Tuesday, May 1, 2012

Back-seat driving AstraZeneca

Just for fun, here's some quick thoughts on how AZ can get back on track after the reign of CEO David Brennan, who announced his early retirement last week while being water boarded by the AZ BoD:

(btw: I really wanted to label Brennan's tenure as disastrous, but that's not fair. Compared to the return on the S&P 500 and PPH (a big pharma ETF) over Brennan's reign (Jan '06 to now), AZN was very bad, but not atrocious. Take a look:

During Brennan's tenure, (as of the day of Brennan's retirement announcement,) AZN was down 5.5%, vs +11.4% for the S&P and +6.8% for PPH. I expected the AZN relative performance to be much worse.

Comparable figures since the Astra-Zeneca merger in 1999:

AZN: -10.3% (total)
S&P: +8.2%
PPH: -14.4%

So, you could say that the AZN merger didn't destroy (relatively) as much value as the pharma industry did over the same time period, but I still can't bring myself to say that it was a worthwhile deal.

In case you're wondering, AZN is <5% of the composition of PPH.

Back to the backseat driving. Here's 8 ideas to get AZN back on track:

1. R&D strategy: go big, or go home. AZ's annual R&D spend is $4.5B, which is only ~40% of the amount AZ annually spends on SG&A. For all of AZN's problems, they still have $11B in cash on hand and throw off nearly $8B in annual operating cash flow. It is time for AZ to either double down on their R&D, or dismantle it.

Everyone knows AZ's pipeline is thin. If it is because the $4.5B of R&D is unproductive, shut down/shrink R&D.

For the last decade the trend in pharma has been to shrink R&D, but the only way that AZ is going to reverse their fate is swim against the tide and massively expand the R&D budget. This option is especially attractive to AZ because of the European R&D assets shuttered over the last decade, and now available for a song. For example, AZ could re-open Pfizer's former R&D facility at Sandwich, UK, attract a very talented team, and likely win government financial assistance in doing so.

There are two counter-arguments to "going big" in R&D - the fact that payoff from the increased R&D is years off, and the fact that EPS would take an immediate hit. I'd argue, though, that the benefit of the increased R&D investment would be felt pretty quickly, as much of the investment would be in downstream clinical development, and not necessarily in basic discovery.

As for EPS, yes, it would take a hit, though not as bad as the gross increase in R&D, as the tax authorities would be paying roughly a third of the gross increase. I'd also argue that perversely, the R&D spend would INCREASE the amount of economic value added annually by AZ, as you'd be replacing the meek interest income from the $11-19B cash on hand with (hopefully) dynamic returns from R&D.

2. Sell Iressa to NVS or another interested party. Iressa (EGFR inhibitor) probably never got enough corporate attention once it landed in regulatory limbo. There's still value to Iressa to to unlock, though, and I think NVS could make the most of the product amidst their other successful targeted cancer therapeutics. (Of which they lack an EGFR inhibitor.) I also think having a new set of eyes to look over Iressa's clinical results would be beneficial.

3. Focus the MedImmune/biotherapeutics group on biosimilars. The combined MEDI and Cambridge Antibody assets are formidable though underutilized engines, both in terms of capabilities and capacity. Why not leverage both in pursuit of biosimilars, as Pfizer is doing with some of their bio-production assets? This is an area where AZ could take the lead, based on their MEDI investment, and an area with a modest capital demand. It would certainly be cheaper to spend another $500M on additional MEDI R&D to develop saleable products than to spend $5-6B in capital to acquire Amylin - a good, though one-market (diabetes) company that doesn't match well with AZ's existing portfolio.

4. Seek more big-big partnering, as exemplfied by the deal with AMGN. (See "AMGN & AZN get creative.") Points #1 and #3 are all about refilling the product pipeline with internally developed "upside." Another route to the same outcome is to buy large chunks of upside to augment the weak AZ pipeline. Combining points 1, 3, and 4 would diversify the R&D risk for AZN and fatten the pipeline, with good cost control.

5. Avoid the urge to make late-stage acquisitions to fill the pipeline. Congrats on the Ardea deal, but please don't think a string of acquisitions is the cure for what ails AZ. Any acquisition right now would represent paying full price, as every other pharma company is shopping hard for late stage products. AZ isn't big enough to outbid PFE, not specialized enough to win many niche acquisitions, and is too desperate at this point to NOT overpay sooner or later. Instead:

6. Climb the risk curve and make early (-er) product development partnerships. Whereas EVERY big pharma has the financial wherewithal to make a bid for a late-stage clinical candidate, many pharmas are too risk-averse to pursue partnering early programs. This represents an opportunity for a big pharma willing to take on more risk AND represents the best return on R&D dollars. Why spend $5-6B on an acquisition like Amylin or $1.2B on a late-stage deal like Ardea when AZN can probably sign and fund 10 early stage partnerships for a fraction of these amounts?

One other consideration: AZ's new CEO probably has 3-4 years to make an impact at AZ, which is enough time that a Phase I lead gained through partnership now can become an exciting Phase III product.

7. Recognize that there is a historically massive opportunity for AZ, and concurrently cut the dividend. There has never been a better time to be in the drug discovery & development business. Incomes are rising around the world while populations are aging. At the same time, medical knowledge has exploded over the last decade, and emerging technologies (e.g. in silica screening) are making drug discovery easier, less costly, and less risky.

It has been a long time since AZ or most any pharma was a growth stock, but with the context above, why wouldn't you want to transform AZ into a growth stock, and increase investment in R&D, as funded by reducing or eliminating the dividend? Yes, changing the dividend will set off alarms in the financial community, but better to do it proactively as part of a growth strategy than reactively once everything goes off patent.

8. Quit pretending that AZ decisions aren't heavily influenced by geography and political concerns by relocating corporate HQ to……….Dubai. AZ's HQ is in London. Except R&D, which is based in Sweden. And except UK R&D, based in NW England. And except biologics, based in Maryland. And except their biggest office in their biggest market, in Delaware.

Some tech companies see geography as a competitive necessity, such as the growing big pharma labs in Cambridge, MA (PFE, MRK, NVS….) AZ goes so far in the other direction, that you wonder if they are intentionally avoiding tech hotspots. UK R&D in Cheshire, UK instead of Oxbridge? Swedish R&D not near the Karolinska Institute? Weird.

You just know that decisions aren't made at AZ solely on their merits and without considering the geo-political ramifications. One way to negate this is to relocate corporate HQ to a "neutral" territory, and publicly commit that future UK & Swedish investment will be tied to leading academic locations. I'm not saying that AZ's weak R&D productivity is due to their location in NW England, but I believe that one way to boost the R&D productivity is to gain more exposure to leading labs in Oxbridge and the Karolinska. Watch AZ's R&D be reinvigorated.

Dubai is a silly answer to "what's a neutral country roughly equidistant to the UK and Sweden?" but I'm sure Dubai or other countries would provide a huge economic incentive to support the corporate relo. Not only would Dubai or others pay a bounty for the influx of meaningful jobs, but you could probably find a country that would be convinced to pay BIG $$$ so that AZ could become the cornerstone of their nascent pharma industry. If Boeing could relocate their corporate HQ from Seattle to Chicago, AZ sure could move to Dubai, or Singapore, or Bangalore.

(not to mention that there could be a substantial savings in corporate taxes for AZ.)

So there's my quick, under-informed ideas to get AZ back on track. Unfortunately, to make real backseat driving recommendations, you have to ignore certain realities, such as the holiness of the EPS expectations, and the tax advantages of filling the pipeline via acquisitions rather than increasing the R&D cash expense. But, you read this far, which means that there's some value in my backseat-driving recommendations…….

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