Stock Synopsis: Pharmaceutical post-pandemic patent development cycle

John Fourier

2024-05-05 10:31:00 Sun ET

Eli Lilly (LLY) CEO and Chair Anat Hakim

Stock Synopsis: Pharmaceutical post-pandemic patent development cycle

In terms of stock market valuation, the major pharmaceutical sector remains at its steepest discount to the broader U.S. stock market over the past 15 years. We expect to see a unique opportunity for this discount to narrow in due course. Although the next pharmaceutical post-pandemic patent cycle from 2025 to 2030 has been top-of-mind for many U.S. stock market investors, both pipeline progression and business development across the sector leave us with only a relatively modest decrease in top-line sales revenue growth over this time frame. Further, we expect to see an upward bias to bottom-line profit margins on the basis of a mix of both further pipeline progression and capital deployment. As part of the Medicare Part B and Part D reforms and Inflation Reduction Act, U.S. medicine price hikes and limits may lift the overhang on the pharmaceutical sector. This new legislation helps re-rate both P/E and P/B multiples for many U.S. pharmaceutical companies. Our proprietary alpha stock signals skew toward Eli Lilly (LLY) and AbbVie (ABBV) with both the longest runways for EPS growth, operational performance, and attractive stock market valuation as of March 2024. The U.S. pharmaceutical companies with robust fundamental strength in animal health specialty are Zoetis (ZTS) and Horizon (HZNP). The next tier includes Merck (MRK), Pfizer (PFE), Royalty Pharma (RPRX), and Johnson & Johnson (JNJ) with some fresh incremental improvements in Tobin’s q, stock market valuation, and operational performance over the next few years. 

We are constructive on these mainstream U.S. pharmaceutical companies with solid product launches and new patent development trends. Although the U.S. pharmaceutical sector may experience a modest decline in top-line sales growth in the next decade, we can expect the current patent development trends to support mid-single-digit top-line sales revenue growth for some U.S. pharmaceutical companies with rare and unique competitive advantages over the next 5-7 years. These U.S. pharmaceutical companies face few patent expirations from early-2026 to late-2029. It is reasonable for us to project more than 5% sales revenue growth per year over the next few years. A recent new product cycle combines with ongoing pipeline success for these U.S. pharmaceutical superstars. These positive trends represent potential upside value drivers to medium-term and longer-run estimates of stock market valuation for these U.S. pharmaceutical companies. In the broader context, both pipeline progression and patent development for prescription medicine should substantially improve the fundamental prospects for these superstars in the U.S. pharmaceutical sector. Beyond solid organic sales and EPS growth, we expect these superstars to leverage their ample balance sheet capacity for additional bolt-on acquisitions, cash dividends, and share repurchases. In the meantime, these U.S. pharmaceutical superstars still trade near their all-time low P/E and P/B multiples relative to the S&P 500. To the extent that this ubiquitous discount in stock market valuation tends to narrow in due course, we believe many investors can benefit substantially from this major stock market investment in some mainstream U.S. pharmaceutical companies.

The next wave of pharmaceutical patent expirations may start to emerge from 2026 to 2029. Many stock market investors continue to focus on bottom-line profit margin growth through this time frame. In time, continual pipeline traction should help gradually ease these broader concerns about stock market valuation. Whether these U.S. pharmaceutical superstars can attract higher P/E and P/B multiples remains an open controversy. The new U.S. legislation should result in more manageable target prices for medications, treatments, and therapies. As this legislation imposes upper limits on medicine prices for the elder Americans, greater demand for price-inelastic medications can help boost both sales and profits for our chosen U.S. pharmaceutical superstars.

 

The recent U.S. legislation leads to new medicine price negotiations in favor of our chosen U.S. pharmaceutical superstars.

After many years of public debate, we now expect to see the first meaningful medicine price reforms since 2008. Many components of the new legislation should be manageable for the U.S. pharmaceutical sector. Specifically, the Medicare Part D design serves as a net positive fundamental factor subject to U.S. medicine price negotiations between health care service providers and associations (the latter of which act in the best interests of elder U.S. patients). Also, the Inflation Reduction Act introduces both upper limits on more than 100 prescription medications as well as penalties for medicine price hikes beyond inflation. The former now require many U.S. pharmaceutical companies to pay hefty inflation rebates to Medicare for outrageous price hikes on prescription medications for more than 750,000 senior Americans per year. These inflation rebates range from $1 to $2,786 for each senior American over the annual time window. Also, the latter allow Medicare to negotiate lower prices on prescription medications, cap the cost of insulin for Medicare beneficiaries at $35 per dose, render adult vaccines free for all, and then require U.S. pharmaceutical companies to pay rebates if these companies raise medicine prices faster than the CPI inflation rate. As a result, this legislation would likely lock in medicine cost rebates up to $800 per year on health insurance for almost 15 million Americans. In terms of economic logic, this new legislation can help reduce U.S. medicine price growth to better match the reasonable range of 2% to 3% inflation rates. This socioeconomic outcome helps enhance the U.S. standards of both medicine and health care, especially for senior, poor, and less healthy Americans who rely heavily on these medicine price reforms in search of less pricey medications, treatments, and therapies. Overall, these reforms accord with the hot pursuit of both cost-effective and affordable medicine in America. In sum, these long overdue medicine price reforms help bolster part of the U.S. social safety net in the next decade.

We expect to see the Medicare Part D redesign with out-of-pocket caps and smoother costs as an incremental positive fundamental factor for the U.S. pharmaceutical sector. In fact, the U.S. pharmaceutical sector as a whole has been advocating for this major price reform over the past few years. Even though these changes may raise medicine costs to some particular U.S. pharmaceutical companies (especially for more expensive medications), these higher medicine costs should be partially offset by substantial sales volume gains (because broader demand for many medications remains relatively price-inelastic). In the next few years, many U.S. pharmaceutical companies should benefit substantially from these Medicare Part B and Part D reforms as the resultant volume gains lead to greater medicine sales and profits. In due course, these Medicare reforms help strengthen part of the U.S. social safety net.

Medicine price negotiations represent the more controversial and potentially negative aspect of the new legislation. Ideally, we would like to see clear guardrails around some prescription medications under selective price negotiations. Indeed, these medications should be subject to some form of price cuts in the future to avoid a slippery slope where numerous U.S. health care providers interpret this provision more broadly. On balance, the rising tide of medicine price redesign lifts all boats in the U.S. pharmaceutical sector.

In light of the high fragmentation of the U.S. health care payer system, the U.S. government pays for about 40% of the annual sales revenue for U.S. medicine; and private insurers pay for another 40% to 45% of the annual sales revenue for U.S. medicine. As a result, 10% to 15% of the annual sales revenue for U.S. medicine represents out-of-pocket costs that each average American should share per year. Through the Inflation Reduction Act and Medicare Part D redesign, the Biden administration effectively promises to subsidize a higher fraction of the annual sales revenue for U.S. medicine over the next decade. Our stock synopses for the chosen U.S. pharmaceutical superstars highlight the fact that these superstars benefit substantially from these macro trends. Each stock synopsis conveys a rare unique business success story for each of our chosen U.S. pharmaceutical superstars.

Bristol-Myers Squibb (BMY) and GlaxoSmithKline (GSK) seem to face greater exposure to both the Medicare Part B and Part D reforms than their U.S. peers do. These pharmaceutical companies are much less likely to benefit from structural shifts in the relatively price-inelastic demand for prescription medications. For this reason, we believe these companies continue to share relatively low P/E and P/B multiples in the next few years.

AbbVie (ABBV) faces much lower exposure to U.S. government copayments for prescription medications. However, the Medicare Part D reform may impact the fundamental prospects of AbbVie’s trademark medicine for blood cancer treatment, Imbruvica, as a good alternative regimen to chemotherapy. Further, AbbVie may face somewhat greater exposure to sector-wide inflation rebate policies under the Inflation Reduction Act.

Merck (MRK) would probably face primary exposure to the Medicare Part B reform through its prescription medicine for cell cancer treatment, Keytruda. Eli Lilly (LLY) faces reasonably low exposure to U.S. government co-payments. Its prescription medicine for Type 2 diabetes and cardiovascular disease treatment, Trulicity, would likely benefit from the Medicare Part D reform. Both Pfizer (PFE) and Johnson & Johnson (JNJ) now face less exposure to U.S. government co-payments relative to key U.S. pharmaceutical peers, primarily due to Pfizer’s significant Covid-19 vaccine franchise and Johnson & Johnson’s large non-pharmaceutical portfolio.

In recent years, we have witnessed widespread prescription medicine price declines across the U.S. pharmaceutical sector. In the past 8 to 15 years, medicine rebates have gradually increased as the margin between gross and net medicine prices continues to widen by more than 7 to 15 percentage points. These higher rebates arise from significant medicine mixture, intense competition from alternative therapeutic treatments, higher payer focus on formulary management, and payer consolidation within the U.S. pharmaceutical sector. In the next few years, we expect the U.S. pharmaceutical sector to experience modest net price erosion (in low single-digit percentage points). Under the Inflation Reduction Act and Medicare reforms, any additional medicine price hikes would almost always automatically translate into rebates. In effect, these inflation rebates help ensure greater medical protection for senior, poor, and less healthy Americans.

As the U.S. pharmaceutical sector enters a new patent development cycle, we expect to see a new fundamental shift from price-driven sales growth to innovation-driven sales growth as a natural evolution of the mass market for prescription medicine. New distributive therapies and medications attract far better insulation from price pressures and payer access firewalls in stark contrast to old therapies and medications. Since mid-2005, the U.S. pharmaceutical sector has experienced a clear uptick in new product approvals (from fewer than 15-20 new product approvals per year to about 40-50 new product approvals per year). We expect this higher level of medical innovation to continue for the foreseeable future.

 

Longer-term M&A deals and business development opportunities should help substantially boost disruptive innovations in medicine for our chosen U.S. pharmaceutical superstars.

With few near-term major patent expirations, we can expect the U.S. pharmaceutical super-stars to experience relatively healthy top-line and bottom-line growth in the next 5 years. In particular, we expect these U.S. pharmaceutical superstars to enjoy 5% to 8% sales growth and 10% to 15% EPS growth per annum in the current patent development cycle from 2024 to 2030. In a fundamental view, these medium-term growth expectations exclude AbbVie’s Humira (trademark prescription medicine for severe rheumatoid arthritis) and Pfizer’s Covid vaccines and therapies. In addition, these medium-term growth expectations fundamentally reflect the next pipeline progression of product launches from 2024 to 2030. We now expect to see substantial upside opportunities for these chosen U.S. pharmaceutical superstars to enjoy further pipeline traction because our expectations are relatively conservative for their trademark assets.

In light of the next wave of major patent expirations from early-2026 onwards, Bristol-Myers Squibb (BMY) and GlaxoSmithKline (GSK) face the highest potential erosion of prescription medicine assets. In contrast, both Eli Lilly (LLY) and AbbVie (ABBV) face the least potential erosion of prescription medicine assets. However, AbbVie’s Humira and Pfizer’s Covid-19 vaccines and anti-viral therapies would probably face the more significant headwinds in the medium term. Merck (MRK) maintains a longer patent development cycle, and its trademark prescription medicine for cancer treatment, Keytruda, would probably not face fundamental headwinds until mid-2029.

Longer-term M&A deals and business development opportunities should help substantially boost new disruptive innovations in medicine for our chosen U.S. pharmaceutical superstars. Many recent bolt-on acquisitions help strategically diversify prescription medicine assets for these chosen U.S. pharmaceutical superstars. In the U.S. pharmaceutical sector, the recent major M&A deals include:

  1. AbbVie’s (ABBV) $83 billion acquisition of Allergan in 2019-2020;
  2. AstraZeneca’s (AZN) $39 billion acquisition of Alexion in 2020-2021;
  3. Gilead’s (GILD) $19 billion acquisition of Immunomedics in 2020;
  4. Bristol-Myers Squibb’s (BMY) $11 billion acquisition of MyoKardia in 2020;
  5. Viatris’s (VTRS) $10 billion acquisition of Upjohn Business in 2019-2020;
  6. Elanco Animal Health’s (ELAN) $7 billion acquisition of the animal health unit of Bayer in 2019-2020;
  7. Gilead’s (GILD) $4 billion acquisition of Forty Seven Inc in 2020;
  8. Sanofi’s (SNY) $3 billion acquisition of Principia Biopharma in 2019-2020, and $2 billion acquisition of Synthorx in 2020;
  9. Merck’s (MRK) $2 billion acquisition of ArQule in 2019-2020; and
  10. Eli Lilly’s (LLY) $1 billion acquisition of Dermira.

 

These U.S. pharmaceutical M&A activities seem to be well above historical levels in recent decades. At the same time, the average M&A deal size has gradually decreased since 2010. Nowadays, there are more strategic bolt-on M&A deals and adjacent business development opportunities within the U.S. pharmaceutical sector. In light of the big cash stockpiles among our chosen U.S. pharmaceutical superstars (Eli Lilly, AbbVie, Merck, Pfizer, Royalty Pharma, Zoetis, and Horizon), it would not be a surprise for these superstars to accelerate the next wave of bolt-on M&A deals for strategic reasons.

We can expect the chosen U.S. pharmaceutical superstars to remain active on the business development front. Many U.S. pharmaceutical companies maintain significant cash capital deployment capacity. Specifically, their cash capital balances are almost 1.3 times average net leverage. Further, our chosen U.S. pharmaceutical superstars can use their cash capital balances to retire all available debt as of early-2024. In a macro view, we expect these bio-pharmaceutical business development plans to skew toward smaller adjacent acquisitions because our chosen U.S. pharmaceutical superstars tend to focus on building out their long prevalent therapeutic vertical integration. New product development opportunities can better arise from smaller strategic tuck-in acquisitions.

 

Each stock synopsis provides a rare unique business success story for each of our chosen U.S. pharmaceutical superstars: Eli Lilly (LLY), AbbVie (ABBV), Merck (MRK), Pfizer (PFE), Royalty Pharma (RPRX), and Johnson & Johnson (JNJ).

Eli Lilly (LLY) continues to enjoy double-digit sales growth and 20%+ EPS growth over the remainder of the current decade with Tirzepatide (prescription medicine for Type 2 diabetes and obesity) and Donanemab (prescription medicine for both Alzheimer’s disease and other dementia). Given its best-in-class control over glycaemic hemoglobin (HbA1c), Tirzepatide has the rare unique capability to generate more than $20 billion in peak sales per annum in the next few years. With final-phase clinical data, the recent product approval should further boost Wall Street’s confidence in this key trademark asset. In addition, Donanemab remains attractive with the final-phase trailblazer-2 readout and fast product approval in recent years. We can expect Donanemab to help substantially ramp up Eli Lilly’s operational profit margins from 30%-35% to 37%-39% in due course. As operational expenses decline as a fraction of total sales, Eli Lilly has ample cash capital to further invest in prescription medicine research and development to better match the U.S. pharmaceutical sector average of 23%-25% R&D of total sales. At Eli Lilly, this high level of capital investment can translate into a steady flow of new product opportunities in the current patent development cycle from 2024 to 2030. In fact, this capital investment helps ensure better connectivity between the primary health care physicians and specialists in the broader context of lab infrastructure for clinical tests. Over time, this lab infrastructure continues to serve as a critical competitive advantage for Eli Lilly. We expect Eli Lilly to benefit substantially from the probable product approval of Donanemab on the basis of its significant plaque regression in dementia. With double-digit sales growth, Donanemab can probably support peak sales of more than $15 billion per annum over the current patent development cycle.

Beyond Tirzepatide, Eli Lilly maintains a growing set of early-stage product opportunities in Type 2 diabetes and obesity. These early-stage assets include glucagon triple agonists, GIP, GLP-1, dual glucagon, and GLP-1 agonists. Most of these assets are now in second-stage clinical tests. In light of these new product opportunities, Eli Lilly continues to blaze the trail with potential follow-on products and incremental benefits on weight loss beyond Tirzepatide. Over the next decade, we can expect Tirzepatide to be one of Eli Lilly’s 2 major value growth drivers with more than $20 billion in peak sales per annum.

Eli Lilly’s Verzenio adjuvant represents the third meaningful value growth driver. For breast cancer treatment, the trademark Verzenio adjuvant can probably attract more than $5 billion in peak sales per annum. For prostate cancer treatment, the Verzenio adjuvant can probably attract more than $3.5 billion in peak sales per annum. For Eli Lilly’s Verzenio adjuvant, its current FDA approval represents only 45%-50% of the population in final-phase clinical data. The complete FDA approval may likely result in a more gradual ramp-up for the full high-risk population in the next few years. Beyond the Verzenio adjuvant for breast cancer treatment, Eli Lilly continues to develop the Verzenio adjuvant for prostate cancer treatment with a final-phase expansion for the ongoing Cyclone 2 trail with high efficacy. Overall, we expect to see 30% to 35% sales ramp-up for Eli Lilly’s Verzenio adjuvant in the next few years.

 

AbbVie (ABBV) continues to enjoy high single-digit sales growth with 2 major new product launches, Skyrizi for the treatment of severe plaque psoriasis, and Rinvoq for the treatment of several immune-driven inflammatory diseases (such as severe rheumatoid arthritis, active psoriatic arthritis, ankylosing spondylitis, ulcerative colitis, and Crohn’s disease), and a rare unique aesthetics franchise as AbbVie moves well beyond Humira, trademark prescription medicine for severe rheumatoid arthritis. Despite steep top-line and bottom-line erosion for Humira from 2025 to 2030, we expect to see robust low-to-mid single-digit overall sales and EPS growth for AbbVie in the same time frame.

In terms of the top-line targets for Skyrizi and Rinvoq, we expect AbbVie to benefit from peak sales of more than $20 billion per annum in the current patent development cycle. In addition to these new product launches and their concomitant sales and profits, AbbVie may further experience some upside expansion of current P/E multiples. AbbVie now trades at only 11 to 14 times EPS. These P/E multiples of 11 to 14 for AbbVie remain well below the long-run average P/E multiples of 15-23 for S&P 500 and the U.S. pharmaceutical sector. Both Skyrizi and Rinvoq have consistently beaten broader Wall Street top-line growth expectations since their product launches. Many investment banks and fund managers expect this fundamental growth momentum to persist in the next few years. New medical indications help attract new FDA approvals and then start to ramp up sales and profits for AbbVie in due course.

 

Merck (MRK) now faces a clear path of robust capital deployment for high single-digit sales growth and double-digit EPS growth in the current patent development cycle from 2025 to 2029. The central prescription medicine assets include Keytruda (for cell cancer treatment), Gardasil (vaccination for female HPV-driven cancer prevention), Lynparza (first-line therapy for pancreatic cancer, prostate cancer, and ovarian cancer), Lenvima (for both recurrent and metastatic thyroid cancer treatments), and other medications for animal health and oncology. All these prescription medicine assets collectively support a healthy sales outlook for Merck. At the same time, pipeline progression combines with portfolio diversification and business development to bolster the Merck success story well before the end of the Keytruda decade from 2022 to 2032. Specifically on M&A business development, Merck management seems to highlight asset diversification as an important priority across a reasonable range of deals with sound scientific logic. Merck has significant cash capacity to pursue M&A transactions in adjacent and complementary medications, treatments, and therapies.

For Merck’s Keytruda, we continue to witness a steady market uptake of the product in non-small cell lung cancer, renal cell carcinoma, and other non-lung indications. Some pending adjuvant studies can potentially drive significant upside to Merck’s sales and profits prior to the ultimate loss of exclusivity over Keytruda. In the meantime, we can expect Keytruda to maintain its dominant market position in non-small cell lung cancer with an impressive 75%+ market share of metastatic lung cancer treatment over time. Also, we can expect Keytruda to expand in some other tumor types in due course. We should further highlight the Keytruda adjuvant indications as a significant top-line sales opportunity with many final-phase data in the next few years. Today, there are still few low-cost PD-1 and PD-L1 immune responses, therapies, and medications, so there is virtually no or little competition for Merck’s Keytruda. Overall, we forecast Keytruda sales to substantially ramp up from $18 billion in 2021 to more than $30 billion in 2026.

Merck retains significant balance sheet cash capacity as total debt is only 1.5 times EBITDA. Further, Merck can generate more than $100 billion free cash flows in the next 5 years. On the M&A front, we can expect Merck to launch a healthy mix of tuck-in acquisitions. These deals can help Merck to strategically focus on a wide variety of medical assets for the next-generation pipeline with longer-term sales and EPS growth. In this context, we can highlight Merck’s recent acquisition of Acceleron and key joint ventures with AstraZeneca (Lynparza), Eisai (Lenvima), and Seattle Genetics (LIV-1 ADC), and smaller early-stage acquisitions of Peloton and Pandion. In sum, Merck now faces significant capital deployment optionality in the current patent development cycle from 2024 to 2029.

 

Pfizer (PFE) continues to enjoy steady sales and profits from the Covid-19 vaccine franchise. Covid vaccination remains the focal point of the near-term Pfizer success story. Specifically, Comirnaty and Paxlovid vaccine sales are likely to exceed market consensus expectations in the next few years. Pfizer’s Covid franchise rakes in almost $52 billion per year. This top-line ramp includes $34 billion Comirnaty vaccine sales for children and $18 billion Paxlovid vaccine sales for adults. Outside of Covid, our core Pfizer view highlights the near-term loss of exclusivity from 2026 to 2029. The Pfizer loss of exclusivity includes Ibrance (prescription medicine for the treatment of breast cancer), Eliquis (prescription medicine for the treatment of systemic embolism in patients with non-valvular atrial fibrillation), Vyndaqel, (prescription medicine for the treatment of transthyretin amyloid cardiomyopathy), and finally, Vyndamax (trademark prescription medicine for the treatment of hereditary transthyretin amyloidosis). Pfizer is likely to sustain 5% to 6% sales growth until the U.S. pharmaceutical superstar hits the next major wave of losses of exclusivity from 2026 to 2029.

Pfizer management continues to regard business development as an ongoing priority. In the next few years, Pfizer focuses on the strategic bold-on acquisitions of adjacent mid-to-late-stage assets. This strategic business development helps address concerns around the post-2026 patent expirations. Pfizer retains meaningful capital deployment optionality from Covid vaccine sales worldwide. Over the next decade, Pfizer management plans to use free cash flows from the Covid-19 vaccine franchise to fund additional M&A deals in light of the longer-term loss-of-exclusivity headwinds.

 

Johnson & Johnson (JNJ) faces a reasonably manageable wave of patent expirations in the current decade. JNJ can sustain healthy growth over the next few years with 5%-7% annual top-line growth and high single-digit bottom-line growth. As JNJ faces the near-term loss of exclusivity over Stelara (prescription medicine for Crohn’s disease, ulcerative colitis, plaque psoriasis, and psoriatic arthritis treatment), we can expect to see slower growth for JNJ from 2024 to 2029. Over the next 5 years, Darzalex and Tremfya account for the vast majority of JNJ’s fundamental growth. The former applies to the combination therapy with monoclonal antibodies for multiple myeloma treatment, and the latter acts as prescription medicine for severe plaque psoriasis and psoriatic arthritis. In the meantime, JNJ’s extant pipeline assets include Cilta-cel (CAR-T cell therapy for multiple myeloma treatment), Amivantamab (FDA breakthrough therapy designation for the treatment of lung cancer), and Nipocalimab (FDA breakthrough therapy designation for the treatment of severe hemolytic disease of the fetus and newborn). In addition to these prescription medicine assets, JNJ maintains its profitable medical devices franchise, especially for surgery, vision, and procedural intervention, as the world market for medical devices normalizes from Covid disruptions. We believe competitive dynamism for JNJ can improve substantially in the post-pandemic era.

 

Royalty Pharma (RPRX) sustains good business development progress to secure its current dominant position in the U.S. pharmaceutical sector. Royalty Pharma faces a healthy growth outlook with reasonably broad core portfolio diversification. With near-term M&A deals and business development opportunities, Royalty Pharma attempts to use post-IPO cash capital of $5 billion to support $2.8 billion bolt-on acquisitions and $2.2 billion upfront payments for smaller target companies. Indeed, future business development contributes to at least more than half of the double-digit top-line and cash flow growth in the current patent development cycle from 2024 to 2029. Specifically, Royalty Pharma is likely to experience 12%-15% free cash flow growth per annum in the next few years, and further capital deployment continues to support adjacent and complementary M&A deals and business development plans.

Royalty Pharma continues to receive steady cash flows and royalty streams from the Vertex next-generation treatment of cystic fibrosis. In the meantime, however, this franchise faces intense competition from AbbVie’s early-stage triple combo for cystic fibrosis treatment. For this reason, whether Royalty Pharma can ease broader stock market concerns remains an open controversy. Specifically, Royalty Pharma outline 3 major outcomes in association with the extant Vertex franchise. In the best-case scenario, Trikafta remains the lead product with few follow-on Vertex prescription medicine assets; thereby, the royalty streams would persist at the current 10% threshold. In the medium scenario, the new triple combo moves forward to include Kalydeco for the early-stage treatment of cystic fibrosis; thus, Royalty Pharma is likely to experience a moderate decline in royalty streams to the 8% threshold. In the worst-case scenario, the new triple combo moves forward with Kalydeco, and Royalty Pharma can only receive net profits and free cash flows from Tezacaftor for the treatment of cystic fibrosis in patients over 6 years old. In this case, Royalty Pharma would experience a hefty decrease in royalty streams to the bare minimum 4% threshold. In the broader market consensus view, Trikafta represents a technically high bar for vigorous competition from AbbVie. On balance, it is more reasonable to project 8% to 10% royalty streams from the current Vertex franchise. After all, Vertex remains a major competitive advantage for Royalty Pharma.

Royalty Pharma management highlights widespread stock market expectations for greater portfolio diversification over the next few years. With Royalty Pharma’s recent deals, every $1 billion of capital deployment would translate into $170 million new royalty streams several years later ceteris paribus. If Royalty Pharma spends at least $1 billion cash capital on M&A deals each year over the current decade from 2021 to 2030, we would expect to see almost $2.4 billion incremental free cash flows from this active capital deployment by 2030 (versus current $700 million royalty streams from the Vertex franchise). In this virtuous cycle, active capital deployment supports broader portfolio diversification with new M&A deals, and then these new deals help rake in higher royalty streams and free cash flows in support of future business development.

 

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