So far, 2019 is starting off with a bang in the pharmaceutical industry. Last week, we learned that Bristol-Myers Squibb (NYSE: BMY ) is buying out beleaguered Celgene (NASDAQ: CELG ) in a behemoth $74 billion takeover. Eli Lilly (NYSE: LLY ) followed that up with a large deal of its own, announcing an $8 billion offer for Loxo Oncology (NASDAQ: LOXO ). Whether the purchase helps Eli Lilly stock in the long term is another question altogether.
While it may seem small compared to the blockbuster Celgene deal, $8 billion is still a major announcement. Don't forget Gilead Science's (NASDAQ: GILD ) deal to buy the revolutionary Hep-C cure company Pharmasset for $11 billion in 2011. Within a couple years, GILD stock quintupled as the Pharmasset drugs lifted Gilead's profitability to the stratosphere.
Needless to say, Loxo, if it delivers in similar fashion, could fundamentally reshape Eli Lilly's future for many years to come. That's especially as Eli Lilly has some patent expirations of its own to consider and really could use a big new product launch or two.
Loxo: A Steep Price Could Hamper Eli Lilly Stock
It's no secret that biotech stocks got crushed in the 2018 correction. The SPDR Biotech ETF (NYSEARCA: XBI ) dropped as much as 35% within three months. That meant that companies with strong balance sheets had the ability to go discount shopping. Bristol-Myers was first to take a big swing with the Celgene deal.
However, Eli Lilly's move will also be a game-changer. Not only did Eli Lilly pay $8 billion for Loxo, they also paid a huge premium. LOXO stock previously traded as high as $188/share. Due to the biotech correction it was trading around $140 prior to Eli Lilly's offer.
As such, you'd think something like $200/share (above Loxo's all-time high) would be enough to close the deal. Instead, Eli Lilly offered a whopping $235/share.
Now, to be fair to Eli Lilly, Loxo did enjoy a positive development in that interim period; they managed to get FDA approval for their leading pipeline drug candidate. Though, that approval was widely expected. Regardless, Eli Lilly is paying heavily for a company that is just at the beginning of the commercialization process for their drug candidates.
Loxo and Eli Lilly Stock
Loxo has taken a different path from most companies in oncology. Instead of targeting its drugs for specific types of cancer, such as lung or prostate, Loxo targets genetic mutations. These genetic mutations appear to lead to cancers across a variety of different body parts.
Loxo's first approved drug targets NTRK gene fusions. This is a rare condition which occurs in roughly 0.2% of the population. Loxo estimates that there are a few thousand eligible patients with NTRK fusions in the U.S. at this time. Thus, with a nearly $400,000/year price tag for the drug, it may take longer than expected for Loxo's product to become a huge commercial seller.
The Chief Business Officer for Loxo, Jake Naarden, stated last year that:
"We expect the initial launch to be challenging, though we remain optimistic about the longer-term trajectory. One of the truisms you often hear about new drug launches is that the first few quarters determine the commercial fate of the drug. Given the penetration of tumor genomic testing today, we do not believe that the first few quarters of this launch will inform very much."
He makes an important point. Most oncology patients are not prescribed genomic testing today. Additionally, some genomic tests do not include the NTRK fusion. As a result, many potentially eligible patients may not know that Loxo has a beneficial therapy for their condition.
This, however, highlights one big advantage to the Eli Lilly purchase. Eli Lilly has far more connections and influence within the medical community. It has the budget and reach to ensure that more cancer patients test their genomes and are aware of potential novel solutions.
It's likely that Eli Lilly's purchase will bring Loxo's first drug far more attention and quicker clinical uptake. Loxo also brings its promising Loxo-292 therapy which is still in clinical trails.
Eli Lilly Stock Takeaway
One point in favor of the deal is that Eli Lilly has a strong balance sheet and can pay for Loxo with cash. Heading into the deal, Eli Lilly had $9 billion in cash against $13 billion in total debt. The Loxo purchase will consume almost all of the company's existing cash reserves, but still leave it in a reasonably sound fiscal position.
After adjusting for one-time expenses, Eli Lilly will earn in the ballpark of $4.5 billion dollars for 2018. That means that it's net debt load is not especially problematic. On a debt/EBITDA basis, it comes in around 1.5x, which is quite conservative. From an earnings basis, the Loxo deal will consume just under two full years of Eli Lilly's ongoing net income.
Given the limited size of Loxo's market, at least at first, Eli Lilly won't earn back its $8 billion purchase price in the near-term. But the potential is still great. Eli Lilly is buying a drug platform with a rather novel approach to treating cancer.
If the company is able to commercialize other Loxo drugs that are earlier along in clinical trials, the deal could end up being a big win for Eli Lilly stock.
At this point, Eli Lilly stock may be a bit overvalued. It's still trading at 20x forward earnings. That's quite aggressive for a pharma company, as patent expirations tend to keep PE ratios rather low.
And Eli Lilly stock is up 35% over the past year which is a stark contrast to struggles elsewhere in the health care space. As for the Loxo deal in particular, it could pay off big, but for now, a wait and see approach seems most prudent.
At the time of this writing, Ian Bezek owned GILD stock. You can reach him on Twitter at @irbezek.
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