THRX - Theravance

[Chalk bag]

Has anyone done work on this name? Certainly intrigues me as (1) the stock sold off, (2) spin is coming within the next 2 months, (3) Baupost owns a big chunk, (4) Most guys skip it because it's "too hard" and a biotech, and (5) on various assumptions (see attached) the RoyaltyCo seems to account for the price today and you get Biopharma business for free (i.e. ~$10 of value). What am I missing that could really hurt me?

 

And here's a very good Jefferies note, surprised that it's public.

http://jefferies.com/CMSFiles/Jefferies.com/files/Insights/JeffreyHolford_Pharmaceuticals_09122013.pdf

THRX_Model.xlsx

[thefatbaboon]

Hello,

 

I have done some work on THRX.

 

This is not my usual type of investment but I like it because I think there is limited downside. 

 

If Europe approves Anoro, Breo gets asthma indications in US, Advair generics are slow to arrive, and GSK is first to market with a triple play  - i.e. if things go right - THRX might be a triple in 5 years.  If things go wrong:  breo does't get asthma indications, generic advair arrives beginning '17, and the triple play runs into development problems - i can't see how THRX is worth less than $4bn in 5 years. 

 

Unfortunately, at the moment we are closer to the  "wrong" version and obviously turning $3bn into $4bn over 5 years is hardly a good investment.  That said I think this is a rare investment where the bear case has a very high probability of at least not being worse.  Anoro and Breo are already COPD approved globally, they are the only once a day medicines, they have a device favored by patients, GSK has immense respiratory marketing, they are building their business around the ellipta device, drugs delivered through inhaled devices are long lived (look at ventolin).  Even if Anoro and Breo have smaller peak sales than expected these are drugs that will be around for decades in one form or another (i.e. in combination with something else and/or in some fancy new device).

 

 

 

 

[CorpRaider]

(6) Arms length valuation (for a strategic buyer) was just provided on the royalty portfolio via Elan's failed $1 billion bid for 21% of royalty streams; (7) GSK and Klarman were buying away in the mid to upper 30s recently.

 

I'm a buyer a couple points lower. 

 

 

 

[Chalk bag]

Thanks, still wrapping my head around how much market share they can take. Anybody can share good info on market dynamics besides the Jefferies piece?

Also, Anyone know why MS's analyst David Friedman is so negative on Breo and Anoro sales? (I think he is projecting combined peak sales of $1.5-2 Bn), he is citing that early ramp in Breo is indicative to latter numbers and Breo had clearly been sluggish due to "lack of differentiation". Not sure how i can go ahead and verify / disprove it.

[no_free_lunch]

Is the Elan bid realistic though?  Some articles I read indicated that it was basically an attempt to fend off a hostile takeover.  In the end the share-holders rejected the offer.

[CorpRaider]

Well, only time will tell.  Elan mgmt was arguably under some pressure to do something with gobs of cash in effort to fight off hostile bid, and strategic buyers are often thought to pay up; then again i'll always take an arms length transaction negotiated by actual executives in the industry as pretty strong evidence of value. Also, personally I decided that if price was overly fantastic, why didn't thrx sell more than 21%, when they are clearly rational and not wed to royalty co; indeed the whole spin is thought by many to be a device to pressure and/or set up the pins for gsk takeout of thervance inc.

[Chalk bag]

Hello,

 

I have done some work on THRX.

 

This is not my usual type of investment but I like it because I think there is limited downside. 

 

If Europe approves Anoro, Breo gets asthma indications in US, Advair generics are slow to arrive, and GSK is first to market with a triple play  - i.e. if things go right - THRX might be a triple in 5 years.  If things go wrong:  breo does't get asthma indications, generic advair arrives beginning '17, and the triple play runs into development problems - i can't see how THRX is worth less than $4bn in 5 years. 

 

Unfortunately, at the moment we are closer to the  "wrong" version and obviously turning $3bn into $4bn over 5 years is hardly a good investment.  That said I think this is a rare investment where the bear case has a very high probability of at least not being worse.  Anoro and Breo are already COPD approved globally, they are the only once a day medicines, they have a device favored by patients, GSK has immense respiratory marketing, they are building their business around the ellipta device, drugs delivered through inhaled devices are long lived (look at ventolin).  Even if Anoro and Breo have smaller peak sales than expected these are drugs that will be around for decades in one form or another (i.e. in combination with something else and/or in some fancy new device).

 

Thanks for the reply – I want to go specifically into your assumptions around  the downside scenario of ~$4 Bn in 5 years.

Currently the script data for Breo is very bad vs. consensus (see Morgan Stanley’s bearish note), much lower than Dulera’s and Symbicort’s initial launch 13 weeks in. We can argue whether Part D coverage and trial period for patients play a big part to it, but the way I see it, if you were to run a DCF on $1-1.5 Bn peak sales for Breo (which is what it looks like now), the decay after the 2018-2019 generic cliff seems real, THRX stands to get ~ $10 of value in this drug. Would you say this number is too pessimistic and don’t give Breo credit for Asthma approval?

 

On Anoro’s side, I guess I’m more comfortable around the $3 Bn+ projection thrown around by people given the LABA-LAMA combo.

 

What really scares me the most is that GSK seems to be treating both Anoro and Breo as transitory drugs to THRX’s MABA + ICS (i.e. the triple-play) as they develop their own generics. Where do you think TBPH will print? With 300 mm of cash and mgmt point to it as the THRX 3 years ago – roughly $1 Bn, but the thing is do I peg $4-6 Bn peak sales on MABA+ICS? How do you triangulate to TBPH’s valuation?

 

Would love to discuss off-line too. Feel free to send me a message. My gut tells me there is money here, but it’s the first time I have looked at a bioptech and it makes me uncomfortable pointing a wet finger to the sky towards 2018 numbers.

 

[undervalued]

Don't forget about the split which is about to happen in 2nd quarter.. probably a week or so.

 

http://finance.yahoo.com/news/theravance-announces-planned-separation-stage-215535729.html

 

Here is a new Seeking Alpha article posted a few days ago

 

http://seekingalpha.com/article/2123883-theravance-is-a-classic-ben-graham-bargain

[Chalk bag]

Don't forget about the split which is about to happen in 2nd quarter.. probably a week or so.

 

http://finance.yahoo.com/news/theravance-announces-planned-separation-stage-215535729.html

 

Here is a new Seeking Alpha article posted a few days ago

 

http://seekingalpha.com/article/2123883-theravance-is-a-classic-ben-graham-bargain

 

Yep, exactly why I brought it up. The leverage he mentioned is not new given how vocal the management is. I think they will need to ramp into place given the EBIT doesn't flush in until 2016+. It feels less like an event-driven story to me (unless the biopharma piece gets seriously mispriced aka PRTA-style) and more like a story on whether they can bring Breo and Anoro jointly to at least currently Spiriva & Symbicort level, whether BAMA will be a hit, and whether the generic Advair + else will have a significant impact on THRX. My gut tells me yes so I really want to get comfort on the downside -- upside is clearly what Cowen and Leerink point to so I'm fine there.

[thefatbaboon]

Chalky,

 

Keep in mind I said $4bn in year 5.  So depending on your discount rate…say 10%…that's $2.5 present value.  That is 20% below the current market cap.

 

So, if we're talking in PV terms, your question is regarding the "downside scenario of" $2.5bn today.

 

I can't really think of a way of valuing Breo, Anoro, the triple, $500m, and the various other bits and pieces at less than that - even using MS's Breo and Anoro estimates.  MS's valuation is $1.4bn and it is just of Breo, Anoro and Vibativ and it models zero bond/bank issuance. If you assumes some minor leverage, model the $500m cash and additional assets: the triple, MABA and some other stuff….even using MS you can't come in under $2.5bn.

 

 

 

 

[timidbid]

Amended form 10 is out...spin-off will be taxable as a dividend

 

All or a portion of the Theravance Biopharma shares you receive is expected to be taxable to you as a dividend. In connection with the spin-off, we submitted a private letter ruling request to the Internal Revenue Service (the "IRS") regarding the tax treatment of the spin-off. In the course of discussions with the IRS regarding the ruling request, the IRS has indicated its intention to treat the distribution of Theravance Biopharma ordinary shares as a taxable transaction.

[thefatbaboon]

U.S. Federal Income Tax Consequences

 

The Distribution

 

        Because of uncertain issues relating to the taxable status of the distribution, Theravance sought a private letter ruling from the IRS regarding the U.S. federal income tax consequences of the distribution of our ordinary shares to the Theravance stockholders substantially to the effect that the distribution, except for cash received in lieu of a fractional share of our ordinary shares, would qualify as tax free under Sections 368(a)(1)(D) and 355 of the Code and, that, for U.S. federal income tax purposes, no gain or loss would be recognized by a holder of Theravance common stock upon the receipt of our ordinary shares pursuant to the distribution. The IRS declined to issue such ruling and has informed us that in the view of the IRS, the distribution will fail to satisfy the requirements of Section 355 of the Code. Specifically, the IRS informed us that, in its view, Theravance will not be engaged in an "active trade or business" immediately following the distribution, as required by Section 355 of the Code, and that the IRS intends to treat the distribution as a taxable transaction.

 

        Accordingly, each Theravance stockholder who receives Theravance Biopharma ordinary shares in the distribution is expected to generally be treated as receiving a taxable distribution in an amount equal to the fair market value of the Theravance Biopharma ordinary shares received, including any fractional share sold on behalf of the stockholder. Such stockholder will be taxed on the full value of the Theravance Biopharma ordinary shares received in the distribution (without reduction for any portion of such stockholder's tax basis in its Theravance shares) as a dividend for U.S. federal income tax purposes to the extent of such stockholder's pro rata share of any current and accumulated earnings and profits of Theravance, measured as of the end of the year in which the distribution occurs (including Theravance's taxable gain on the contribution and distribution, if any). If the spin-off is taxable, any amount in excess of Theravance's earnings and profits will be treated first as a non-taxable dollar-for-dollar reduction in the stockholder's basis in its Theravance's stock, and thereafter as capital gain from the sale or exchange of such stockholder's Theravance's stock. Subject to certain exceptions, any amount treated as a taxable dividend that is paid to a non-U.S. holder of Theravance stock that is not effectively connected with the non-U.S. holder's conduct of a trade or business within the United States will generally be subject to U.S. federal withholding tax at a rate of 30% of the gross amount of the dividends (or such lower rate specified by an applicable income tax treaty). Additionally, backup withholding (as discussed below) may apply with respect to the amount treated as a taxable dividend.

 

        Because a definitive calculation of the U.S. federal income tax impact of the distribution will not be possible until after the close of Theravance's 2014 taxable year, Theravance and other applicable withholding agents will withhold an amount equal to 30% of the fair market value of our ordinary shares distributed to a non-U.S. holder (as if the gross amount of such distribution was a taxable dividend) unless a reduced rate of withholding or an exemption from withholding is applicable. In addition, because the distribution is an in-kind distribution, Theravance and other applicable withholding agents will collect the amount required to be withheld (to the extent any cash in lieu of fractional shares is insufficient) by reducing to cash for remittance to the IRS a sufficient portion of the ordinary shares that a non-U.S. holder would otherwise receive and such non-U.S. holder may bear brokerage or other costs for this withholding procedure. Non-U.S. holders should consult their own tax advisors regarding their entitlement to benefits under an applicable treaty or other exemption and the manner of claiming the benefits of such treaty or other exemption. Non-U.S. holders may be eligible to obtain a refund of any excess amounts withheld if (1) all or a portion of the distribution is treated as a tax-free return of capital or capital gain or (2) the non-U.S. holder is eligible for a reduced rate of withholding tax pursuant to an applicable income tax treaty.

 

The distribution may, under certain circumstances, be subject to "backup withholding," unless a stockholder provides proof of an applicable exemption or a correct taxpayer identification number, and otherwise complies with the requirements of the backup withholding rules. Corporations and non-U.S. holders will generally be exempt from backup withholding, but may be required to provide a certification to establish their entitlement to the exemption. Backup withholding does not constitute an additional tax, but is merely an advance payment that may be refunded or credited against a holder's U.S. federal income tax liability if the required information is timely furnished to the IRS.

[CorpRaider]

Well I guess there won't be any need for GSK to wait to meet a safe harbor under 355(e).  Sorry, I'm a bit obsessed with that scenario, probably just fondly remembering the NVS acquisition of Chiron in which I was able to wet my beak.

[thefatbaboon]

I think this is essentially a non issue for everyone except some international investors who get withheld automatically.  It's pretty messy for them with the forced sale of 30% of the dividended shares and then a rebate at some point in a year or two.  They would have to simultaneously buy a number of shares equal to their forced sale shares and then remain out of pocket the $ expense until the IRS rebate.  For everyone else - THRX would have to magically make up all their losses by the end of 2014 AND the amount of profit, pro rata, would have to surpass an investor's tax basis.

[CorpRaider]

Wouldn't the nimble dividend rule in section 316 look at the current year's E&P first and hit us with a dividend or does it allow netting cumulative losses?  I can't remember off the top.

[thefatbaboon]

Corp,

 

I am not a tax expert…but wouldn't the >$1bn of NOLs ensure that reportable income in 2014 will be zero?  As such whether it is cumulative or just 2014 shouldn't make a difference.

 

 

[CorpRaider]

I would check it out with your tax advisor, if its material.  I haven't looked at that rule in several years and wouldn't want to steer you wrong, but I think it could be an issue if there is current year E&P (which they won't know until year end 2014) even though there is an accumulated deficit b/c of the nimble dividend rule.

 

 

What do you make, if anything, of the withdrawal of GSK's member of the BOD?

[Chalk bag]

Chalky,

 

Keep in mind I said $4bn in year 5.  So depending on your discount rate…say 10%…that's $2.5 present value.  That is 20% below the current market cap.

 

So, if we're talking in PV terms, your question is regarding the "downside scenario of" $2.5bn today.

 

I can't really think of a way of valuing Breo, Anoro, the triple, $500m, and the various other bits and pieces at less than that - even using MS's Breo and Anoro estimates.  MS's valuation is $1.4bn and it is just of Breo, Anoro and Vibativ and it models zero bond/bank issuance. If you assumes some minor leverage, model the $500m cash and additional assets: the triple, MABA and some other stuff….even using MS you can't come in under $2.5bn.

 

I currently have Breo at 1 Bn peak sales, Anoro at 3 Bn, and then some for MABA, UMEC/VI/FF + VI Monotherapy with 25% tax rate and 10% discount rate I get to $19 of value with the bonds fully converted. Add $1.5 of cash you get $20.5 for the THRX RoyaltyCo.

 

I don’t know how to value the TBPH piece and I don’t think I’m alone. A few ways to triangulate it may be (1) Look at where PRTA printed (3x Book) and put a finger and say, with 300mm in cash, it’s worth 900 mm, or $8 / share, but that’s kind of silly given the pipeline needs to be accessed on a case by case basis. (2) Or I can use what management suggested “the TBPH is like THRX 3 years ago” as a guide-line, and get to ~800-1000 mm of value, or again $8 / share. (3) I guess if MABA and UMEC+VI+FF indeed blossom into 1 Bn peak sales drugs or better eventually and TRC is spun off eventually, on the same DCF basis I get to around $5 / share on that alone, and add back cash of 300 mm, I get around $7.50. So I would assume TBPH prints at $8. But what am I missing? Feels like wet finger in the air here.

 

All in, my base case is $28-30 / share. Hardly good upside. You get downside in Anoro, which if I assume MS is right, the downside is $22-23 / share, or 20% downside. I guess it’s not bad? The upside is if people are willing to pay a lower discount rate on royaltyCo (let’s say 8% vs. my 10% assumption), Breo nails it @ 2 Bn peak sales, and Bio tech gets 4x cash value, then the upside is $40 / share, or 40% upside, I guess 2:1 risk reward is not bad, but it feels wishy-washy to me.

 

[alertmeipp]

any idea why gsk buying so heavily in high 30s?

[thefatbaboon]

alert,

 

gsk has always topped up their 27% allowance at whatever the price is.

 

Chalk,

 

I think we have a similar base…MS estimates for Breo, Anoro & then a very conservative value on cash, the triple, and the rump TBPH…low $20s (THRX+TBPH combined).

 

My way of thinking of the possible upside is a bit wishy washy.  I don't have any predictive pharma skill!  I just look at it like this:  Theravance is effectively the junior partner in ALL of GSK's on-patent respiratory business between 2016 and 2028. I don't know whether Breo or Anoro or the Triple or one of the singles will be big - but if GSK is going to have a respiratory business between 2016 and 2028 anything approaching the size and profitability of the current business ($13bn of sales in 2013) then one or two of these drugs are going to have to be big.  Other than the Umec single (which will be on patent), Advair (off patent) and Ventolin (off patent) - GSK literally has nothing else between 2016 and 2028.  Breo & the triple will be the ONLY way for them to get after the Advair crowd …and Anoro is a great way to get after tiotropium (spiriva).  It will be very helpful if Breo can get an Asthma recommendation…then GSK can start lifting Advair pricing aggressively and forcing people across to Breo.  The sooner they get this strategy working the better and I'll feel a lot more comfortable about bull scenarios if they get this asthma recommendation.

 

This is a very small position for me - it really isn't the type of investment I enjoy.  I've put a fair amount of work into establishing conviction in a value floor in the low $20s…I've put very little work into predicting the upside. 

[Chalk bag]

alert,

 

gsk has always topped up their 27% allowance at whatever the price is.

 

Chalk,

 

I think we have a similar base…MS estimates for Breo, Anoro & then a very conservative value on cash, the triple, and the rump TBPH…low $20s (THRX+TBPH combined).

 

My way of thinking of the possible upside is a bit wishy washy.  I don't have any predictive pharma skill!  I just look at it like this:  Theravance is effectively the junior partner in ALL of GSK's on-patent respiratory business between 2016 and 2028. I don't know whether Breo or Anoro or the Triple or one of the singles will be big - but if GSK is going to have a respiratory business between 2016 and 2028 anything approaching the size and profitability of the current business ($13bn of sales in 2013) then one or two of these drugs are going to have to be big.  Other than the Umec single (which will be on patent), Advair (off patent) and Ventolin (off patent) - GSK literally has nothing else between 2016 and 2028.  Breo & the triple will be the ONLY way for them to get after the Advair crowd …and Anoro is a great way to get after tiotropium (spiriva).  It will be very helpful if Breo can get an Asthma recommendation…then GSK can start lifting Advair pricing aggressively and forcing people across to Breo.  The sooner they get this strategy working the better and I'll feel a lot more comfortable about bull scenarios if they get this asthma recommendation.

 

This is a very small position for me - it really isn't the type of investment I enjoy.  I've put a fair amount of work into establishing conviction in a value floor in the low $20s…I've put very little work into predicting the upside.

 

Fatbaboon,

 

Thanks for your thoughts. I have noodled around with the valuation range and here are my thoughts:

- My distribution is between $18 and $40 with mean @ ~$27 and peak of pdf around $24-25. I envision in the most bearish case the stock trade as low as $20, and that needs to come with MS type base-case and TBPH trading at cash-value. I don't think we get there. More realistic is around $22 downside. where TBPH trades at ~$8 / share.

- I view the current valuation of $28 pretty fair given what i know. the risk reward of losing $6 and winning a range of betwen $4-$12 is okay but not great. I will be much more interest around $24-25 / share, I doubt we get there but if we do I'll add.

- Your observation around GSK's gameplan is quite astute; ultimately I think they will need to lean on Breo after it gets the Asthma approval and discount maybe it a little bit to get maximum penetration. After all, their game plan makes sense to me -- Have Ellipta to build device loyalty around a full product portfolio from Phase B to D, Have Breo to reach maximum penetration with is once-per-day compliance advantage, and have MABA + Anoro do their thing (And I think Anoro is strictly superior to Spiriva given it's easier to deal with on all spectrums). Once gets paid ~10% per annum w/ the THRX piece thanks to mgmt's front-loaded, aggressive game-plan, and have upside optionality around all the other GI mobility + CNS drugs on the TBPH front.

- I doubt GSK will swing the bat in full-force when Advair is still humming, I do think that everything will pick up in full-force once Breo gets the green-light on Asthma in 2015-16 and generics is just around the corner. I think the chances aren't bad that Anoro and Breo capture at least 20% market share in the new world w/ generics, and if they do so we get paid 10% front-loaded, so not bad I guess, I do want to get THRX @ 25 though.

- I doubt the generics will fully crush the market, from speaking to a few analysts, it seems like folks like TEVA can at most get the cost ~20% below GSK due to the device cost. I think it's a key difference between this genre vs. other drugs, where there's an added moat of device cost, operating leverage, and customer loyalty, so I'm warming up to the idea, but I want to get a 3~4 to 1 risk-reward @ $25, if it's not clear already.

 

So let's hope the market pukes.

[thefatbaboon]

Chalk,

 

Pretty much agree with your range.  But on the "topsides" valuation I would call out the triple (umec, vi, ff) as the key swing factor, that GSK tellingly refers to as "Diamond".  This has the potential to become a standard of care in mid-to-advanced COPD.

 

Have to say I find the split into Roy co and Bio co a bit strange.  Especially with the GSK partnership assets being split between the two companies.  Seems messy.

 

I do like that a lot of the management/directors have exercised options and stumped up the cash.  A couple of them haven't even sold partials to meet the option premium or taxes.

 

[Chalk bag]

http://investor.theravance.com/releasedetail.cfm?ReleaseID=841239

 

Yuck, that's some expensive 9% debt.

[mankap]

Does anybody have any number on BRIO sales in Q1. I do not see much revenue for THRX in Q1.Is it because the sales of BRIO is very small or the royalty has a time lag.

[mankap]

Never mind, I found the data in 1Q GSK report. It is showing total Breo sales in 1Q as 3m pounds. May be it is early days.