Pfizer: Global Blood Therapeutics Deal Is Risky, More M&A Needed

Investment Thesis

Shareholders of Pharmaceutical giant Pfizer (NYSE:PFE) have had to be patient for many years – prior to July 2021, the highest price the stock had reached was ~$45 – and that was way back in the year 2000.

The stock price traded as low as ~$12 in 2008 after the global financial crash, subsequently rising to a price of ~$44 in late 2018, for a gain of >260%, which represents a reasonably solid recovery, although the S&P gained >360% over the same period.

Pfizer’s stock slipped again in 2019 while the S&P kept climbing, and in March 2020 it slipped to near 3-year lows after COVID was first declared a pandemic. After a couple of barren years, and this new low, Pfizer stock suddenly began to pick up as the company partnered with Germany-based, Nasdaq-listed BioNTech (BNTX) and produced the biggest selling vaccine of the COVID era, Comirnaty.

Between 2012 and 2020, Pfizer’s top line revenues had fallen from $54.7bn to $40.9bn, whilst net income fell from $14.6bn to $9.2bn (although fluctuating from year-to-year – in 2017 the company earned $21bn net income) – and earnings per share fell from $1.96 to $1.85 – a fairly meager return owing to the Pharma’s monumental share count of 5.6bn. That is the seventh largest float on the stock market, after only Apple (AAPL), Google (GOOG) (GOOGL), Amazon (AMZN), Bank of America (BAC), Microsoft (MSFT) and AT&T (T), and all of these companies generate substantially more revenue – 10x greater in the case of Amazon in 2020 – and income – >10x more in 2020 in the case of Apple.

In other words, pre-Comirnaty, Pfizer’s stock price and revenue growth were stagnant or declining for 5 years or more, and it was hard to make the case for owning the Pharma’s stock. Its reasonably generous dividend, which has risen from $0.3 per quarter in 2016 to $0.4 presently, was the company’s one saving grace.

Fast forward to today however and the situation has been transformed not just by Comirnaty, which generated an astonishing $36.8bn of revenues in 2021 (profits are split equally with BioNTech it should be noted) but also by Paxlovid – the COVID antiviral Pfizer developed in house and won approval for in late 2021- this drug is expected to generate $22bn in revenues in 2022.

Pfizer generated a massive $81.2bn of revenues in FY21 – up 52% year-on-year, which is a staggering achievement for a Big Pharma that has not engaged in any transformative M&A activity – and the forecast for FY22 is even better – $98 – $102bn of revenues.

Pfizer’s share price has certainly responded to the uplift in revenues, climbing from its March 2020 low of $27.5, to nearly $60 at the end of 2022 – a 118% gain, although in 2022 it has declined, trading at $50 at the time of writing.

The market knows that Comirnaty and Paxlovid sales are likely to decline substantially after 2022, with COVID no longer posing the threat it once did, which is likely why Pfizer stock has been declining in value despite the massive revenue uplift.

Management’s task is therefore to reinvest the profits from Paxlovid and Comirnaty in R&D and M&A and try to deliver a new portfolio of blockbuster (>$1bn sales per annum) drugs that can help the company offset the likely decline in sales volumes of these 2 drugs.

Led by CEO Albert Bourla – who reported himself as having contracted COVID this week – and Chief Business and Innovation Officer Aamir Malik, Pfizer believes it can generate an additional $25bn of risk-adjusted revenue by 2030 and much of this revenue will be driven by the M&A spree Pfizer had been on over the past year.

The latest acquisition is Global Blood Therapeutics (GBT) – the Sickle Cell Disease (« SCD ») specialist – and in this post, I will try to explain what this deal will do for Pfizer, how it fits into the company’s overall strategy, and how the deals Pfizer has been able to make thanks to the additional cashflow generated by Paxlovid and Comirnaty will affect the company’s share price going forward.

Before we do that it is worth taking a brief look at Q2’22 earnings.

Pfizer Overview & Recent Performance – Q2’22 Earnings

Pfizer delivered revenues of $27.74bn in Q2’22, which is up 47% year-on-year, and up 8% sequentially – pretty good progress by any company’s standards, and exceptional for an organization as large as Pfizer. The best-selling assets were of course Paxlovid and Comirnaty, which generated revenues of respectively $8.85bn and $8.2bn. Adjusted EPS was $2.04 – up 92% year-on-year – and H1’22 EPS was reported as $3.66.

Management issued FY22 guidance for $98 – $102bn of revenues, and adjusted EPS of $6.25 – $6.45 – up >50% year-on-year. That translates to a forward price to earnings (« P/E ») ratio of ~8x, which is significantly lower than the Big Pharma sector average of ~23x, implying that Pfizer stock is cheap and can be expected to rise in value.

There is a catch, however, since nobody knows what kind of sales Comirnaty and Paxlovid may make in 2023 and beyond. Since there may not be a government-sponsored mass vaccination program in the US or Europe next year, and given COVID cases are down significantly from their early 2022 peak, with symptoms generally milder, my guess would be that sales of both drugs will fall by nearly half in 2023 versus 2022.

Ex-COVID, Pfizer’s portfolio delivered just 2% year-on-year growth in Q222. Based on FY21 results, Pfizer markets and sells only 7 Blockbuster assets ex-COVID. These are, as I have discussed in previous posts:

the blood thinner Eliquis which earned $5.9bn of revenues in 2021 – up 19% year-on-year; breast cancer therapy Ibrance, which earned $5.4bn, about the same as in 2020; pneumococcal vaccine Prevnar, which earned $5.2bn of revenues, down 11% year-on-year; JAK inhibitor Xeljanz (for auto-immune conditions), which earned $2.46bn, flat year-on-year; Vyndaqel/Vyndamax, which earned $2bn, up 55%; prostate cancer therapy Xtandi, which earned $1.12bn, up 26%; and tyrosine kinase inhibitor Inlyta (indicated for kidney cancer), which earned $1bn, up 26% year-on-year.

In total, Pfizer reports sales performance of ~50 drug products across its major divisions, which are Vaccines, Oncology, Internal Medicine, Hospital, Inflammation & Immunology, and Rare Disease, and each division has other drugs whose sales are lumped together.

Compare that to, say, Bristol-Myers Squibb (BMY), which markets and sells 17 major products, 8 of which generate blockbuster sales, and which drove 9% revenue growth year-on-year in 2021 or AbbVie (ABBV) – 26 major products and 9 blockbusters, 23% revenue growth in 2021 – or Merck (MRK) – 27 products and 7 blockbusters, 17% growth in 2021 – and we can see that Pfizer markets and sells a large number of assets that are neither blockbusters, nor growing sales volumes year-on-year, which could be seen as a problem.

Pfizer’s M&A Spree

Pfizer’s relatively unappetizing product portfolio ex-COVID underpinned the flat revenue growth and share price prior to 2021, and management needs to avoid falling into that same trap when sales of its COVID products begin to fall, which will likely happen in each year from 2023 – management has not commented on 2023 guidance to date.

Therefore, the decision to go out and acquire promising biotech companies with drugs close to commercialization is the right strategy in my view. Free cash flow in 2021 was $29.9bn, versus $10.5bn in 2019, according to Pfizer’s Q2’22 earnings presentation, so this is the perfect opportunity to go shopping.

Management began its M&A spree with the modest acquisition of Trillium Therapeutics (TRIL) and its early-stage CD47 immunotherapy drugs to treat hematological cancers. That was followed by the buyout of Arena Pharmaceuticals and its auto-immune drug Etrasiomod in a $7bn deal. If approved, as seems likely based on positive data from late-stage studies in Ulcerative Colitis, Etrasimod ought to achieve peak sales of >$2bn – exactly the kind of asset Pfizer needs.

Next, Pfizer spent $11.6bn acquiring Biohaven (BHVN), and its portfolio of migraine therapies, led by Nurtec. Management believes this portfolio could be worth $6bn in peak sales, which may be over-optimistic, but Nurtec is already a blockbuster and again, is exactly the kind of drug Pfizer needs in its portfolio, in my view.

The latest M&A deal was announced on August 8th – a $5.4bn deal to acquire Global Blood Therapeutics – and it is an interesting, if potentially risky purchase, for several reasons.

What Can Global Blood Therapeutics Buyout Do For Pfizer?

Besides marketing and selling Oxbryta, a $200m per annum selling therapy for Sickle Cell Disease (« SCD »), GBT is developing GBT601, which it believes can be a potential « functional cure » for the condition.

SCD is an inherited condition that affects the shape of red blood cells and causes them to die much quicker than normal cells, leaving patients struggling to deliver oxygen to the body, causing fatigue, episodes of extreme pain, swelling, and growth and vision problems in some cases. Complications include stroke, pulmonary hypertension, organ damage, and deep vein thrombosis amongst others. SCD predominantly affects populations of African, Middle Eastern and South Asian descent.

There are no cures for the disease currently and patients often undergo regular blood transfusions to relieve symptoms. GBT601 is a sickle hemoglobin polymerization inhibitor, orally administered and taken once daily, that is progressing through the Phase 2 portion of a Phase 2/3 trial. In a press release announcing the buyout, Pfizer stated that GBT601:

has the potential to be a best-in-class agent targeting improvement in both hemolysis and frequency of vaso-occlusive crisis (« VOC »).

The Phase 2 trial has a primary outcome measure of the number of participants with a change from baseline in Hb through Week 12, and after that, a 48-week Phase 3 trial will begin. GBT601 has the same mechanism of action as Oxbryta, but may be capable of achieving higher hemoglobin levels and occupancy at a lower dose.

There are a couple of caveats, however. Oxbryta itself has arguably never lived up to its initial promise and only made it to market after the FDA agreed to approve on a surrogate endpoint.

GBT601 achieved a mean haemoglobin occupancy rate of 32.6% in its Phase 1 trial at 50mg or 100mg, whilst Oxbryta is administered daily at a 1,500mg dose, and typically achieves haemoglobin modification of around 26%, so we can conclude it is more potent and promising, but the suggestion that it is a functional cure may be over-stretching.

It’s also worth noting that before the end of this year Cystic Fibrosis focused Pharma Vertex (VRTX) and its partner CRISPR Therapeutics (CRSP) will submit a New Drug Application to the FDA for a gene therapy, Exa-cel, indicated for SCD. Vertex recently updated on data from Exa-cel’s pivotal trial, as follows:

75 patients with up to 37 months of follow-up continue to demonstrate that exa-cel holds the potential to be a durable, onetime functional cure for these patients and the safety data continue to be consistent with myeloablative conditioning and autologous bone marrow transplant.

Exa-cel is an in-vitro therapy, meaning patients’ cells must be harvested, re-engineered outside of the body, and then re-administered, making it expensive and potentially risky for patients, but if it really can cure patients for life, it is likely to have a detrimental effect on sales of Oxbryta, and potentially GBT601 too, if approved.

On the other hand, patients would doubtless prefer a daily oral therapy over a complex procedure if both had the same effect, so GBT601 could be the drug putting Exa-cel in the shade if its pivotal trial results are good enough. Meanwhile, bluebird bio (BLUE) is hopeful its own gene therapy, Lovo-cel, can win approval in SCD next year, whilst other companies are working on an in-vivo gene therapies targeting SCD.

As such, although some analysts believe GBT601 could be a multi-billion dollar per annum selling drug, the risk is that gene therapies become the new standard of care. These types of risks are unavoidable in the Pharmaceutical industry and is another reason why Pfizer needs to keep doing M&A deals – some of them won’t pay off.

Looking Ahead – Will Pfizer’s M&A Strategy Pay Off?

Theoretically speaking, Pfizer could potentially earn peak sales of ~$5bn per annum for Etrasimod, ~$6bn per annum from Biohaven’s migraine portfolio, and $3bn per annum from Oxbryta/GBT601.

There is also an RSV vaccine in pivotal trials, a potential Lyme disease vaccine, alopecia therapy Ritlecitinib, and a lung cancer drug, Lorbrena, in the late-stage pipeline. Cibinqo is a potential $3bn per annum selling anti-inflammatory, approved for Atopic Dermatitis last year, plus there is the bispecific Elranatamab for triple class refractory myeloma, potentially up for approval next year, and a meningococcal vaccine, Trumenba, which is expected to launch next year.

Even the most optimistic analyst would not try to argue that the above can generate an additional $25bn per annum in revenues by 2030, so in my view, the acquisition spree must continue.

CEO Bourla spoke of his desire to see the ex-COVID portfolio generate 6% CAGR between 2019 and 2025, and as these new assets come to market, that does seem to be an achievable ambition – by 2025, Pfizer may have added 8 new blockbuster assets to its portfolio.

When I model for 6% per annum growth in revenues, and also model for a 55% decline in revenues of Paxlovid and Comirnaty in each year from 2023 to 2025, then a 10% per annum decline from 2026 to 2030, I see Pfizer’s revenues falling to ~$66bn in 2025, before growing in each year, to $81bn by 2030.

After calculating EBITDA (based on historical operating expense margin of ~70%, my expectation would therefore be for Pfizer to generate between $25bn – $30bn of free cash flow in most years to the end of the decade, and when I use discounted cash flow and EBITDA analysis using a weighted average cost of capital of ~10.5%, my share price targets for Pfizer are respectively $53, and $64, for an average of $58.5.

Conclusion – PFE Stock Is Safe To Hold, But Management’s M&A Work Is Not Yet Done

A share price target of $58.5 – representing ~17% premium to the current price – is one that I feel quite comfortable with – so long as management keeps allocating cash to M&A activity.

Between 2019 and 2021, management deployed ~$86bn of cash, according to its Q222 earnings presentation, with $27bn spent on internal R&D, $25bn on business development, $25bn in dividends, and $9bn on share repurchases.

Pfizer is a cash-rich company – total current assets are $60bn, whilst total long-term debt is $36bn – but it is not a bank, and it needs to keep deploying that cash. In 2022 so far, ~$12bn has been spent on M&A, $5bn on R&D, and $2bn in share repurchases.

In the second half of 2022 I would like to see at least as much spent on M&A as in H1’22, and even more spent on share repurchases, to reduce some of that monumental share float.

Pfizer’s troubles over the past decade have mainly been caused by a product portfolio that shrank in size, and the portfolio continues to look heavily on only marginally profitable products that deliver <$1bn per annum in sales.

Spending double-digit billion-dollar sums to acquire late-stage assets that have a high chance of becoming multi-billion dollar selling drugs ought to be management’s focus at this time. Perhaps the company could continue to trim older, less profitable assets, as it did when spinning out its Upjohn business to create Viatris (VTRS) last year.

If management continues to pursue such a strategy then driving 6% per annum growth until the end of the decade, and rewarding shareholders with a rising share price as well as a dividend and buybacks, ought to be the least of expectations.

Falling back into old habits, however, letting revenues slide and failing to find blockbuster assets, and the massive opportunity provided by Paxlovid and Comirnaty will not be capitalized upon, and investors may as well forget about share price accretion. Pfizer has made its own luck developing these 2 drugs, which ought to future-proof the company until halfway through the next decade, if the cash is used wisely.