On 25th August 2013, Amgen announced that the acquisition price of USD 125 per share has been approved by the board of Onyx and as a result Amgen will be paying USD 10.4 billion to acquire the mid size Oncology drug development company. Onyx is a California based bio-pharmaceutical company specializing in Oncology drug development. The company was incorporated in 1996 and is listed on the Nasdaq stock exchange since then. The company reported revenues of USD 362 million for the year ending 2012 with an operating loss of USD 271 million.
Stock performance of Onyx
Between May 1996 (when Onyx actually got listed) and September 2013, the annualized return from the stock was 8.95% with a standard deviation of 35.1% where as S&P 500 during this period gave a return of 7.35% with a standard deviation of 18.5%. However in the last five years, Onyx still delivered a annualized return of 8.05% with a standard deviation of 24.5% but S&P 500 slipped to deliver a return of just 1.78% with a standard deviation of 11.5%. One may argue that Onyx is a mid cap company and why am I comparing its returns with S&P 500. So a better comparison would be to S&P healthcare index. In the last five years, S&P health care Index (constituting of 52 companies) delivered an annualized return of 9.38%. So we can broadly conclude that from an investor perspective, Onyx has not done anything remarkable which is typically expected of a growing company although it has benefited a few short term investors.
Onyx started generating revenues from 2008 and since then in the last five years, the company has reported profits only twice - 2009 and 2011, when it earned royalties for licensing one of its products to Bayer (Germany) to commercialize the product outside USA. Since the earnings for the company are negative (in 2012), its Price to Earnings ratio is reported in negative however for any growing company such as Onyx, Sales makes more sense than earnings as much of the income would be invested in R&D and SG&A. The Price to Sales ratio for Onyx was about 17 (as of year ending 2012). This is way high even if it is a growing company. I say this because, the average Price to Sales ratio for the healthcare stocks listed on S&P 500 as of 2012 was 2.9. In addition, the Price to Earnings ratio for the companies listed on S&P 400 is 25 thus indicating that the Price to Sales ratio should be far less (should not be more than 6 considering the net profit margin for a mid cap company is optimistically about 25%). This clearly tells me that the stock is way too over valued however we cannot conclude without estimating the growth potential for the company.
Although not much relevant for a growing company, but still the Price to Cash ratio for Onyx for the year ending 2012 was about 12.4 and the average Price to Cash ratio for the healthcare stocks listed on S&P 500 for the year ending 2012 was about 12.1. Generally one would expect the price multiples for mid cap stocks to be higher than large cap but in this case, the Price to Cash ratio is almost same. This is not surprising for the investors have placed not much emphasis on the cash generation potential of Onyx as they realize that Onyx will be investing majority of its income in to R&D and SG&A.
Why such a high P/S ratio
Onyx concentrates on two varied platforms - Protease inhibitor and Kynase inhibitor. Without getting in to the technicalities of the targets (platforms), the efforts of the company has resulted in three commercialized drugs (Nexavar for treatment of Kidney and Liver cancer, Kyprolis for treatment of Multiple Myeloma, and Stivarga for treatment of Colorectal cancer and Gastrointestinal cancer). In addition, the three drugs are being evaluated (currently in varied phases of clinical trials) for other forms of cancer. The company has a partnership with MMRF (Multiple Myeloma Research Foundation) for development of drugs for treatment of Multiple Myeloma. Besides the efforts of the company in evaluating the existing commercialized drugs for other forms of cancer, Onyx has two more drug candidates (one being Oprozomib for treatment of blood cancer) undergoing Phase II and Phase III clinical trials respectively. This indicates that there is considerable growth potential for the company particularly with the relationship with Kathy Giusti lead MMRF, which managed to get four drugs approved by FDA in just six years. The positive news i guess for Onyx is that its equity investors realize this potential and so the high Price to Sales ratio.
Company performance
In the last five years (2008 - 2012), Onyx reported an average revenue growth rate of 19.3%. The company, with an employee base of about 750, outsources much of its production and as a result, the gross margin for the year ending 2012 was about 98%. But Onyx invests heavily in R&D and SG&A. In the year 2011 and 2012, the R&D to sales ratio was 59.9% and 89.8% respectively. Much of this investment went towards conducting clinical trials and seeking commercialization approval for the drugs. Considering that the company reported operating losses for the year 2012, its interest coverage ratio, ROE, and ROA were negative. However the asset turnover for the the year ending 2012 was 0.27, which was way low relative to its competition. Analysts estimate that Kyprolis that was fast tracked and approved by FDA in 2012, when it generated a revenue of USD 64 million, has potential to generate a peak sales of USD 3 billion by 2025. In addition, Oprozomib (currently undergoing Phase III trials) along with Kyprolis could generate combined sales of about USD 4 billion. Between 2011 and 2012, the sales of Nexavar increased in USA (USD 288.4 million in 2012) where Onyx has retained commercialization rights. Although the analysts predictions look positive, considering the pipeline and research initiatives of the company, it is very hard to predict when Onyx will start reporting consistent profits for it is likely to face huge pricing pressures (even though the company develops life saving drugs) and generic competition (both large and small molecules) as time progresses.
Cost of Capital
The levered beta for the company, calculated using linear regression, was 1.05 (however Financial times reported a beta of 1.33 and Yahoo finance reported a beta of 2.01). Considering the recent treasury bill rate and equity premium for US stocks (on S&P 500), the cost of equity for Onyx was 9.3% (considering regression beta as it is a very pessimistic estimate relative to FT and Yahoo Finance). The post tax cost of debt for Onyx was 8.13%. When most of the companies in the US could borrow at low interest rates (average post tax cost of debt for US companies ranges between 4% and 6%), 8.13% for Onyx is not very surprising because the company had reported positive earnings only twice in the last five years and lenders, unlike equity investors, do not look at future potential of the company but past performance of the company.
With a debt to equity ratio of 1.91%, the weighted average cost of capital (WACC) for Onyx came out to be about 9.31% (if we had taken the FT beta, WACC would have been 10.93% and if we had taken the Yahoo Finance beta, WACC would have been 14.93%). So this is the minimum return the company has to return to any investor including potential acquiring companies.
Amgen acquisition of Onyx
Amgen is paying USD 10.4 billion to acquire Onyx. This equals to USD 125 per share when the share was trading at USD 117. The acquisition value is at a control premium of 21% when the average control premium for acquisitions carried out in the last two years is about 40%. So this is good news for Amgen that it is able to buy a high profile research and development company at a reasonable price. However on the contrary, the present value of USD 10.4 billion means that the target company (Onyx in this case) has to deliver a free cash flow of USD 1.41 billion per year for the next 13 years (considering a WACC of 9.31%). This means the Net Operating Profit After Tax (NOPAT) should be close to USD 1.6 billion (calculated at present Working capital requirements and depreciation). This means the operating profit (EBIT) that Onyx has to deliver year on year for the next 13 years should be close to USD 2.45 billion. A company that barely reported positive earnings in the last five years needs to deliver a consistent operating earnings of at least USD 2.45 billion year on year for the next 13 years to make the investment appealing for the Amgen shareholders. Even after considering the peak sales potential of the drugs that Onyx currently commercializes and those in pipeline, I have my doubts if this target could be achieved. Yes, with the acquisition, Amgen will consolidate the R&D and SG&A spend in addition to diversification of its portfolio but still I am not sure if the Amgen has secured Onyx at a right price. Even Amgen, after 33 years of its existence, is able to generate a sales of about USD 17 billion (in 2012) with a operating profit of about USD 5.6 billion so it will be challenging to expect a nascent drug development company to generate USD 2.45 billion.
One may argue that why consider 13 years for no acquiring company takes control over a target company just for a minimum period of time (for any company has to be valued as a going concern). My contention here would be that the efforts put forth by Onyx till date resulted in three drugs and a few in approaching registration and approval (as they are undergoing phase III trials or Phase IV safety trials) and any valuation effort needs to look at the future growth potential of the target company considering the assets it posses as on the date of valuation or acquisition. Any future expansion or investments will not be carried out by the target company (Onyx) rather by the acquisition company (Amgen in this case) once it acquires the target company. So from this point of view, I believe that the assets (drugs and R&D efforts) that Onyx posses can only long 13 years (highly optimistic - actually it should be about 10 to 12 years). However to the benefit of my audience, If I consider that the assets possessed by Onyx will yield perennial income (hypothetical situation), still Onyx has to deliver a free cash flow of USD 968 million, which means the operating profit has to be at least close to USD 1.2 billion if not more.
Conclusion
I am ready to give credit to Onyx management (very promising one with very respectable credentials) and its potential to take the company on a linear growth path however I might want to conclude that Onyx shareholders won a jackpot here with Amgen paying a higher price for a company that might be extremely challenged to deliver a return on the price paid by Amgen to acquire Onyx.
One of my colleagues inquired about synergies so I thought i should update this post with my thoughts on the same. Agreed that there will be synergies and for a highly efficient company like Amgen, getting synergistic benefits out of any acquisition will not be a big deal. In fact i have mentioned in this post that Synergy will be there with respect to sales and marketing, R&D efforts, operations, and human capital. However said that the maximum synergistic benefits a company can attain in a technology acquisition (Amgen is acquiring a drug development firm) is in the range of 15 to 20% (thumb rule based on past acquisitions) if managed well. Since this is a mid cap acquisition, we can increase this percentage to say 25 or 30% (being highly optimistic). Even considering the synergies, we are talking about going from negative operating earnings to at least USD 970 million year on year perennially at a WACC of 9.31%. For the first two quarters in 2013, Onyx reported revenues of USD 298.5 million with an operating loss of USD 87 million. Besides these figures, Onyx flagship product - Kyprolis - is yet to pick up pace. This year I can estimate that the product will earn about USD 250 to 300 million in revenue. So even if the synergies were to be achieved, i have my doubts if the investment can make the NPV positive in 10 to 13 years (I have explained earlier in this post as to why i want to consider 13 years).
Having said this, most of the Oncology companies are trading at very high P/E ratios. This is because FDA is fast pacing many of the Oncology drugs since they are life saving however we still do not know if different countries (across the globe - because after acquisition, the bandwidth for products such as Kyprolis, Stivarga, and yet to be launched Oprozomib will increase) including US (thanks to the Sequestration program) will put pricing pressures on these drugs (Nordic countries have already started efforts on this front). Amgen is very strong in Oncology as they have recently reported trial results for nine of their drugs in the portfolio and they want to strengthen their portfolio with this buy. They are buying Onyx for the products they have in market (3) and pipeline (2). So from a relative (Oncology related companies) standpoint, Amgen got Onyx at a good price (21% control premium) but from a broader acquisition standpoint, I am not sure if this is adding value to Amgen shareholders.
Should Amgen have waited some more time. I am not sure because I don't see the prices falling for these Oncology drug development firms for the regulations are becoming more amicable to them and will become even more as time progresses.
One of my colleagues inquired about synergies so I thought i should update this post with my thoughts on the same. Agreed that there will be synergies and for a highly efficient company like Amgen, getting synergistic benefits out of any acquisition will not be a big deal. In fact i have mentioned in this post that Synergy will be there with respect to sales and marketing, R&D efforts, operations, and human capital. However said that the maximum synergistic benefits a company can attain in a technology acquisition (Amgen is acquiring a drug development firm) is in the range of 15 to 20% (thumb rule based on past acquisitions) if managed well. Since this is a mid cap acquisition, we can increase this percentage to say 25 or 30% (being highly optimistic). Even considering the synergies, we are talking about going from negative operating earnings to at least USD 970 million year on year perennially at a WACC of 9.31%. For the first two quarters in 2013, Onyx reported revenues of USD 298.5 million with an operating loss of USD 87 million. Besides these figures, Onyx flagship product - Kyprolis - is yet to pick up pace. This year I can estimate that the product will earn about USD 250 to 300 million in revenue. So even if the synergies were to be achieved, i have my doubts if the investment can make the NPV positive in 10 to 13 years (I have explained earlier in this post as to why i want to consider 13 years).
Having said this, most of the Oncology companies are trading at very high P/E ratios. This is because FDA is fast pacing many of the Oncology drugs since they are life saving however we still do not know if different countries (across the globe - because after acquisition, the bandwidth for products such as Kyprolis, Stivarga, and yet to be launched Oprozomib will increase) including US (thanks to the Sequestration program) will put pricing pressures on these drugs (Nordic countries have already started efforts on this front). Amgen is very strong in Oncology as they have recently reported trial results for nine of their drugs in the portfolio and they want to strengthen their portfolio with this buy. They are buying Onyx for the products they have in market (3) and pipeline (2). So from a relative (Oncology related companies) standpoint, Amgen got Onyx at a good price (21% control premium) but from a broader acquisition standpoint, I am not sure if this is adding value to Amgen shareholders.
Should Amgen have waited some more time. I am not sure because I don't see the prices falling for these Oncology drug development firms for the regulations are becoming more amicable to them and will become even more as time progresses.
No comments:
Post a Comment