Action: Dr Reddy's partnership with Merck Serono is strategically
positive
We believe the deal catapults Dr Reddy's as a global player in biosimilars.
We believe the partnership provides Dr Reddy's with: a) Merck Serono's
development, manufacturing and commercial expertise across markets; b)
financial support that can expedite some of Dr Reddy’s development
programmes; c) the option of an efficient integrated worldwide product
development; d) lower risks as investments in R&D, manufacturing and
sales force are lowered and e) reasonable upsides as it gets to keep a
share of profits in the most lucrative US market and certain branded
markets like India and Russia. We think the deal may not have resulted in
any immediate value discovery as there are no upfront and milestone
payments disclosed. But the partnership, we believe, is the right strategic
move and the deal has struck a right balance between risks and rewards.
Catalyst: Biosimilar remains an interesting opportunity
The deal appears well timed, as some clarity on regulatory pathways has
begun to emerge in its developed markets of the US and Europe. With
biologic drugs of USD100bn+ in sales going off-patent by 2020, we
estimate the biosimilar opportunity in developed markets to record ~50%
CAGR to reach USD20bn by 2020F. Also, we expect a 3-fold growth in
patient volumes in emerging markets by 2020F as affordability increases
on lower prices of biosimilars. Dr Reddy's biosimilar revenue of USD25mn
(FY12) is <5% of the overall biosimilar market currently, on our reading.
Valuation: Maintain Buy
The deal does not impact our estimates but reduces risk. At 16x FY13F
P/E, the valuations appear reasonable. Our TP implies 19% upside.
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Dr Reddy’s - Merck Serono partners for
generic monoclonal antibodies
Dr Reddy’s announced a collaboration with Merck Serono (MRK GR) for the
development and commercialisation of its biosimilar portfolio, particularly monoclonal
antibodies. As per the deal, Merck Serono shall commercialise the products globally,
except for the US and certain emerging markets. These emerging markets most likely
include India and Russia, where Dr Reddy’s has a significant presence in front-end
branded generics. For the markets where Merck Serono exclusively commercialises the
product, Dr Reddy’s receives royalty on sales. In the US, both companies will cocommercialise
the products on a profit-sharing basis. Manufacturing-related investments
will largely be done by Merck Serono. However, Dr Reddy’s will retain the option of
manufacturing, if required. Development expenses on select products will be shared
from here on. Though the sharing proportion has not been disclosed, it does take into
account the costs incurred by Dr Reddy's on the development of biosimilars, so far. The
products for development haven't been disclosed, but we assume they would include
more recent opportunities and would exclude any innovation product in Merck Serono's
portfolio like Erbitux.
The deal follows a series of deals in the recent past
The Dr Reddy’s-Merck Serono deal follows a large number of biosimilar deals concluded
in the recent past. Some of the deals are listed below.
Fig. 1: Deals in biosimilars
Deal Period Comments
Teva-Lonza Jan ‘09 Teva and Lonza established a 50:50 JV. Lonza brings development and manufacturing expertise,
Teva brings expertise in clinical development and marketing of generics
Mylan-Biocon Jun ‘09
Five products- Herceptin, Neulasta, Avastin, Humina and Enbrel are part of the deal. Mylan would
have rights to commercialize in the US/Canada, EU, Australia/NZ through a profit sharing
arrangement. In other countries Mylan/Biocon have co exclusive marketing rights
Hospira-Celltrion Oct ‘09 The deal covers eight biologic products and geographies of the US, Canada, Europe, Australia/NZ.
The company has a separate deal with Nippon Kayaku in Japan.
JCR-Glaxo May ‘10 JCR has presence in recombinant DNA technology and Glaxo currently has ~25% stake in the
company. To start with Glaxo shall commercialize EPO outside of Japan
Hanwha-Merck Jun ‘11
The deal is only for Enbrel. Merck will conduct clinical trials and do manufacturing. Hanwha retains
commercial rights in Korea and Turkey and for other markets, Merck will commercialise the product.
This is like a licensing deal where Hanwha gets upfront and milestone payments and gets royalty on
sales.
Kyowa Hakko Kirin- Fujifilm Nov ‘11 This is a 50:50 JV
Samsung-Biogen Idec Dec ‘11 85:15 JV (85 for Samsung) to develop, manufacture and market biosimilar.
Watson-Amgen Dec ‘11 Developing, commercialisation and manufacturing responsibilities are with Amgen. Watson provides
financial support and in-kind development services.
Baxter-Momenta Dec ‘11
The deal involves six drugs. Baxter brings in clinical, manufacturing and commercial expertise
whereas Momenta has established track record of developing difficult to make generics. The deal
involved an upfront payment of USD33m and milestone payment up to USD419m.
Dr Reddy's-Merck Serono Jun ‘12
The deal is for monoclonal antibodies. In the US, both the parties have co-promotion rights and will
share profits. In certain emerging markets like India and Russia, Dr Reddy's will retain commercial
rights. In all other markets, Merck would commercialise. Dr Reddy's will do initial trials and later
trails will be taken up by Merck. R&D costs will be shared.
Source: Nomura research
Almost all large generic companies such as Teva, Mylan, Watson, and Hospira have, in
the past, entered into collaborations to gain synergies and de-risk development
programmes. Sandoz, which is currently the largest player in the biosimilar market, has
the support of parent Novartis. We note the deals are structured to bring together
complementary skills in development, manufacturing and commercialisation. The
contours of the Dr Reddy’s-Merck deal are interesting, as it brings in a good balance of
risks and rewards, in our view. The Dr Reddy’s-Merck deal has not resulted in any
immediate value discovery as there is no upfront and milestone payment disclosed. But
the partnership, we believe, is the right strategic move.
We think the deal is well timed as the regulatory landscape is gradually clearing up in the
regulated markets of Europe and the US. Having developed some products for emerging
markets, Dr Reddy's is on the verge of expanding development for developed markets.
We think the EU opportunity is likely to be realised sooner, compared with the US. In the
EU, clinical study requirements are relatively short and less stringent. Since producers
are required to establish clinical activity and not any clinical end-points, entry barriers are
relatively low in the EU. For the US, the draft guidelines suggest that the extent of clinical
studies shall be determined by the level of characterisation of the higher order biological
structures. Therefore, the draft does suggest a possibility of limited bridged studies.
Across the world, we believe, complex generic biologics like monoclonal antibodies are
likely to remain branded and non-substitutable, at least in the initial stages of
genericisation and, hence, would require a strong front-end.
Positives from the deal
• Merck Serono brings in development and regulatory expertise: As an innovator,
Merck Serono brings relevant expertise, particularly in product development and on the
regulatory front. Merck Serono has a strong biologics portfolio with a presence in
therapeutic areas such as neurodegenerative disorders, oncology and fertility. The
company’s top-three selling products are biologics (contributing 55% of Merck Serono’s
revenue in 2011).
• Dr Reddy’s has the relevant front end: Merck Serono has a significant presence in
Europe, which we think is possibly the most attractive market in the near term. Europe
contributes 46% of Merck Serono’s revenue. Emerging markets is a high growth area
contributing 35% of revenue. Merck Serono has revenue base of EUR6bn (2011).
• Merck Serono's expertise and financial support could accelerate development
programmes: Dr Reddy’s is one of the early mover in biologics among Indian
pharmaceutical companies. However, we note, globally, its development programme
lags behind the likes of Teva, Sandoz in terms of product development. Therefore, the
deal could help expedite Dr Reddy’s development programme, in our view. The Dr
Reddy's-Merck Serono entity may not participate in the first wave, but may be a later
entrant, in our view. This could imply a relatively lower market share but could benefit
the combined entity from the learnings of the early movers.
• A more integrated development approach: So far, Dr Reddy’s biologic development
programme had a step-by-step approach. For instance, the development programme
was first focused on India, then on other emerging markets and thereafter for
developed markets. With its partnership with Merck Serono, we expect a more
integrated worldwide development programme simultaneously, which we believe is
more efficient.
• Lower risks: Biologics development programme entails higher risks given uncertainties
around regulatory pathways, commercialisation and market share gains. We estimate
the development cost for biologics to range from USD40-50mn to more than USD100m
per product. The sharing of R&D costs reduces risk. Dr Reddy’s had indicated recently,
the possibility of R&D costs increasing significantly in the coming years due to
biosimilar development. More than cost-sharing, Merck Serono’s development
expertise reduces risk, in our view. Apart from R&D, Dr Reddy’s would have to invest
less in manufacturing and the front-end. We understand that manufacturing will largely
be driven by Merck Serono.
• Decent rewards: We believe the risk-reward is well balanced. Dr Reddy’s will get to
keep the entire upside in certain emerging markets, which we believe include India and
Russia. In addition, the deal allows Dr Reddy’s to co-market and retain material upsides
in the US which we believe should emerge as the most lucrative market over time. The
deal is therefore in sync with Dr Reddy’s long-term objective of a branded presence in
the US market.
Are biologics worth pursuing?
Given the numerous risks right from development, regulatory to commercialisation and
the limited expertise of Indian companies, the moot question is whether Indian generic
companies should pursue this opportunity?
Biologics would contribute a greater portion of the overall pharma market and, with
patents expiring would contribute even more to the generics market, we estimate.
Approximately 30% of the industry pipeline and ~20% of the current pharma market is
biologics. As per Sandoz’s estimates, biologic drugs with brand sales of USD63bn shall
go off patent by 2016, which is likely to increase further to USD100bn by 2020. Nomura
estimates the biosimilar market in regulated markets to increase to USD20bn-plus by
2020F, compared with just under USD500mn currently, which implies a CAGR of >50%
over the next nine-year period. The opportunity in emerging markets is also large, as a
drop in prices could lead to significant market expansion, resulting in an overall increase
in sales. For instance, in the case of generic Rituximab in India, the market size has
grown six-times since the price was reduced by half. Similarly, for GCSF in India, market
volume has expanded 30x and prices have fallen by 80% over the past decade as per
Dr. Reddy’s. As per Nomura estimates, the patient population using biologics in the
emerging world will triple from the current baseline by 2020F.
The opportunity is too large to be ignored, on our assessment. However, given the
uncertainties and risks, a calibrated approach is required, we think. Given the growth
opportunities, we note that almost all generic and big pharma companies intend to
pursue this opportunity. Even non-pharma players such as Fujifilm and Samsung are
entering the space, as per company data. Dr Reddy’s current biosimilar sales of
USD25mn are less than 5% of the market, in our view. Dr Reddy’s has four biosimilar
products in the market, while seven others are in early development and pre-clinical
testing stages. We believe the partnership with Merck Serono would catapult Dr Reddy's
into the league of a serious global player.
We reaffirm Buy, as low expectations make risk-reward
favourable
Current consensus estimates for FY13F imply revenue growth of 15%, much lower than
management expectations of maintaining growth at FY12F levels of 30%. A depreciating
INR presents a tailwind to revenue growth. Furthermore, consensus earnings estimates
of INR16.1bn for FY13F on the back of 4Q profit of INR4.16bn appear conservative to
us. Valuations are relatively attractive at 16x FY13F P/E vs. 18-20x for its larger peers.
We retain our target price at INR 1,918.
Our valuation is based on 18x FY14F EPS estimates. We expect front-line generic
companies to trade at 18-20x FY14 EPS estimates. We attribute our lower multiple for Dr
Reddy’s to account for the relatively higher dependence on the US business and
expected slowdown in growth post FY14.
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