On Shire's R&D pipeline evaluation

INTRODUCTION

Summer is coming in a month.

This year I decided to buy a new species of morning glory flowers. I will sow the seeds beside the fence at my home and continue watering. During the hot summer it will bring cool, ultramarine colored flowers not seen before around my house. 

This particular seed is sold at a certain garden shop.

Normally, the price of seed is 500 yen per bag, but this new species sells for 10,000 yen as an innovative, completely new product. On the other hand, it appears that each bag contains 40 seeds, twice the usual amount.

Well, it is time to pay, and I'm standing here in line, holding a 10,000 yen note. It would be disappointing if, after planting the seeds and caring for the plants for a month, the flowers that bloom are normal aqua blue and pinks, rather than ultramarine colored. 

If that’s the case, will I be able to get my 10,000 yen back from the store?

That garden shop just opened recently. No one knows whether the 10,000 yen seed has ever bloomed ultramarine colored morning glory flowers. 

If the shop was a branch of a well-known chain store, I would not be so worried, but the shop’s name is not well known even among people in the industry.

It may be reckless to pay 10,000 yen no matter how big the dream.

It's my first time to shop at this store, so I would prefer to limit my purchase to 500 yen. For that amount, even 1 or 2 seeds would be fine.

Meanwhile, Shire has disclosed around 40 R&D projects in its annual 10-K reports over the past three years. If that is truly wonderful news, why has the stock price remained at its lowest level of 10x PER and 1.0x PBR?

Viewpoint of TTBF:  You cannot buy time in R&D 

The stock market is very efficient, and share prices move instantly on good news and bad news. Extremely low multiples of 10x earnings (PER) and 1.0x book value (PBR) are a signal that there is an obvious problem with the company’s business. As for Shire, there are two possible views regarding this valuation signal.

• If sales of existing products are stable, then there is nothing worth seeing in the development pipeline. Or, conversely;

• “The pipeline has some value", but this is offset by an anticipated decline in sales of existing products.

For Shire’s existing products, an impairment loss of more than 1 trillion yen is expected to be recognized for its blood plasma business. This is because the Roche Chugai Group's bispecific antibody Hemlibra will become widely available for non-inhibitor type hemophilia patients in the US in October.

Is there potential in the development pipeline to make up for the loss of 1 trillion yen? In the table on the previous page, we have forecast potential revenues from projects in phase 3 or higher stages to remain at around 100 billion yen as of 2022. We could consider the pipeline as having a present value of 500 billion yen. If, however, there is a new drug with a 100% probability of annual sales reaching 200 billion yen, it would be possible to add 1 trillion yen to the present value.

It seems like Takeda has good “connoisseurs" of R&D projects who have found a hidden blockbuster that the market has not noticed. If there is such a project, it would be necessary to discuss and amend the evaluation of the entire pipeline.

In the world of stock investment, it may be interesting to buy stocks recommended by an analyst who claims that "the market is wrong” or that “the market has not yet noticed it.” However, such investments should be limited to just one or two names out of a 50-stock portfolio, not an all-in bet on a single stock. Similarly, taking on debt to fund such a focused single-stock investment should not be considered.

Finally, we (TTBF) have a different view on the expression “buying time”, which we often hear in M&A cases. Buying time may be possible and meaningful, for example, when acquiring a local company overseas to launch a new drug. TTBF thinks the reverse is true for research and development. 

Researchers are able to finally achieve success when they can stand on a solid foundation built with a series of “good failures” over a long period of time. Shire acquired many venture businesses that had developed rare diseases treatments, and has 2 trillion yen of goodwill. That amount is the founders’ gain on the sale of their venture companies to Shire, and is also a non-cashable, virtual asset for Shire. Are the inventors of those venture drugs still with Shire and supporting its R&D?

Questions arise from Mr. Weber's remarks on Shire's R&D in this regard.

Bloomberg’s article on the interview dated June 13 was alarming.

In conclusion

Mr. Weber's remarks as reported by Bloomberg on June 13 were as follows:

“I think M&A or integration in the pharmaceutical industry is often highly disruptive for R&D. And this is where we have a big advantage because 

Shire has not invested strongly in research. 

We don’t have to go through the disruption of closing a research site or merging a research site, which takes a long time and has some impact on the pipeline and is so complicated. The R&D integration is relatively simple because of that.”

(Bloomberg 6/13)

Wasn’t Mr. Weber saying until just recently that Shire was an R&D focused company?

The story of a morning glory, again.

The garden shop that put the seeds in each bag may in fact not know the origin of each seed.

The shop must have purchased the stock of seeds from trusted vendors. However, at this point, nobody knows where these seeds came from.

If the shop has difficulty selling its seeds and instead comes up with the idea of selling the shop as a whole... 

Doesn’t that sound like Shire?