Exelixis for SZ Year End 2018

Aiming to go three-for-three[1]- the next high potential, commercial stage oncology takeout target:  Buy Exelixis

This write-up is going to be short and to the point.

–      Exelixis is a one cancer drug pharma company with a great runway ahead of it.  Cabozantinib (aka Cabometyx®) is a TKI (Tyronise Kinase Inhibitor) which is approved for the treatment of Renal Cell Carcinoma (aka “RCC” or kidney cancer) in the US & Europe, Hepatocellular Carcinoma (aka HCC or liver cancer) in Europe and certain types of thyroid cancer.   Kidney cancer is the 6thmost observed cancer in men and 10thmost observed in women.  Liver cancer is the 5thmost prevalent form of cancer worldwide and causes approximately 9% of all cancer deaths.

–      In addition to its current approvals, Exelixis and its partners are in various stage trials to expand Cabometyx’s indications in RCC, HCC and Thyroid cancer but also start addressing non-small cell lung cancer (NSCLC), metastic urothelial[JP1] [JP2] cancer, breast cancer, colorectal cancer, high grade uterine sarcomas, metastic gastrointestinal stromal tumor, pancreatic, soft tissue sarcomas and others.  Some of these other development programs are with Cabometyx as a monotherapy and others are for Cabometyx in combination with other therapies.

–      The RCC drug market is currently estimated to be ~$4bn[2]in size with the market growing at an 8% CAGR through 2025 (making it a >$6.4bn market in 2025).  The main competitor drugs in this market are Novartis’s Votrient and Bayer/Amgen’s Sutent with BMY’s Opdivo + Yervoy combo which was just approved six months ago.  Exelixis’s and BMY’s offerings are gaining share at the expense of Novartis’s and Bayer/Amgen’s offerings.

–      The HCC market is currently estimated to be a modestly sized market, but it is expected to grow to $1.5bn2 (with a 22%+ CAGR) by 2022.  HCC is experiencing an annual, gradual increase in incidence driven by the obesity epidemic in the developed world. According to William Blair research that alludes to outstanding medical literature, the incidence of HCC is likely to increase as a bi-product of NASH (nonalcoholic fatty liver disease).  NASH is an area of high interest and activity in the pharma community with no approved drugs currently addressing the disease which has a poor prognosis in its advanced stages.  Broadly speaking, the same drugs noted previously that compete in RCC are also either currently or expected to be competing in HCC.

–      Unlike some other notable, young in their lifecycle, commercial stage oncology companies, Exelixis is not one to throw out grandiose forecasts for out year revenues (unlike Tesaro for instance).  Exelixis seems to follow the “under-promise and overdeliver” mantra and lets its product growth to date speak for itself.  Cabometyx has grown from $32mm in revenues back in Q2 2016 (the quarter it received FDA approval for RCC treatment) to over $162mm in revenues last quarter (or a 66%+ CAGR over that period).  Sell-side forecasts range from $1.5bn-$2bn of peak revenues for Cabometyx. With the drug already run-rating at close to $700mm of revenues, those forecasts could easily prove conservative should Cabometyx continue its success in expanding its label for additional indications.

–      The only quarterly guidance that Exelixis provides is on expenses. Impressively, for a one drug pharma company in a strong ramp mode with multiple development programs in progress, Exelixis’s expense forecasts are meaningfully less than expected 2018 revenues.

–      Common takeout multiple for fast growing biotech and oncology assets can be 10x+ two-year forward revenues (see shareholder letter sent to Medivation shareholders at the time they were contesting Sanofi’s offer https://www.sec.gov/Archives/edgar/data/1011835/000119312516630503/d208883dex991.htm).  At a 8.5x multiple for company revenues in 2021 using the mid-point of the high and low sell-side revenue forecasts, Exelixis is arguably worth ~$12.7bn or $40 per share.

–      Exelixis trades at $4.9bn enterprise value or 40% of that warranted estimated takeout valuation.

–      As Cabometyx has been gaining traction and consistently expanding its label and market access, Exelixis has increasingly been speculated as a takeout candidate (and at times had its stock price thrust higher on that speculation).  Unlike some other early commercial stage biotechs, Exelixis doesn’t have an impetus to sell due to a) high cash burn and limited resources (Exelixis generates meaningful FCF and has $750mm of cash on the balance sheet) b) anxious pre-ipo investors (they are long gone as the company IPOd in 2000) or c) because they have an older management team that wants to spend more time on their hobbies (EXEL’s CEO is only 57).  That said, the Company presents as a very attractive takeout candidate for any potential buyer that is trying to bulk up in oncology with a drug with a great runway at a price that isn’t a “bet the Company” type transaction for big biopharma.  Also, insiders have been consistent sellers with the stock in the $20s so with a reasonably justified takeout price at $40+, I would be surprised if Exelixis wouldn’t take a deal.  While the company may elect to voluntarily undergo an auction process, I think it more likely that an unsolicited approach will compel the Company to run a process.

–      For this type of asset, it’s probably easier to determine which large cap biopharma wouldn’t be interested vs. which ones would be most interested.  Novartis and Bayer/Amgen have direct competitor drugs so are probably off the list.  Virtually every other major biopharma with oncology interests could be interested. Exelixis also has partnerships and collaborations with: Ipsen, Takeda, Daiichi Sankyo, BMS, Roche and others. Certain of those companies may be especially suitable acquirers.

Background on Exelixis, CEO Dr. Michael Morrisey and Cabometyx

Exelixis was founded in 1994 and executed an IPO in 2000.  Its business is to discover, develop and commercialize new drugs to improve the care of people diagnosed with cancer.  CEO Michael Morrisey (57) joined the company in 2000 pre-IPO and has been CEO since 2010.  Prior to joining Exelixis, Dr Morrisey was VP of Discovery Research at Berlex Biosciences (a Company that was eventually purchased by Bayer) and prior to that worked at Ciba-Geigy (part of the merger that formed Novartis).  Dr. Morrisey owns 3.8mm shares of company stock.

Cabometyx was originally approved by the FDA in 2012 in capsule form for the treatment of medullary thyroid cancer.  This initial indication had limited commercial reach and only resulted in $37mm of annual revenues as of 2015.

Where things started torqueing up was when Cabometyx obtained FDA approval in tablet form for second line treatment of RCC in April of 2016.  Since then Cabo has made steady gains in not only that indication but other indication and in foreign markets.

As highlighted in the NRx volume & share chart above, Cabometyx continues to make strong inroads in RCC.  One of the reasons they have been so successful is Cabometyx is the only TKI that is approved in both 1stline (for those with a less favorable outlook) and 2ndline therapy.  The Company also highlighted as recently as Q3 earnings that it is the preferred TKI in its indications of use amongst 90% of the Key Opinion Leaders (KOLs) it has surveyed (of which there are over 50).

It is Exelixis’s intent to broaden Cabometyx’s label to address all aspects (1stline and follow up therapy) of the RCC and HCC markets (either as a monotherapy or in combination with other therapies) and in a number of additional indications. The following table provides an overview of the breadth of areas that are trying to be addressed with Cabometyx.

Of note, Exelixis has commercial partners for Cabometyx outside of the US.  Ipsen SA ($11 bn market cap) has the rights to Cabometyx in Canada and the ROW ex-Japan.  Takeda ($25 bn market cap) has rights in Japan.  Royalty rates are different between the two companies but escalate to as high as 22-26% of revenues.  In the case of Exelixis’s relationship with Ipsen, there are multiple milestone and incentive payments involved and Ipsen is compelled to pick up as much as 35% of development costs for Cabometyx.

Rationale for an approach

The never-ending challenge for big biopharma is building and re-filling the product portfolio of patent protected drugs.  There are salesforces to feed, significant fixed costs to cover and typically plenty of drugs that are near the end of their patent life that need to be replaced with other high value drugs with long runways.  It is part of virtually every major biopharma’s modus operandi to supplement internal R&D with acquisitions where a product can easily be slotted into the portfolio and significant redundant costs at the acquired company be removed.

Of the nine multi-billion biopharma M&A transactions committed to over the past two years, five of them were for companies focused on oncology.  Of note, Exelixis is likely to deliver revenues in 2018 that are roughly comparable to all the product revenues of the 2017 & 2018 acquired oncology companies combined (which were acquired for a combined $33 billion).

Potential Positive Catalysts

1)   January 14, 2019 PDUFA date for Cabometyx in HCC – this approval is expected and should be positive for Exelixis.  There are certain potential acquirers, like Gilead, that should become particularly interested in Exelixis post this anticipated approval.  Between liver disease expertise (Hep C, Hep B, NASH (arguably the most promising area in Gilead’s development efforts)) and oncology broadly, Exelixis would be a particularly good fit for Gilead.  The two companies also happen to be based in the same city (South San Francisco, CA).  Just because January 14 is the PDUFA date doesn’t mean that approval couldn’t come sooner.  I wouldn’t be surprised if approval for Cabometyx in HCC came the 1stweek of January.

2)   In 2020 (RCC) and 2021 (HCC) trials related to Cabometyx for the Japanese market come to conclusion. These are not immediate catalysts, but progress on breaking into the Japanese market should be well received.

3)   As indicated earlier, there are multiple other trials ongoing for Cabometyx as both a monotherapy and in combination with other therapies like Opdivo.  Positive data flow from various trials should be positive for the stock.

4)   If an approach is made to Exelixis or the company decides to put itself up for sale, that would be the most impactful positive catalyst for the stock.  The five most obvious potential acquirers are arguably:

a.    Roche (strong presence in oncology, already collaborating with Exelixis in trials and Genentech (Roche subsidiary) is based in SF).

b.    BMS (strong presence in oncology and multiple trials ongoing with Exelixis on combination therapies).

c.    Gilead (in addition to prior points, incoming Gilead CEO comes from Roche suggesting an increasing oncology focus at Gilead).

d.    Glaxo (with the intent to combine its consumer health business with Pfizer’s and then spin it off, Glaxo will be looking for additional assets to bolster its portfolio (a la Tesaro)).

e.    Pfizer (not only is Pfizer a serial acquirer, similar to Glaxo with it jettisoning its consumer health business Pfizer will be looking for additional therapies to add to its portfolio (a la Medivation).

Potential Takeout Valuation Sensitivity

As highlighted earlier, a rough baseline for high growth biopharma/especially oncology assets is ~10x 2-3 year forward revenue.  Surveying sell-side research I’ve seen a range for 2021 revenues of $1.2-$1.64 billion. Anchoring on a $1.4bn revenue number and using a more conservative takeout multiple of 8-9x, one could easily justify a $40 takeout price for Exelixis’s shares (125% above the current stock price). See the following sensitivity tables.

Risks

1)    A material slowdown for Cabometyx.  While Cabometyx has been gaining share at the expense of Votrient and Sutent, Opdivo+Yervoy was approved in April and is making significant inroads.  Exelixis management represent that given the challenging prognosis for patients with RCC and HCC, that it is likely to be a question of when, not if, Cabometyx will be used during a patient’s treatment lifecycle.

2)   Channel inventory adjustments.  Q4 2017 sequential quarter sales growth slowed due to distributors managing inventory. The market didn’t respond well.

3)   Negative outcomes in either new indication approvals or drug trials for Cabometyx.

4)   Any drug price reform that lands firmly on Cabometyx.

5)   Exelixis is a volatile stock.  An investor needs to appreciate this.

Summary

In a market that has been punishing pro-cyclical stocks with significant overseas (especially Chinese) exposure, Exelixis represents a somewhat idiosyncratic opportunity.  It is primarily leveraged to growth in US sales of its only approved drug.  Cabometyx has a bevy of additional indications it could gain approval for that could materially increase its potential peak sales.  The Company is not only generating real earnings and free cash flow, it has $750mm of net cash ($2.50 per share or 13% of its market cap) on the balance sheet.  Exelixis is amongst a very small group of biopharma companies.  It represents a “digestible” acquisition (not bet the Company acquisition) for a number of major biopharma companies that are in need of expanding their oncology portfolios with assets that can immediately move the needle on the top line.  The stock trades at a 45% discount to its 52 week high and 44% of a reasonably arrived at takeout value for the Company.  While buying a stock in anticipation of a takeout is often foolhardy in many industries, in biopharma for “young” commercial stage companies with only one meaningful approved drug a takeout is often the ultimate outcome.  Exelixis appears to be a highly attractive takeout candidate for 2019 particularly if it receives FDA approval for Cabometyx use in HCC; which we should be hearing about in just a few weeks.

Exelixis – take the pill.

Postscript:  While I am recommending Exelixis as an outright long, I also recommend selling long-dated out-of the money puts as an additional way to gain exposure and monetize the high implied volatility in EXEL options.  EXEL $15 strike Jan 2021 puts should be able to be sold for approximately $3.70+ per contract at the time of my writing this report.  Implied volatility is 59%.  While the upside will not be as significant in the kind of takeout scenario I’ve outlined, the risk in such a short position is also appreciably less (risk is only if the stock goes below $11.30 vs. $17.72 where the stock is currently trading). Something to consider.
Research and analysis data in pdf.