It’s a nice problem to have. Gilead Sciences is one of the most successful big biotechs of recent times, and with a $100bn valuation and some $20bn of annual operating cash flow its biggest quandary right now might be what it should buy.
On the other hand, however, all is not well. Gilead trades on the pedestrian multiples of a chemicals company, its hugely successful hep C franchise is in its death throes, and despite massive stock buybacks its shares are off 25% in the past year. Little wonder that there are calls for it to split, put the Pharmasset acquisition behind it and go back to its roots as a high-risk growth business (see tables below).
It was the $11.2bn acquisition of Pharmasset in late 2011 that brought with it the hep C business that transformed Gilead. But in the intervening five years the company has suffered from an unusual problem: no matter how compelling its fundamental valuation was investors steadfastly refused to reflect this fully in the stock.
Perhaps they had a point: hep C has proved to be a huge money-spinner, but it has been the victim of its own success. With most patients cured the focus is turning to a shrinking pool of those with intractable types of the disease; add to this a pricing revolt by payers and you have a business in terminal decline.
Gilead surely saw this coming, so it is surprising that it did not do some big M&A to fill the hole. Instead its management opted for stock buybacks to try to stem the share price decline, and these amounted to $10bn in 2015 and $9bn so far this year, with a further $8bn still to go under a February plan.
Little wonder that there have been calls for Gilead’s new chief executive, John Milligan, to get radical, and RBC Capital has argued that the company could be split.
This could, for instance, see the shrinking hep C business set up as a standalone unit in a tax-free spinoff to shareholders, destined to do little more than generate cash, pay dividends and pay down debt. Gilead would then be left with a growth business that investors might value more generously.
Of course, this would be pure financial engineering – a way to “unlock value” by altering sentiment. But sellside consensus numbers from EvaluatePharma back such a plan, which might see the fairly predictable hep C unit valued on a simple multiple of profits; an undemanding multiple of six might be appropriate for a declining business, yielding some $55bn.
|A valuation for Gilead's declining hep C business ($m)|
|Product||2016e sales||2016e net profit*|
|Sofosbuvir, velpatasvir & voxilaprevir||0||0|
|Valuation at 6x 2016 profit||54,786|
|*Estimate derived from EvaluatePharma NPV calculations.|
It might then be more appropriate to value the rest of Gilead on an NPV basis more typical of a biotech. Using sellside consensus this yields $61bn.
If this scenario were to play out the combined value of the two businesses, $116bn, would represent 15% upside to Gilead’s market cap today. Interestingly most of this value comes from Gilead’s HIV drugs – its key pre-Pharmasset strength and a still underappreciated asset.
|Gilead's growth business*|
|Product||Therapy area||2022e sales||Today's NPV|
|Letairis & Ranexa||Cardiovascular||221||1,912|
|Cayston & Ambisome||Anti-infective||280||1,034|
|GS-5745 & filgotinib||Crohn's disease||200||1,033|
|Total risk-adjusted NPV at 6.5% WACC||61,052|
|*Key products only. Source: EvaluatePharma.|
Leerink analysts recently wrote that the HIV business alone could generate $20.5bn of sales in 2021, with bictegravir contributing $4.7bn.
Gilead’s problem is that much of this value is at present being lost among the hep C noise. Indeed, its current valuation represents a multiple of just 6.4 times this year’s expected earnings; in comparison Celgene trades on an astonishing 22x.
More like Celgene?
True, there is little precedent for a separation; Theravance splitting to try and generate a buyer is hardly comparable, and neither is the example of conglomerates hiving off unrelated units.
A separate question is where Gilead’s current assets and liabilities would go – it might not be as simple as putting its $24.6bn of cash, equivalents and long-term investments to work at the innovative business while long-term debt ($22.2bn) sits with hep C and is slowly paid down.
But it could allow Gilead to become more like Celgene. Splitting would just be the beginning; it could serve as the basis for a higher valuation that would serve as a springboard for some big takeovers. If Gilead lost out on Medivation then it can still look at Incyte, Seattle Genetics or Vertex (Who’s next after Medivation?, August 23, 2016).
Its biggest recent licensing deal brought filgotinib for $725m up front, while the only significant acquisition after Pharmasset snared YM Biosciences and momelotinib for $510m; neither is big enough to move the needle. The takeouts of Medivation, Pharmacyclics and Onyx show that targets will not come cheap, but Gilead no longer has the luxury of waiting for a bargain.