Gilead Pharmaceuticals: Can they stop the bleeding?

If you had the foresight to purchase shares of Gilead Pharmaceuticals (GILD) as Y2K gave birth to the new century, you did outstanding. On Jan 1 of 2000, the shares were at $1.50 a share. By mid-2015 they topped $117 a share. If you were blessed with double foresight and got out at $117, you banked a 7,700 percent gain. Even if you held to this day with the stock trading at $67 a share, you still hit pay dirt. But if you bought in the past 18 months, you have been in a world of pain. The descent has been gradual until last week when GILD announced earnings that were on par with estimates, but guidance for 2017 was below the street’s expectation.

GILD’s amazing ascent since 2000 was mostly due to its very lucrative Hepatitis C franchise. It had an amazing run with its 1-2 punch consisting of Harvoni and Sovaldi. Both were multibillion dollar blockbusters. Both were controversial as the prices were in the $84,000 range. But as we have mentioned several times in this publication, paying $84 grand for a virtual cure is much cheaper than the two alternatives: a liver transplant (cost: $750,000 and not a cure) or end stage liver disease which is fatal.

But as always happens in the drug and biotech industry, competition happens! Abbvie, and others came up with Hep-C drugs and priced them lower. That got the attention of the payers and the pharmacy benefit management systems. And in what seemed like an instant, GILDs HCV (hepatitis C virus) franchise began to slowly bleed away, much like its stock price until last week when it dropped nearly 7% in one trading session. The question is, will this slow bleed continue or will GILD find a tourniquet?

The pundits claim that because GILD’s drugs are a cure and they are literally eliminating their patient base, that the franchise is eroding quickly. The competitive forces also don’t help their revenues. While this may be true, I have a hard time reconciling this with estimates of the number of people worldwide with HCV infections—a number that eclipses 100,000,000. True, many are in underdeveloped nations and would have a hard time affording the treatment even with government subsidies, but the real conundrum is that many of those infected with HCV don’t even know they’re infected until years or decades after infection. GILD also has a pretty entrenched HIV franchise too, with several drugs in the pipeline and several in their existing portfolio–although none appear to have the potential that Harvoni and Sovaldi had.

But the real enigma here is the valuations. The trailing P.E. is about 7 and its forward P.E. is about 8—both values are unheard of in biotech and shows that the street is placing very little value on the HCV business. GILD’s price to sales ratio is just under 3 (Regeneron Pharmaceuticals’ price to sales is around 9) and its enterprise value to / EBITA stands at 4.38 (Regeneron’s is 28!) The stock is dirt cheap and it generates massive cash flow. It also pays a 3% dividend–not bad for a biopharma company.

So, the street (and In Sickness and Wealth) is convinced of two scenarios 1) GILD will spend that cash and engage in the Mergers and Acquisitions game. They will do some aggressive acquisitions to build out their portfolio and/or pipeline; or a more remote possibility, someone gobbles up GILD for the cash, the HIV portfolio, and somehow reinvigorates the HCV franchise to capitalize on the world-wide HCV population. In Sickness and Wealth believes that GILD might use some of their massive cash hoard to buy back stock and/or increase dividends to shareholders. Any of the aforementioned actions would help support the shares.

This is what makes investing in healthcare such a fun challenge—every day is filled with potential opportunity. While GILD is not in the ISAW portfolio, it does look tempting. Will they spend the cash like a drunken sailor or will they make strategic acquisitions that will get the stock back up over $100? The street is hoping for the latter, mainly because they recommended the stock at various prices between here and $90.

If you look at the technical action of the stock on a chart and some of the momentum indicators, investors are discounting the worst case scenario regarding the HCV business. All major support levels have been broken. With an $80 billion market cap and estimates of $30 billion in the till, only a handful of companies have the financial might to take out GILD.

This will go down as a terrific case study in biotech and one worth watching closely. That said, the next few months will find GILD rumors surfacing regularly. BE CAREFUL.

David Lerman & Jodie Warner

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