougher labels and reimbursement had been affecting the products since safety concerns emerged in 2007--we expect both products to decline going forward. Neutropenia blockbusters Neupogen and Neulasta have direct biosimilar competition in Europe. In the United States, Teva TEVA has launched Granix, its branded version of Neupogen, and Sandoz recently gained Food and Drug Administration approval for a biosimilar version of Neupogen (Zarxio). While legal battles are delaying Zarxio's launch, we expect this product, as well as Epogen and Neulasta biosimilars from Hospira (Pfizer PFE) and Sandoz, could compete by 2016. Finally, branded competitors are poised to continue to erode Enbrel's share, and biosimilar Humira could weigh on Enbrel sales by 2018.

To address these headwinds, Amgen has invested heavily in more efficient manufacturing and has undertaken a massive cost-cutting program, both poised to improve margins. Amgen's own large biosimilar pipeline and low manufacturing costs could make it a viable competitor in this nascent market, as well.

Amgen's newest drugs and its pipeline will also be key to countering these challenges. Prolia (osteoporosis) and Xgeva (fracture prevention in cancer patients) were approved in 2010, and each should see $2 billion in peak sales. Kyprolis--acquired with Onyx in 2013--is poised to become a $2 billion product in multiple myeloma. In the pipeline, Amgen is launching several important products in 2015, and Repatha (cholesterol-lowering) looks like the biggest opportunity (we estimate $5 billion in peak sales).

Blockbusters Build a Wide Moat Amgen markets several blockbuster biologic therapies in the oncology and immunology markets, giving it the intangible assets that form the foundation of its wide economic moat. One of the original biotechs, Amgen launched innovative recombinant proteins for anemia and neutropenia, beginning with Epogen in 1989 and Neupogen in 1991. Longer-acting products Aranesp and Neulasta were launched in 2001-02, just as the firm decided to acquire Immunex and bring Enbrel into its portfolio. These highly profitable biologics continue to drive very strong free cash flows for the firm, generally north of 30% of sales. We expect Amgen to continue to see free cash flow margins improve from this level and returns on invested capital to remain above its cost of capital for the foreseeable future.

Amgen has continued to grow despite steady regulatory and competitive headwinds, including safety issues weighing on Epogen and Aranesp since 2007, as well as established biosimilar competition for anemia and neutropenia drugs in Europe. Generic (biosimilar) pressure has not been as severe for biologics as for traditional pharmaceuticals, largely because manufacturing difficulties and the costs of clinical trials and product marketing have created high barriers to entry and limited the number of entrants. In addition, Amgen's longer-acting products Aranesp and Neulasta have helped defend against biosimilar threats to older products.

Amgen is also highly diversified, with Enbrel accounting for 23% of sales in 2014 and Repatha poised to be the top product in 2024 at 16% of sales. Strong growth from Enbrel and neutropenia drugs countered Epogen and Aranesp headwinds over the past few years, and Prolia/Xgeva (approved in osteoporosis and cancer indications in 2010) as well as renal disease drug Sensipar have now reached blockbuster status. Key to the Onyx acquisition, multiple myeloma drug Kyprolis is generating strong data that should expand U.S. sales and allow a European launch, and we think the drug could become the leading proteasome inhibitor in this $8 billion (and rapidly growing) market.

Regulation and Competition Continue to Be Risks Regulatory and reimbursement changes could continue to plague Aranesp and Epogen, including Medicare dialysis reimbursement cuts. Biosimilar competition with two of Amgen's key franchises already exists in Europe, and the FDA is beginning to approve biosimilars in the U.S. Teva is launching branded product Granix in the U.S., which will compete with Amgen's neutropenia drug Neupogen, and Sandoz has gained FDA approval of a Neupogen biosimilar. Enbrel is a key growth driver for Amgen, and growing competition in both rheumatoid arthritis and psoriasis could further weigh on the firm's market share, making it even more reliant on the continuation of U.S. pricing power for growth. Amgen's overall pricing power could wane if proposed reductions in Medicare Part B reimbursement are implemented, given the firm's reliance on the Medicare for a high proportion of sales. In addition, several of Amgen's newer products have entered highly competitive markets. Prolia competes with established drugs such as Novartis' NVS Reclast and cheaper generic bisphosphonates; Vectibix competes with Roche's RHHBY Avastin and Eli Lilly LLY and Bristol-Myers Squibb's BMY Erbitux. The first head-to-head study of Kyprolis against leading proteasome inhibitor Velcade was positive, but if this comparison fails to differentiate Kyprolis in the first-line setting, Amgen's $10 billion acquisition of Onyx will prove expensive. In addition, Amgen has the vast majority of its cash offshore and could face repatriation taxes if it brought the cash back to the U.S.

Shareholder-Friendly Moves Amgen's R&D engine had been struggling to churn out promising drug candidates since the launch of Prolia/Xgeva, and we believe new management might be beneficial to the firm's productivity and future share performance. Amgen's sales and profitability skyrocketed under the 12-year reign of CEO and chairman Kevin Sharer, but significant multiple compression led to flat performance of the shares over his tenure. Former president and COO Bob Bradway replaced Sharer as CEO in May 2012 and as board chairman at the start of 2013. While Bradway has been advancing at Amgen since his arrival as vice president of operations in 2006, we wish the firm had selected someone with a longer record in the pharmaceutical industry (before Amgen, Bradway was at Morgan Stanley for 19 years). We think this experience would be particularly useful for Amgen, as the firm will face steep biosimilar competition in the coming years and will need a cohesive strategy if it hopes to keep top-line growth in positive territory. That said, new CFO David Meline (from 3M) appears to be making the necessary cost cuts to achieve double-digit growth despite top-line pressure. The company's head of research and development, Roger Perlmutter, retired in February 2012, replaced by Sean Harper. Harper has been at Amgen for 10 years, and we think his medical background and experience as senior vice president of global development will serve him well.

Amgen has made several shareholder-friendly moves in recent history. Share repurchases and a tender offer at levels below our fair value estimate appear to be a good use of cash, and Amgen's quarterly dividends grew roughly 30% annually from initial levels in 2011 through 2014. However, we remain wary of the firm's compensation policies (rewarding executives for easily manipulated earnings per share growth instead of returns on invested capital) and board structure (not enough healthcare-related experience).

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