SSR Health New Product Approval Portfolios & Supporting Data Update

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Richard Evans / Scott Hinds / Ryan Baum

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

203.901.1631 /.1632 / .1627

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richard@ / hinds@ / baum@ssrllc.com

@SSRHealth

July 15, 2015

SSR Health New Product Approval Portfolios & Supporting Data Update

  • Drug, biotech, and research-based spec pharma stocks tend to outperform their peers in the year or so before and after regulatory actions (‘PDUFA’ dates) on major new products, with a large portion of total risks being concentrated in the days immediately preceding and following the PDUFA date
  • Since November of 2011 we’ve run model portfolios consisting solely of names with pending (i.e. ‘pre-PDUFA’) or recent (i.e. ‘post-PDUFA) major-product regulatory actions, respectively. Within each broader ‘pre-‘ and ‘post-PDUFA’ portfolio are three sub-portfolios that differ only in terms of how large the new product is as a percentage of the company’s total sales forecast. E.g. the ‘1% pre-PDUFA’ portfolio consists of all names with pending regulatory decisions on products that account for at least 1% of the company’s total sales forecast, and so on for the ‘5%’ and ‘20%’ pre- and post-PDUFA portfolios. To moderate risks, all portfolios follow rules to limit long positions in the days immediately before and after regulatory actions
  • Since inception the 1% pre-PDUFA portfolio has produced greater annualized returns (58% v. 37%) with a lower standard deviation of annual returns (11% v. 15%) than an ‘innovator index’ of nearly the entire universe of biopharmaceutical stocks. The 5% and 20% pre-PDUFA portfolios have outperformed by even greater margins as compared to the innovator index (76% and 89% v. 37%), though at higher s.d. of returns (23% and 47% v. 15%)
  • We expect US real pricing power for pharmaceuticals to fade, increasing the importance of new product flow to relative performance. Thus screening for names with attractively priced new product flow is an appropriate first step to stock selection across the drug, biotech, and spec pharma sub-sectors. We offer two related tools, the first being these portfolios of names with major pending or recent regulatory actions (published monthly); the second being our Hidden Pipeline series of reports that identify undervalued phase 2 and earlier pipelines (published quarterly)

Please note: regularly included in this series of reports are detailed tables of all (major or not) pending new drug applications (NDAs) and biologics license applications (BLAs) for all US-listed drug, biotech, and research-based spec pharma companies; and, detailed tables of all phase 3 products under active development by these companies

Where we’re BULLISH: Biopharma companies with undervalued pipelines (e.g. AMGN, BMY, CELG, GILD, SNY, VRTX); Biopharma companies with pending major product approvals (e.g. ABBV, ALIOF, AMGN, AZN, BDSI, BIIB, CLVS, ENDP, GNMSF, HLUYY, HSP, ICPT, JAZZ, LLY, MACK, MRK, NVS, PTCT, RLYP, RPRX, SHPG, SNY, SRPT, TSRO, UCBJY, ZSPH); SNY on undervalued basal insulin franchise and sales potential for Praluent (alirocumab), in addition to its undervalued pipeline; ABBV and ENTA on sales prospects in Hep C; RAD as an acquisition target as WBA and CVS seek to defend against narrowing retail networks; CFN, BCR, CNMD and TFX on rising hospital patient volumes; XRAY and PDCO on rising dental patient volumes and rising average dollar values of dental products and services consumed per visit; CNC, MOH and WCG on bullish prospects for Medicaid HMOs; and, DVA and FMS for the likely gross margin effects of generic forms of Epogen

Where we’re BEARISH: PBMs facing loss of generic dispensing margin as the AWP pricing benchmark is replaced (e.g. ESRX); Drug Retail as dispensing margins are pressured by narrowing retail networks and replacement of AWP (e.g. WBA, CVS); Research Tools & Services companies as growth expectations and valuations are too high in an environment of falling biopharma R&D spend (e.g. CRL, Q, ICLR); and, suppliers of capital equipment to hospitals on the likelihood hospitals over-invested in capital equipment before the roll-out of the Affordable Care Act (e.g. ISRG, EKTAY, HAE)

Background and Rationale

We have analyzed at length[1] the tendency for drug, biotech, and research-based spec pharma stocks to outperform their peers in both the period preceding anticipated approval of major new branded products as well as the period following pivotal regulatory action (regardless of whether the decision is positive or negative). Separately we have stressed the unsustainability of gross over-reliance (of traditional drugs, in particular) on US real price inflation[2], while defending the durability of US pricing power (of specialty drugs, in particular) at launch[3]. Taken together we expect an increasing proportion of therapeutic stock performance will be driven by firms’ ability to generate new product flow

The rate of relative performance is reasonably constant across the period from the date of new product filing until the date of scheduled regulatory action (generally the ‘PDUFA’[4] date); however negative surprises tend to crowd in the period immediately (+/- 45d) prior to the PDUFA date. Similarly, the rate of relative performance following the regulatory action tends to be fairly consistent for the first year or so, with the exception of concentrated risks in the days immediately following the regulatory action

To capture relative performance before and after regulatory actions, without being unduly exposed to the risks concentrated immediately before and after the PDUFA date, we developed a simple set of rules for buying and selling stocks with pending (i.e. ‘pre-PDUFA) or recent (i.e. ‘post-PDUFA) regulatory decisions on major new products; these rules are summarized in Appendix 5

We’ve established three overlapping rules-based portfolios of companies with pending or recent product approvals; the portfolios vary only by the definition of what constitutes a major new product. In all cases the new product must have an NDA or BLA; generics (with ANDAs) or e.g. existing products seeking new indications (via sNDA) are excluded. Each portfolio then consists of NDA/BLA products crossing any (or all) of three sales potential ‘thresholds’: products whose out-year[5] forecasts account for at least 1%, 5%, or 20% of total company sales. The ‘1% portfolio’ includes all names having a major new product that accounts for at least 1% of out-year sales, the ‘5% portfolio’ includes all names having a major new product that accounts for at least 5% of out-year sales, and so on. The portfolios are overlapping; all of the 20% names are in the 5% portfolio, and all of the 5% names are in the 1% portfolio. In all portfolios, companies are held on an equally weighted basis. If a company has more than one product that qualifies it for inclusion in a given portfolio, the company is held at a correspondingly greater weight

Any of the three (1%, 5%, 20%) portfolios can be further divided into those containing only names whose major products have yet to reach their PDUFA date (‘pre-PDUFA’), those containing only names whose major products have passed their PDUFA date (‘post-PDUFA’), and portfolios containing all pre- and post-PDUFA names (‘combined’ portfolio)

Results

Exhibits 1 thru 3 show how the risk / return of our pre-PDUFA, combined (i.e. pre- and post-PDUFA), and post-PDUFA portfolios compare to the risk / return characteristics of the DRG, BTK, S&P 500, and our own ‘innovator index’[6]. The period examined is November 2011 to present. The pre-PDUFA portfolio (Exhibit 1a) is our superior strategy across the period analyzed. The 1% pre-PDUFA portfolio has produced greater annualized returns (58%) than the innovator index (37%), but at substantially lower risk (as measured by the standard deviation of annual returns on the x-axis; 11% v. 15% s.d. of returns). The 5% and 20% pre-PDUFA portfolios have produced yet greater returns (76% and 89%, respectively) than the 1% pre-PDUFA portfolio and all benchmarks, but at substantially higher risks (23% and 47% s.d. of returns, respectively). Over the last twelve months, all of the pre-PDUFA portfolios have seen significantly reduced levels of risk versus the total period since November 2011, while simultaneously offering even greater outperformance (Exhibit 1b)

The combined (i.e. both pre- and post-PDUFA) 1% portfolio (Exhibit 2) has produced 56% absolute returns as compared to 37% absolute returns for the innovator index, but at higher risk than offered by the pre-PDUFA portfolio. The 5% and 20% combined portfolios again produced greater returns for greater risk than the 1% combined portfolio and all benchmarks. For the 5% and 20% portfolios risk is reduced versus their pre-PDUFA counterparts, although returns also are smaller

Recently the post-PDUFA portfolios have dragged down the performance of the combined portfolio (Exhibit 3). All three (1%, 5%, 20%) post-PDUFA portfolios produced comparable or lower returns to benchmarks at substantially higher risk

Discussion

The relative performance (v. the innovator index, y-axis) of all closed pre-PDUFA positions (1%, 5%, and 20%) over time (x-axis; oldest purchase date at left and most recent at right) is summarized in Exhibit 4a. Just under half (48.5%) of positions outperformed the index in the largest (1%) pre-PDUFA portfolio; yet owing to the positive skew of returns (average relative performance of 34.1% for outperforming positions v. average relative negative performance of -18.7% for underperforming positions), the overall pre-PDUFA portfolio outperformed. The table in Exhibit 4b identifies the positions with ≥40% relative performance (positive or negative); and the table in Exhibit 4c further summarizes the performance of closed pre-PDUFA positions by sales threshold (i.e. the 1%, 5%, and 20% pre-PDUFA portfolios). Positive outperformance tended to come from holdings in the 5% and 20% portfolios; beside the higher betas associated with these generally smaller companies, positions of this nature naturally represent a more precise bet on the prospects of a major product. A number of these positions’ returns were also boosted by acquisition premia (e.g. Santarus, Onyx, MAP, Avanir, Prosensa)

Exhibit 5a displays the relative performance (v. the innovator index, y-axis) of all closed post-PDUFA positions (1%, 5%, and 20%) over time (x-axis; oldest purchased date at left and most recent at right). In contrast to the pre-PDUFA portfolio, over two-thirds of post-PDUFA positions (68.1%) outperformed the innovator index in the largest (1%) portfolio; however the minority of positions that underperformed did so by a very large margin (-24.6% average underperformance, as compared to only 8.7% average relative gains for outperforming positions). The table in Exhibit 5b identifies the positions with ≥40% relative performance (positive or negative); and the table in Exhibit 5c further summarizes the performance of closed post-PDUFA positions by sales threshold

Since inception (November 2011) the pre-PDUFA portfolios have plainly outperformed the comparator indices. The 1% pre-PDUFA portfolio has offered greater returns at less risk than the comparator innovator index; while the 5% and 20% pre-PDUFA portfolios have offered reasonably efficient options for added returns at added risks as compared to the 1% pre-PDUFA portfolio. All post-PDUFA portfolios were inferior to the comparator indices. Accordingly we recommend any of the pre-PDUFA portfolios, depending on risk tolerance (Exhibits 1a, 1b)

Appendix 1: Current Portfolio

Appendix 1: Current Portfolio (cont.)

Appendix 2: Closed Positions

Appendix 2: Closed Positions (cont.)

Appendix 2: Closed Positions (cont.)

Appendix 2: Closed Positions (cont.)

Appendix 3: Current NDA/BLA Pipeline Sorted by Days (Until) / Since PDUFA

Appendix 3: Current NDA/BLA Pipeline Sorted by Days (Until) / Since PDUFA (cont.)

Appendix 3: Current NDA/BLA Pipeline Sorted by Days (Until) / Since PDUFA (cont.)

Appendix 4: Current Phase 3 Pipeline Sorted by Date of Projected Filing (Soonest First)

Appendix 4: Current Phase 3 Pipeline Sorted by Date of Projected Filing (Soonest First) (cont.)

Appendix 4: Current Phase 3 Pipeline Sorted by Date of Projected Filing (Soonest First) (cont.)

Appendix 4: Current Phase 3 Pipeline Sorted by Date of Projected Filing (Soonest First) (cont.)

Appendix 4: Current Phase 3 Pipeline Sorted by Date of Projected Filing (Soonest First) (cont.)

Appendix 4: Current Phase 3 Pipeline Sorted by Date of Projected Filing (Soonest First) (cont.)

Appendix 4: Current Phase 3 Pipeline Sorted by Date of Projected Filing (Soonest First) (cont.)

Appendix 4: Current Phase 3 Pipeline Sorted by Date of Projected Filing (Soonest First) (cont.) Appendix 4: Current Phase 3 Pipeline Sorted by Date of Projected Filing (Soonest First) (cont.)

Appendix 5: Rules for buying and selling

Pre-PDUFA Rule

In the pre-PDUFA portfolios, stocks are included on the date a qualifying product is submitted to FDA for approval, and holdings are equally weighted. In the pre-PDUFA period extending from submission to 45 days preceding the scheduled regulatory action, the stocks are held long unless a final regulatory action is announced, or the scheduled regulatory action is indefinitely postponed; in either of these events the position is sold. In the period 45 days prior to the scheduled action date and the scheduled action itself, the stock is held long until the earlier of a final regulatory action, an indefinite postponement of the scheduled action date, a relative gain of more than a threshold magnitude[7], or the scheduled action date, at which point the position is sold

Post-PDUFA Rule

Stocks tend to outperform their peers following final regulatory actions on major products (both approvals and failures); however timing of entry is crucial. Product approvals tend to lead to periods of relative outperformance; presumably the market has tended to under-appreciate the revenue and/or earnings gains driven by newly approved products. Product rejections also tend to lead to relative outperformance; we interpret this as simple mean-reversion of stocks that were over-sold in the wake of products failing to gain regulatory approval. In both cases, purchasing on or shortly after a regulatory action tends to lead to relative underperformance, whereas purchasing within 30 days following the regulatory action tends to lead to relative outperformance

The post-PDUFA portfolio consists of equally weighted stocks having received a final regulatory action on products whose consensus forecasts represent (or in the case of rejections, represented) at least 1, 5, or 20 percent of the consensus forecast for the entire company. Stocks are included on the earlier of a relative share price reaction (versus the innovator index) of a threshold magnitude[8], or a date 30 days after the final regulatory action. The pre-30 day relative share price reaction trigger is agnostic to the ‘direction’ of relative performance; the purpose of the rule is simply to indicate whether the stock appears to have had its ‘full’ reaction – positive or negative – to the regulatory action, as buying ahead of or during the share price reaction to a final regulatory decision appears to be value-destroying. Stocks included in the post-PDUFA portfolios are held until the earlier of a relative gain above a threshold percentage[9], or a period 365 days following the final regulatory decision

©2015, SSR, LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein. The views and other information provided are subject to change without notice. This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. Through a wholly-owned subsidiary, SSR Health provides paid advisory services to Pfizer Inc (PFE) on both securities-related and non-securities-related topics. One or more of SSR Health’s analysts holds a long position in ENTA

  1. Our original work quantified this tendency over the look-back period 1996 – 2H11: “A Simple Formula for Drug (and Biotech and Spec Pharma) Stock Selection”, SSR Health LLC, September 9, 2011
  2. Please see: “BIG Monkeys & a Looming Intervention: Pharma’s US Pricing Addiction”, SSR Health LLC, May 9, 2014; and, “Large Cap Pharma’s Dependence on US List Price Growth is Unsustainable”, SSR Health LLC, February 26, 2012
  3. Please see: “The Bull Case for Specialty Drug Pricing”, SSR Health LLC, July 7, 2014
  4. For new product sponsors paying fees under the Prescription Drug User Fee Act, the Food and Drug Administration (FDA) is required to reach a regulatory decision – with some exceptions – in a set time frame. Thus the date on which a final regulatory action is due is referred to as the ‘PDUFA date’
  5. Years +2 through +4
  6. An equally weighted index of all therapeutics stocks eligible for inclusion in these portfolios
  7. Defined as total relative outperformance of >6% AND >3% outperformance over a 15-day period
  8. Defined as >+/-3% relative performance over a 5-day period
  9. Defined as total relative outperformance of >6%
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