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Summary
Royalty Pharma (Nasdaq: RPRX) is a profitable, dividend paying company with a business model that involves purchasing royalty streams. It has provided funding for unprofitable biotech companies, funded R&D projects for large pharma companies and purchased commercial products such as royalties. Humira and Lyrica. The company has a sustainable business model and a solid track record of investing in quality properties. The CF franchise showed significant growth (14% year/year) in addition to accounting for a significant portion of Royalty Pharma’s current revenue ($208 million of $704 million in Q3). The focus of this article is on the development of new CF drugs and how this may affect royalty revenue in the future.
Royalty Pharma CF is the owner of Royalty
The CF Foundation provided funds to Vertex to develop medicines for CF patients and later sold these royalties to Royalty Pharma. Royalty Pharma bought CF Foundation’s royalties for Kalydeco, Orkambi, Symbeko and Vertex’s best seller, Trikafta, in 2014 for $3.3 billion. It was the largest pharmaceutical royalty deal ever. Royalty Pharma recently raised an additional $575 million for Additional Royalty, which an analyst at Evercore ISI values at $1.2-1.3 billion. The analyst was surprised that they sold for half of that amount.
vertex (Nasdaq: VRTX) is currently developing a new triple combination of vanzacaftor/tezacaftor/deutivacaftor and will determine if it is superior to Trikafta (elexacaftor/tezacaftor/ivacaftor). Deutivacaftor, a component of the new triplet, is a deuterated version of ivacaftor. For those who don’t remember high school chemistry, isotopes are atoms that are the same element but have different numbers of neutrons. Deuterated drugs are small molecules where a normal hydrogen has been replaced by a heavier isotope of hydrogen called deuterium. This small change of replacing 9 hydrogen atoms is done to improve the half-life and potentially ameliorate side effects. A better side effect profile is possible because the required therapeutic dose may be lower than with the “un-deuterated” molecule.
This also makes it potentially a new patentable molecule and companies such as Concert Pharma (CNCE) are pursuing fragmented versions of Vertex molecules that they have cleverly developed into a unique drug that is protected by an independent structure of substance patent. can go. If Vertex successfully develops the new triple combination, they could also potentially reduce the burden of royalties payable to Royal Pharma.
Vertex’s CF franchise contributed $208 million to Royalty Pharma’s third quarter sales of $704 million, making it a significant source of revenue. It also represents a growth driver as CF royalties were up 14% year over year and CF sales growth is expected to continue in 2023.
Royalty Pharma Q3
Key questions that affect Royalty Pharma include: whether Vertex will be successful in developing the new triplet therapy and whether this new deuterated molecule will enable Vertex to reduce the burden of royalties paid to Royalty Pharma. In an optimal situation for Vertex, they would only pay royalties on only one of the 3 components of the new triple combination.
Terence Coyne of Royalty Pharma commented on the new triple therapy:
“… Obviously, CF is a very important franchise for us, and we looked at a number of scenarios for CF. I think at a high level, though, we’re just taking a step back, we believe that Trikafta really sets a high bar. It’s been transformative for that disease. We haven’t seen anything based on Phase II data yet. We haven’t seen detailed data, but based on that kind of press release But from what everyone else has seen, we haven’t seen anything that suggests that the new triple combination is better at this point. So I think we feel really good about Trikafta’s long-term potential.”
Perhaps the best indication of whether Vertex has the better triple combination can be gleaned by scientifically reflecting on its leadership position in CF. Vertex is the only company that markets correctors and potentiometers and has a de facto monopoly. These drugs were developed in-house by Vertex following its acquisition of Aurora Biosciences. One of the major scientific breakthroughs that was instrumental in this process was the development of a pre-clinical model that allowed Vertex to screen a large number of potential molecules and accurately assess efficacy.
Vertex developed an HBE (human bronchial epithelial) assay cell line that was derived from donor lung tissue of a relatively healthy CF patient. Vertex perfected the process to grow HBE cells, which then provided a model that proved to be highly predictive of clinical efficacy. In fact, the model has been shown to quantitatively predict how effective drugs are in humans with CF. When Vertex developed Trikafta, they actually put several combinations into human clinical trials, which allowed them to assess the predictive accuracy of the assay. In fact, the results in humans were highly correlated with the assay – they were left with choices as to which drug to bring forward.
This model allows Vertex to test the new triple combination therapy and assess whether it has the potential to improve. While Royalty Pharma has publicly stated that, “we have not seen anything that suggests that the new triple combination is any better at this point,” it is likely that Vertex has data that provide accurate insight into the efficacy profile. provides.
Stuart Arbuckle of Vertex said at a recent Jefferies conference:
“We have great preclinical assays that have proven to be both qualitative and quantitative predictors of what’s going to happen in people with CF. Our HBE tests, which we developed in our labs in San Diego , incredibly predictive of how things would actually work in people with cystic fibrosis. So when we look at the new triplet combination in those same investigations, it provides a high level of chloride transport, which in the lab CFTR is a marker of function. So that’s incredibly encouraging, higher levels than we’ve ever seen before with trikafta. Also, we’ve done a second phase study with this same combination. And again, we’ve seen higher FEV1 of both levels and also lower levels of sweat chloride. Sweat chloride is a pharmacodynamic marker in patients with CF of CFTR function. And we saw a greater reduction in sweat chloride with this new combination than with Tricafta. So both of these give us reason to believe that this combination is trikaf Might be even better than Ta.”
Given the existing trials in CF powered by Vertex are nearly identical in design, cross trial comparisons are particularly meaningful. They also said that the primary endpoint for Phase 3 is non-inferiority to Trikafta, but that statistical analysis for superiority will be done. Thus, even if efficacy is similar, the new triplet may be approved by the FDA if shown to be non-inferior. Patients may benefit from once-daily dosing and a potentially improved side effect profile.
Investors have good reason to believe that Vertex has sufficient scientific expertise in CF to confidently make comparisons that inform their development decisions. The heavy investment to bring this new triple combination therapy from pre-clinical to Phase 3 shows Vertex’s confidence that the clinical trials will show excellent results.
royalties
Current royalty rates for Trikafta are in the low double digits (up to 12% per WSJ). The royalty rate for the new triple will be in the low single digits and could be closer to 4%. Given this, if Vertex successfully brings the new triple combination to market, Royalty Pharma could receive dramatically less revenue from Vertex.
At a recent investor conference, an Evercore analyst addressed the CF franchise issue, saying, “It is your opinion that you expect CF to be very sustainable for a number of reasons, not just based on the incremental offering from Vertex.” , but also because you believe you have a legal basis to believe that you also have royalties on the next-generation molecule.” Terrence Coyne of Royalty Pharma replied, “Obviously, CF is a very important franchise for us , and we looked at a range of scenarios for CF … but we also clearly understood that investors wanted to understand what the risk was in downside scenarios . And what we said is that we see this as a few hundred million dollars of headwind for our business over the back half of this decade.
Royalty Pharma’s position is that deuterated versions of the molecules still require royalty payments. “Yes, we believe that the deuterated Kalydeco is just Kalydeco and that it should have the same royalty rate as Kalydeco,” Mr. Coyne said at a recent conference call. The CEO further added, “When we made the investment, we were extremely careful on our legal due diligence and IP due diligence…. We added a residual $600 million investment in this franchise where we purchased some of the Cystic Fibrosis Foundation’s residual interest. And again, we updated our due diligence, really very careful IP due diligence on all of this. And we got very comfortable and that’s why we ended up putting in another $600 million. So we’ll see. I mean we feel extremely, extremely confident in our legal position here.
Vertex has taken a different position. Stu Arbuckle of Vertex said, “Yes. I mean, from our perspective, it’s not really a matter of opinion. It’s a matter of contractual facts. So we feel very confident in our assessment of the contract and our view that The royalty rate … is going to be in the low single digits … so we don’t think it’s a matter of opinion. We think it’s a matter of fact.” If the new triple combination shows strong efficacy, Vertex would be wise to encourage switching from the older drug and may even have the flexibility to offer it at a lower cost to encourage payers to cover it.
Given the status of both companies, costly legal action may be required to resolve the issue. Vertex can only pay low single digit royalties, which they believe will be a burden on royalty pharma to take legal action. This is likely to be an expensive and lengthy legal process that could weigh on the stock.
risk
Royalty Pharma has a sustainable business, but the model includes risks similar to those for a large pharma company, including negative clinical trial readouts from development-stage assets and competition in the commercial setting, resulting in disappointing royalty payments. Gentanerumab, a drug for which Royalty Pharma had hoped to earn royalties, recently failed in the clinic. This resulted in a non-cash impairment charge of $273.6 million, indicating that the company faces risks that are similar to large cap pharma companies that are diversified but experience setbacks in their pipelines. An adverse resolution of a legal dispute that may occur with Vertex is an additional risk.
conclusion
Given the difficulties unprofitable biotech companies currently face in raising cash, Royalty Pharma is well positioned to negotiate favorable terms. Another positive factor is that the company has a high quality portfolio of medicines from which they earn royalty which speaks to the quality of their due diligence process. Royalty Pharma trades at a modest P/E of 10 and pays a dividend of 2%. In our view, investors could also consider a diversified large pharma company like BMY, which has a slightly lower P/E and a dividend yield of over 3%, instead of Royalty Pharma, if they are looking to invest in the pharmaceutical business.
The CF franchise accounted for approximately 30% of last quarter’s revenue and has been at least partially driven by the CF franchise’s strong performance in recent quarters. Given that Vertex’s new triple therapy could reach the market in 2024, a reduction in CF revenue is likely, rather than a growing CF royalty stream. Furthermore, Royalty Pharma may need to defend its legal position which will undoubtedly be a long and costly process. While other investments in their portfolio may be successful, CF is a significant portion of their revenue and an adverse resolution of the issue could impact Royalty Pharma’s earnings.
