If any confirmation were needed that the Royalty Pharma business model is working, look no further than the $3.3bn it paid yesterday for future royalties on Vertex Pharmaceuticals’ cystic fibrosis franchise. The transaction is by far the largest undertaken by the drug financing firm.
The price paid suggests that Royalty sees greater potential than sell-side analysts are projecting; although precise terms are unavailable, EP Vantage has estimated the NPV of the royalty stream from consensus sales forecasts and the sum involved does not seem unreasonable (see analysis below). And Royalty will clearly be expecting a much higher return, backing the view of those who think that Kalydeco is an under-appreciated asset.
The royalty stream was bought from the Cystic Fibrosis Foundation, a not-for-profit foundation, that several years ago injected $150m into Vertex and another company it subsequently bought in an attempt to spur research into the degenerative lung disease. As a result the foundation has certain rights to Kalydeco, VX-809 and VX-661; Vertex’s annual report says it is due a royalty rising from the single digits to sub-teens, plus undisclosed milestones.
Kalydeco is already on the market – and forecast to generate $470m this year – while VX-809, which will only be sold in combination, is expected to launch mid-2015. It currently ranks as the most valuable product in the pharma industry’s pipeline, with an NPV to Vertex of $15.4bn (PD-1s make way for the next wave of blockbuster launches, November 4, 2014).
Of course, this is not the valuation that Royalty will have looked at. The Foundation would collect a revenue stream extracted from top line sales before costs of selling the drugs and taxes for example, are subtracted.
EP Vantage calculates the NPV of Vertex’s top-line cystic fibrosis revenues to be $38bn. This is based on consensus sell-side sales forecasts, from EvaluatePharma, and assumes a WACC of 10%.
The table below sets out the estimated value of the royalty stream at various blended royalty rates.
|Guesses at blended royalty rate||6%||7%||8%||9%||10%||11%||12%||13%|
|NPV (pretax) of royalty stream ($bn)||2.3||2.7||3.0||3.4||3.8||4.2||4.6||4.9|
This suggests that Royalty’s thoughts on the sales potential of these products must exceed sell-side projections.
A blended rate of 9%, around the midpoint of Vertex’s royalty guidance, yields an NPV not far off the price paid. And Royalty will not have paid this out without factoring in a substantial return on this investment. Particularly as it will be paying tax on any profits and will also have to service the huge $2.7bn bank loan it has taken out to fund the purchase.
Of course, there are also undisclosed milestones due under the original deal – presumably Royalty will also get these – and which are not reflected in this analysis.
According to EvaluatePharma, Vertex’s cystic fibrosis sales will peak at $6.8bn in 2026. Vertex’s $27bn market cap is almost $10bn higher than the consensus NPV of these products, which in itself suggests that investors have already valued the company's assets more generously.
There are of course risks – not only in terms of the possibility of more effective competition emerging, but also from within the Vertex portfolio. VX-661, for instance, which could open up the franchise to a larger proportion of cystic fibrosis sufferers, still has to prove itself in phase III.
So there can be little doubt that this move represents a huge bet for Royalty Pharma. However, it has been striking bigger and bolder deals over the last couple of years, a track record that indicates it has been getting its modelling of future revenue streams right.
For those already bought into to Vertex’s hidden value, its endorsement will be well received.