The Squeeze on Shire
By BILL ALPERT
June 16, 2008
Shire's dependence on a drug for attention-deficit disorder that's scheduled to lose patent protection in April is tough a enough for pill for the British drug maker's holders to swallow. FDA decisions could inflict even more pain on the stock – or provide much-needed relief.
HEALTH-CARE INVESTORS ARE obsessed with shire's "post-patent" period. This non-Gregorian Calendar scheme measures the British drug maker by the day that Adderall XR goes off patent: April 1, 2009. The "Before/After XR" reckoning is understandable, given that $1 billion of Shire's $2.4 billion in revenue last year came from XR. It is the most-prescribed drug for attention-deficit hyperactivity disorder, or ADHD.
Shire's dependence on ADHD drugs has led investors to knock 40% off its American depositary shares (ticker: SHPGY) since September, dropping them to $47. Its new ADHD drug, called Vyvanse, has patents running through 2023, but sales haven't taken off fast enough to prove that Vyvanse can sustain Shire's ADHD franchise. Two XR generics are certain to arrive by the end of next year. Others could follow and crush XR's price if the U.S. Food and Drug Administration denies a pending petition from Shire that calls for would-be generics to undergo clinical trials.
Although Shire shares have given up a lot of their valuation premium in the past nine months, the company's $8.8 billion stock-market capitalization is still 15 times the consensus forecast for next year's earnings.
If the FDA opens the gates to XR generics and Vyvanse can't defend the franchise, then Shire wouldn't merit its 25% premium to the 12 times multiple carried by most pharmaceutical stocks. An industry multiple would pull Shire shares down to a level equivalent to about 40 on the depositary shares.
Shire executives and admirers think investors are unduly worried about the XR patent expiration. Some 60% of Shire revenues come from other products, notes Mike Cola, president of its specialty pharma business. He's confident that Vyvanse will become the best-seller for ADHD. And Adderall XR could end up thriving beyond next year, if the FDA concurs with Shire's petition and raises testing hurdles for XR generics. "If I look at the ADHD business unit," says Cola, "I think it's really well- positioned for the next five years."(Barron's Online recently presented Shire's bull case: "The Light at the End of Shire's Earnings Woes," May 20.)
The Basingstoke, U.K.-based company does have a number of good products besides its ADHD treatments. Those include two drugs for ulcerative colitis, whose sales surpassed $225 million last year. Others treat rare genetic disorders in competition with products from Genzyme (GENZ). Last year's sales of Shire's genetic therapies totaled about $325 million.
But ADHD drugs are Shire's moneymakers. Sales of Adderall XR have grown nearly 20% a year and surely contributed most of last year's cash earnings of $540 million, or $2.74 per depositary share (using an earnings computation that omits option expenses and other non-cash charges required under Generally Accepted Accounting Principles, often ignored by drug stock analysts).
Adderall XR uses a slowly dissolving coating to control the release of amphetamines, the brain stimulants long used to treat ADHD in children, teens and adults. Vyvanse takes a chemical precursor of amphetamine and links it to an amino acid. That combination was originally invented to foil drug abusers who convert amphetamine medicines into a form they can shoot up or snort. But the design also gives Vyvanse a smoother and longer-lasting effect than Adderall XR or other ADHD drugs like Concerta from Johnson & Johnson (JNJ).
AFTER 11 MONTHS ON THE MARKET, however, Vyvanse has garnered about 7.5% of the market, compared with around 23% for Adderall XR and 20% for Concerta. Cola says the launch trajectory of Vyvanse has been about average for a new psychiatric drug. He notes that the FDA only recently approved the product for marketing as a treatment for adults, the fastest-growing patient segment for ADHD drugs. But on the conference call for Shire's March 2008 results, analysts were clearly disappointed when Shire maintained its conservative guidance for Vyvanse sales of $350 million-to-$400 million this year.
There are bulls betting that Shire could become a takeover target for an industry giant like Pfizer (PFE). But a drug company would have to be satisfied that the Vyvanse patents can withstand scrutiny under an important 2007 ruling of the U.S. Supreme Court. In KSR International v. Teleflex Inc., the court invalidated the patent on a gas pedal that was just a common-sense combination of previously known components. The court held that such a combination is too "obvious." This new test for obviousness under patent law doesn't worry Cola. The Vyvanse chemical combination is novel and powerful, he argues.
Regardless of whether Vyvanse proves to be a breakthrough, earnings for the foreseeable future depend on Adderall XR. Shire settled patent challenges by Barr Pharmaceuticals (BRL) and Impax Laboratories by agreeing that those companies could sell "authorized" generic versions of XR next year. Under those deals, Shire will do the manufacturing and its royalties will tame price-cutting. True generic competition would have to await the FDA ruling on Shire's "citizen's petition" urging the agency to require stringent proof that generic XRs exactly match the Shire drug's time-release profile.
Cola happily notes that the agency has sat for four years on a similar petition that J&J filed for Concerta. But the FDA has approved many generic versions of controlled-release drugs. And it has rejected more drug-company petitions than it has accepted. Its decision on Adderall XR, or even J&J's Concerta, could be a sudden thumbs-up, or thumbs-down, for Shire.
The Bottom Line:
Although Shire shares have already dropped, they could fall another 15%-20% if the drug maker can't keep it's grip on the attention-deficit hyperactivity disorder market.
Source: Barron's Online