Since its founding in 1980, Amgen (AMGN) (“the company”) has been a pioneer in the biotechnology industry, successfully discovering, developing, and marketing therapeutic agents that have meaningfully impacted human health. From 1989 to 2002, Amgen grew five revolutionary biologic drugs into billion dollar blockbuster products in oncology, nephrology, and inflammation. Today, Amgen is a $105 billion market cap company with annual revenues of nearly $20 billion and annual net income e of over $5billion.
Considering this track record, Amgen’s long”term underperformance relative to its biotech peers is surprising. The company has a compelling mix of long”duration, high”margin mature products like Neulasta and Enbrel, and a number of exciting high growth assets, including recently launched blockbusters like Prolia and Xgeva along with innovative late-stage pipeline assets like evolocumab. Yet, using nearly any valuation metric, the Company trades at a substantial discount to peers. Amgen even trades at a discount to the US pharmaceutical sector, despite superior revenue and earnings growth rates. Amgen’s current discount to fair valuation – and the lack of structural hurdles to closing this gap – make it an attractive investment opportunity. Third Point is now one of the company’s largest shareholders.
Amgen has all the hallmarks of a hidden value situation, one of our favorite investment themes. The company does not receive proper credit from investors for either the cash generative potential of its mature products or the coming financial impact of its growth assets. In the mature products segment, we believe revenues will be sustainable and concerns about potential erosion are overstated. With respect to Amgen’s pipeline, we believe the market underappreciates how disruptive some of its new products will be. Our conviction about the company’s growth pipeline has been bolstered by our discussions with Third Point’s newly created Scientific and Medical Advisory Board (“SMAB”) led by renowned oncologist Dr. David Agus. Dr. Agus has helped us assemble a world”class team of scientists and physicians to assist in our evaluation of therapeutic companies and their clinicalassets.1
We believe the obscured fundamental value and investor skepticism that have led to Amgen’s valuation discount can be easily unlocked. Throughout our due diligence and discussions with sell”side analysts and other investors, it became clear that the market has penalized Amgen for several key reasons: 1) its historical lack of R&D productivity; 2) more than a decade of flat operating margins; and 3) the suspension of its share repurchase program in 2013 following its $9 billion acquisition of Onyx Pharmaceuticals.
First, on R&D productivity, our analyses confirm that Amgen’s R&D efforts have been more costly and less efficient than those of its biotech peers. Despite investing a cumulative $32 billion in R&D since 2002, over 75% of Amgen’s current revenues still come from products introduced before that year. Amgen also appears to spend significantly more money on its late”stage pipeline assets than any of its biotech peers – both in absolute terms and relative to the number of development projects. Given this sparse output versus to investment, we believe improvements are needed in Amgen’s R&D evaluation process, a hypothesis supported by members of our SMAB.
Second, the market has rightfully punished Amgen for having flat operating margins since 2002 despite a 3x increase in revenues, a failure we attribute to excessive spending. For starters, the bloated cost structure is troubling given that Amgen competes in specialized therapeutic areas which require small, highly focused sales and marketing efforts, and generates the majority of its revenues from just a few well”established, popular drugs. Another puzzle is that while the biotechnology industry has seen substantial improvements in manufacturing efficiency, Amgen has not demonstrated any of the obvious economies of scale (e.g., procurement, sourcing) that should have been realized. Against this backdrop, the company’s lack of operating margin leverage over this period is doubly surprising. Given its revenue growth, we are convinced that Amgen should have seen meaningful operating margin expansion since 2002, a shortcoming which we believe management has now acknowledged. We believe recent efforts to trim costs do not even scratch the potential opportunity.
Third, in 2013, Amgen’s management made a questionable capital allocation decision: the company purchased Onyx Pharmaceuticals at a 40%+ premium for $9 billion in cash while halting its own share repurchase program. At the time, the company said that its buyback would remain halted until 2016. Based on corporate filings, during the deal negotiations, Amgen had concerns about Onyx’s lead compound, Kyprolis, and renegotiated to reduce the price. Since the acquisition closed, Amgen has disclosed that while the ASPIRE trial for Kyprolis met its clinical endpoints, its sister FOCUS trial failed to show clinical benefit and introduced potential concerns over renal”adverse events. Instead of the Onyx purchase, Amgen could have accretively repurchased over 10% of its shares outstanding, at the depressed valuation of just 4x sales. Beyond Onyx, we question whether the return on Amgen’s $17 billion in M&A spending since 2002 (on top of the aforementioned $32 billion in R&D spending) has been economically justified, both in absolute terms and also relative to other transactions in the sector. We are challenged to identify any “home”run” acquisitions and, while still early, believe that most of these transactions will turn out to show mediocre returns.
We believe that Amgen management can directly address all three sources of legitimate investor frustration and, based on our discussions to date with management, we believe that they will. While we applauded Amgen’s first steps in July to target the company’s inflated cost structure by rationalizing its US facilities footprint and creating centers of R&D excellence in San Francisco and Boston, we believe much more can and should be done. Immediate actions Amgen can take to create shareholder value include: 1) Focusing its R&D efforts; 2) Providing long”term margin guidance demonstrating a commitment to reducing a bloated cost structure; and 3) Creating clarity on additional shareholder returns.
We have also asked the company to seriously consider a more radical option, one first proposed by Geoffrey Porges at Sanford Bernstein. It is well”established that disparate business units generally benefit from operating separately due to distinct corporate cultures, superior efficiencies, and a greater focus for employees and management alike. Given the diverse nature of its assets – cash”generative Mature Products and R&D”intensive Growth Products – we believe that Amgen could benefit from a separation into distinct operating units with separate financial statements and should seriously consider separating into two companies (e.g., a MatureCo and a GrowthCo). Internally, each business would have different priorities: MatureCo would focus on efficiency and cashflow, while GrowthCo would emphasize product development and innovation. Externally, each business would be valued with different metrics: MatureCo on a dividend yield and GrowthCo on a peer”based sales or earnings multiple. Our own extensive diligence suggests that a break”up of Amgen is feasible and that purported constraints such as tax strategy and supply chain management can be managed.
A separation of Amgen into MatureCo and GrowthCo would likely be very well received by investors. We expect that MatureCo would receive a valuation based on its dividend yield while GrowthCo would be valued, like peers, on a high growth multiple on earnings, reflective of the burgeoning pipeline. Importantly, however, we believe that a separation would not just be good for shareholders, but that it is a more effective way of running each business. In particular, we believe that the benefits to GrowthCo would be the most meaningful: talent retention, more rapid decision making, and ultimately, accelerated development of new therapies to improve countless lives. We urge Amgen management and a committee of independent directors to conduct their own in”depth evaluation of this strategic option and share their findings with investors.
We believe there are three ways to win in Amgen, depending on the path management takes from here. If Amgen is simply valued at one turn below its pharmaceutical peers at 17x earnings – a change we expect to be driven by management’s current restructuring plans – the stock should be worth $189 per share by the end of 2016. If Amgen fully seizes the opportunities outlined in our recommendations to focus its R&D, announce structural expense reductions, and accelerate capital deployment, we believe 2017 EPS will reach $12.82 (versus consensus of $11.12 currently), implying a share price of $218 on the same multiple. We see the most upside, however, in the scenario where Amgen strategically separates into two standalone business, as we have encouraged management to consider. In two years, we expect that such a separation could create almost $249 per share in total value, over 80% upside to the current share price.
CEO Bob Bradway and his team have been open”minded and receptive to our ideas to date and we firmly believe that the company is at an inflection point. The company’s upcoming Analyst Day presents an excellent chance for Amgen management to take bold action and provide clear direction for the company, its investors, and its employees. We hope to maintain our constructive dialogue with management as the company moves towards closing its valuation gap.
From Daniel Loeb (Trades, Portfolio)’s Third Point Q3 2014 Investor Letter.
