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Amgen's $30 Billion Riddle - Biotech Or Big Pharma?

Posted: Aug 07, 2008 08:47 AM by Ryan Barnes

Tickers in this Article: WYE, DNA, PFE, MRK, AMGN

When biotech outfit Amgen (Nasdaq:AMGN) handily beat earnings estimates and also raised its forward guidance, shares jumped and are now up almost 50% in just two months. For the first time in years, there seems to be more positive than negative catalysts surrounding the stock, but a more important question looms: Is Amgen still a biotech (and worthy of its lofty multiples), or is it doomed to be treated like "Big Pharma" and stuck with the price-to-earnings (P/E) ratio of that group?

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Given Amgen's $67 billion market cap, it’s a question that could mean $30 billion or more to investors in the coming years given the discrepancies between top-notch biotechs, which can trade for 25-times earnings without breaking a sweat, and the chemical pharmaceutical companies, which have an industry average P/E of about 15-times earnings. Size alone isn't the ultimate driver, as Genentech (NYSE:DNA) is now the largest biotech at $100 billion, but still trades for more than 30-times earnings. (For everything you need to know about P/E, check out our P/E Ratio Tutorial.)

Amgen's Old School Roots
Amgen will always be the original biotech in my mind; it was the first to get mainstream attention by creating a billion dollar drug and the first to get huge (it had a $70 billion market cap way back in 2000). It was also the first biotech to deal with the vagaries of that size, as analysts began to wonder out loud why it should have a premium multiple to the Big Pharma staples like Pfizer (NYSE:PFE) and Merck (NYSE:MRK).

Sure enough, as the years progressed, investors have seen the P/E drop from the mid-30s range that shares once commanded; in the second quarter of 2008 you could have snapped up shares for a mere 13-times trailing earnings. There were good reasons why this happened, including stalling sales for its original blockbuster drug Epogen and ongoing safety concerns for its anemia franchise (which includes both Epogen and Aranesp) that contributed more than $6 billion towards Amgen's $14.7 billion revenue total of 2007.

The safety issue served as a "welcome to our world" scenario that Big Pharma as a whole is well accustomed to. Drug discovery can be incredibly profitable, but it can also be backbreaking if there are safety concerns after the drug hits the market. There are usually billions at stake between lost sales and litigation issues, and it will assassinate a high-multiple stock.

Biotech's Generic Immunity
All the big boys have faced this, and it's really just a cost of doing business in that sector. Another cost of doing business is a huge drop in sales when drugs go off patent and the generics swoop in. The biotechs have a unique and potentially lucrative edge here, because there is extremely little precedent in the world of biotech-based generics, also called "biosimilars" or biologics.

Pharmaceuticals are often like bank robbers - once the vault is open (a new blockbuster drug), the race is on to extract as much cash as possible before a new therapy proves more useful, or patent protection is lost and the generics invade. Biotechs have an inherent advantage in that generic versions of biotechnology drugs are much more expensive and complicated to make. Grown in a petri dish, no duplicate can ever be exactly the same as the original. These biosimilars will require a much more rigorous approval process from the FDA than a regular chemical generic compound. (For more on the difference between biotech and Big Pharma, check out Measuring The Medicine Makers.)

Earnings Report Highlights Improvement
In the company's fiscal second quarter, revenue grew just 1% to $3.8 billion but exceeded estimates of $3.58 billion. Adjusted earnings came in at $1.14 per share, well ahead of Thomson Reuters' $1.02 estimate. The beat was largely due to sales for the beleaguered anemia drugs coming in well above analyst targets, which had been slashed in the months following the safety warning. It appears that Aranesp and Epogen sales have progressed past the "bottoming-out phase" resulting from the FDA's actions, which will include adding a strong warning label to the drugs while limiting its future use to only certain patients.

Other key drugs in Amgen's portfolio are looking good. Neulasta/Neupogen combined sales grew 15% year-over-year to $1.2 billion. Enbrel sales were up just 2% to $841 million, but this one of Amgen's least-profitable drugs as profits are split with the drug's co-owner, Wyeth (NYSE:WYE).

Good News Finally Beating Back the Bad
The most promising catalyst for Amgen is the late-stage trial drug Denosumab, which is used to treat osteoporosis. Early test data indicates that Denosumab could be a game-changer in its target markets, with results showing as much as a 40% improvement over Fosamax, the competing treatment currently on the market. "Dmab", as it's sometimes called, actually restores bone mineral density, and if the drug can prove to reduce the chances of a major event like breaking a hip, Medicare and other insurers will be all the more likely to green light reimbursements. That would clear away what has been a roadblock for Amgen and other biotech companies in the past, as their drugs tend to be the most expensive ones in the aisle.

Denosumab is positioned in a fantastic market - incidence rates of osteoporosis rise with age, and the baby boomer demographic is just getting into the target age for symptoms and incidents. Fosamax brought in over $3 billion in revenue to Merck in 2007 before going off patent, so there is a heady optimism over Dmab's potential.

A Back-of-the-Envelope Earnings Model
On a run-rate basis, if Amgen can hit its target of $4.45 per share this year, the stock would trade at a P/E of just over 14. That seems far too low for a company with at least one new blockbuster (it appears, judging from both the data and management's tone on the conference call) in Denosumab, and no eminent patent dangers on the horizon. In fact, the company has so many drugs in its pipeline that it can't focus on all of them, which is why it sold off 13 of its promising molecules in a deal with Takeda Pharmaceutical that will likely net Amgen $1 billion or more, plus ongoing royalties.

Parting Thoughts
Time hasn't yet given us good evidence as to whether generic competition will stake a large claim to the biotech market. Until it does, I think Amgen should get more than half the benefit of the doubt, which could mean an earnings multiple in the range of 19-22 times current year estimates. If you assume that Amgen will hit its fresh-off-the-press 2008 estimate of $4.45 per share, Amgen could have plenty of room to run if it proves worthy of its prior biotech glory.

For related reading, check out Competitive Advantage Counts.

By Ryan Barnes

Ryan Barnes has over 10 years experience in portfolio management and investment research, covering equities, fixed income and derivative products. Barnes has worked with Merrill Lynch, Charles Schwab, Morgan Stanley and many others as an institutional trader, and maintained AIMR compliant performance for a diverse set of high-net-worth investors.

Barnes is currently working as a writer and financial modeling consultant specializing in capital appreciation and hedging strategies, and is the editor of EpiphanyInvesting, a website devoted to finding long-term success in the stock market.

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